LSI Industries Inc. (NASDAQ:LYTS) Q2 2023 Earnings Call Transcript

LSI Industries Inc. (NASDAQ:LYTS) Q2 2023 Earnings Call Transcript January 26, 2023

Operator: 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.

Jim Galeese: 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.

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 re-branding project 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 blip.

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, let alone 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.

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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. As we have spoken before, 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 has 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 in 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, product training for our sales and marketing folks. 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 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.

Jim Galeese: 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 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, $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 application, reflecting the progress in providing a specific complete solution set for key vertical markets, serving 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 7% sequentially in the second quarter, reflecting ongoing supply chain stabilization. Lighting DIO 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 backlog 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 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, QSR 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 remains 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.

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Q&A Session

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

George Gianarikas: 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 it seems like reasonable levels. You’re generating cash, business is going well. So if you just kind of 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.

Jim Clark: Hey, George, thanks for joining, and thanks for the question and the complements 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 assisting as recession-proof, but recession-resistant did show growth opportunity and have long legs, meaning 3, 5, 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 and reposition ourselves, there is two ways we’re going to grow, right?

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, it’s going to be important for our kind of out of market above-market growth. So we’re going to keep continuing to execute against that. I think as we pay down debt, it just continues to open up the opportunities for us to look to add something else to the portfolio. And we try to keep a very active pipeline. And then it’s just a matter of the opportunity coinciding with us being in the right position and the market is aligning relative to a growth opportunity, and we will be ready to execute.

George Gianarikas: 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 science 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 kind of help us understand what your business is capable of, when you look out a few years, what sort of margin structure, what sort of revenue structure should we look to €“ to understand the company?

Jim Clark: I think there is €“ well, let me start with this. First of all, we are looking to revisit that in this quarter and kind of update what our goals are and what our targets are. We hope to share that wildly by the end of the year, if not sooner, by the end of the fiscal year, if not sooner. We definitely see growth opportunity, 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 we pay 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 then 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, the confidence that 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 what our 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 expound on the €“ to great length, but we’re both in there, JSI, LSI were in there as one team, as one company, and we benefit from selling across the product €“ across our product and solution lines to those customers. As we look forward, we want to make sure we leverage on that some more, both in the growth, we look at it as a three-legged stool growth in our commercial market by picking the right verticals to be in, growth through our organic activities, meaning we become that much better at managing margin and managing profitability. And we think we have a long runway to go with that. We’re not out of ideas, we’re not out of opportunities in that regard. And then lastly, what can we add from an inorganic or acquisition?

It’s those three kind of things that we’re focused on, and we plan to, like I said, revamp our targets. I’d also say that there were some pretty lofty goals when we sat down and we penned them out. We actually sat down in December of 2018. We brought it kind of to the market in Q3 of 2019. And there was a lot of skepticism. So we need to make sure that we’re pushing ourselves in a healthy way, but that we’re also able to deliver. So those are the things we’re working on now, and we think we have a lot of runway past the $500 million and double-digit EBITDA.

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

Jim Clark: Yes. We’re still a growth company, and we don’t see that extinguishing any €“ we’ve got runway.

George Gianarikas: Got it. And maybe just lastly, there was €“ there is been some M&A in the supermarket channel or the proposed M&A, I should say. And 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?

Jim Clark: But we don’t have a crystal ball, but I’d agree with what you were saying is 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. And that’s what we’re very good at delivering. And we’re good at delivering that differentiation. We’re good at helping promote the brand of our customers and helping promote the differentiation of our customers, and we think there is a lot of runway left specific to grocery.