LSI Industries Inc. (LYTS) Earnings Call Transcript & Summary

Greetings, and welcome to LSI Industries Fiscal 2025 Second Quarter Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Jim Galeese. Thank you. You may begin.

Welcome, everyone, and thank you for joining today's call. We issued a press release before the market opened this morning detailing our fiscal '25 second 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. A 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 second 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, and good morning, all. Thank you for joining us this morning. Today, we'll be discussing our second quarter and midyear 2025 earnings results. So we're halfway through our fiscal year, and as you've likely seen from our press release this morning, we had a very good quarter with some strong orders across the board. The Grocery segment has begun to recover, while our refueling projects and QSR segment continue to move forward with projects booked throughout the remainder of our fiscal year, and they extend through the calendar year. We saw strong growth in our Display Solutions segment and additional growth in our Refrigeration business this quarter. EMI, who we acquired early last year, continues to do very well, and the entire team at EMI has been an immediate asset to our company. Net sales for the quarter were above $147 million, with adjusted EBITDA above $13 million and free cash flow of almost $9 million, leaving our TTM net debt ratio at 0.6x leverage. Jim Galeese will provide more of the financial details in a few minutes. I think the key word for Q2 is growth, particularly as it relates to organic growth. Whereas top line sales were up 36% on a year-over-year basis, 14% of that growth was organic, and I think it continues to show the opportunities we have in front of us. Lighting had some top line pressures in Q2, but activity inquiries remain strong. The Display Solutions segment shined, though, across the board, creating a compelling story for the quarter. We continue to have very strong project and quote activity levels across all vertical segments, but order timing and mix remains a bit choppy, and I think you see some of that choppiness in Q2. As we've been discussing for some time now, we anticipated a recovery in our Grocery segment as the proposed merger between 2 of the larger grocery players in the United States achieved some clarity. Unfortunately, the courts in the state of Washington and Colorado did not support the merger based on antitrust and competitive concerns. But through their findings, they did give some clarity in the market, and many of the update and remodel projects that have been on hold have begun to move forward. The choppiness that I was referring to is in relation to the surge of orders that came through in the last quarter. When order mix and demand slowed last year, we made some immediate changes to our manufacturing process and overall workforce. When the surge of orders came through in the last quarter, we needed to ramp up quickly. And because of this fast ramp-up, we were a little bit less efficient than we would normally be, and I think you see some of that affecting our margin a bit. The good news is we did not miss a beat, and we didn't leave any orders on the table. In fact, we were able to capture some orders from competitors that were not able to respond in a timely fashion. We anticipate that those order opportunities will remain high for some time, and we'll be ready to serve our customers. Right now, it's hard to tell what this volume increase will look like in the long term and what part of it is a surge in pent-up demand versus what part is the customer's longer-term plans. I feel we'll develop more clarity around this order momentum as we move through the winter and early spring. But all in all, we expect order activity to remain robust for some time. On the Refrigeration side of the business, we've worked hard over the last few months to wind down our inventory of R448 products and fully transition to R290. A change in the EPA rulings around synthetic refrigerants makes this a smart move for LSI, and we're looking for this solution to continue to be a product of choice and a competitive advantage for LSI, for us and for our customers into the future. Our Lighting segment small project activity continues to move along nicely, with strong quote activity and project opportunities. But in a comparative view, our large project activity has experienced some headwinds over the last few months and activity is a bit slower. We remain vertically focused in our efforts. But I did want to mention, much like the EV battery plant we had last year, we are actively engaged in a number of larger projects this year, including a half a dozen data centers and chip manufacturing facilities. But they're all moving slower, and the mix of products used in these projects is a bit different. I feel like we have good momentum, but timing is just proving to be a bit tricky right now. Staying within Lighting, I'm happy to say that interest in our next generation of our outdoor lighting product called V-LOCITY has been very strong. I mentioned V-LOCITY in our last call, and it offers a total update to our core outdoor lighting offering from its performance to its aesthetics to its modular construction and build options. We anticipate that it will be complementary to our current flagship outdoor product offering called Mirada, and it will create some openings for new project opportunities that Mirada just didn't offer. As I mentioned before, in the design of this new fixture, we built on top of our prior investments in adaptability, customization and our REDiMount technology, providing a product that offers next-generation performance, along with reduced installation time and weight reduction. This is a significant investment for LSI, and it continues to underline and illustrate our commitment to new product development and our product vitality. Next week, we'll be hosting our national sales meeting in Cincinnati. This is an opportunity for our internal LSI sales folks to get together from around the country and learn a little bit more about the company, the efforts of each other, our successes and our challenges. I know that most of our folks are hoping for some warmer weather, but I know they're going to be generally excited to listen, learn and network with each other. We always learn so much about our company, our customers and our competitors from these meetings, and I'm genuinely excited for everyone to get together for this great event. Our thesis around vertical market orientation remains very attractive to us, and our model continues to gain strength as we work to offer more and more goods and services to the markets and customers we focus on. We accomplished a lot this quarter. We continue to build a stronger, more capable business with a strong platform equipped to deliver profitable growth, consistent with our growth objectives outlined in our Fast Forward plan. We are using the experiences of our management team to effectively integrate EMI and optimize other parts of our operations on an ongoing basis. We believe that we have significant growth opportunities in front of us, and we remain committed to growing our business while balancing the needs of our customers, our shareholders and our employees alike. With that, I'll turn the call back over to Jim Galeese for a closer look at our financials. Jim?

Thank you, Jim. Our fiscal second quarter results reflect improved year-over-year performance in all major financial metrics. Growth was realized in both total and comparable sales. Adjusted EPS and EBITDA both increased, and cash generation was again strong. Total sales for the quarter was 36% and comparable organic sales increased 14%. Growth was driven by the Display Solutions segment, where sales -- where total sales doubled and organic growth of 50% was realized. Multiple verticals were responsible for the increase, including the demand resurgence in grocery and continued site implementations in the refueling vertical, covering multiple customer programs. Second quarter adjusted earnings per share were $0.26 versus $0.24 last year, and adjusted EBITDA was $13.3 million or 20% above the prior year quarter. Free cash flow was $8.8 million and $20 million for the second quarter and first half, respectively, 21% above the first half of last year. Solid cash generation has reduced net debt to $33 million at the end of the fiscal second quarter. Consequently, we have reduced our leverage ratio by more than half, from 1.3x to 0.6x, since the acquisition of EMI 9 months ago in April 2024. Looking forward to Q3 and the second half of the year, we exit fiscal Q2 with a total comparable backlog, excluding EMI, 14% above prior year. While performance varies across verticals and product segments, total comparable orders increased 4% versus last year, contributing to the increased backlog. Now a few comments on segment performance. Display Solutions had a robust quarter as project activity continues in the refueling/c-store vertical, including strong contributions from specific customer programs in Mexico and Central America. To accentuate our scope of capabilities, LSI provided product and/or services for approximately 1,000 refueling/c-store sites in Q2, meeting the demanding requirements for multiple large customers with sites located throughout North and Central America. This represents our highest quarter in many years. Our Service business continued to realize significant growth in the quarter as customers continue to see the value of our end-to-end product integration capabilities. Service revenue increased over 100% in Q2, with average service per revenue site continuing to grow, while the share of LSI projects containing both products and services continues to expand. We expect steady growth in service revenue for the refueling/c-store vertical moving forward. Jim referenced the resurgence in the grocery vertical demand. Sales increased over 60% in this vertical, with 2 levers impacting demand, customers releasing programs previously put on hold and shipments of refrigerated display cases utilizing R448 technology which can no longer be produced after December 31, 2024. Our manufacturing team did a great job meeting the accelerated demand requirements and managing the overall phase-in, phase-out process of the DOE-mandated technology change. Display Solutions operating income doubled in Q2 compared to the previous year, driven by organic growth, along with the addition of EMI. Operating margin improved 100 basis points, reflecting volume leverage while absorbing incremental onetime costs required to ramp up production to successfully support the volume increase. For the Lighting segment, sales for the quarter were below prior year as we continue to experience wide fluctuations in demand across verticals and project size. Demand strength continues in small project activity, while larger project activity remains choppy, particularly in indoor applications. Overall project quote trends continue to increase, with the total value unfavorably impacted by the project size mix. Large project orders in Q2 did improve sequentially over Q1, contributing to the Q2 backlog increasing 6% over the previous year. Working closely with all our independent agency partners, contractors and key end customers all indicate larger project design and proposal work is improving and expect that activity to translate into a measurable pickup in orders as we progress through calendar year 2025. In summary, Q2 was a successful quarter for LSI with increased financial performance, solid organic growth in many of our key verticals, noteworthy operations execution, growing customer recognition of our integral solution capabilities and the ongoing successful integration and performance of EMI. EMI enhances LSI's position with many key customers, and the reverse is true as well. Teams have identified key cross-selling opportunities with progress made on numerous opportunities, all contribute to the increasing momentum as we enter the second half of the fiscal year. I'll now turn the call back to the moderator for the question-and-answer session.

[Operator Instructions] Our first question comes from Aaron Spychalla with Craig-Hallum Capital Group.

First for me, can you just kind of talk a little bit? It sounds like you expect the strength to continue here in the second half, a combination of backlog and orders and maybe a pickup of activity. So I just want to kind of unpack that a little bit. And then maybe just talk a little bit about seasonality here, potentially in the third quarter off of a strong second quarter. Just curious of your thoughts there.

Yes. Thanks for calling, Aaron. Good to hear you on the call. Listen, we've been talking -- we've been under this cloud that's been impacting grocery for 2 years. As we said a number of times, we -- our preference would have been that the project moved forward. But certainty -- at least some type of certainty was going to be a good result no matter what. As you know, the courts in Colorado and Washington voted against the merger, the 2 big players in the grocery sector, that merger. And so that -- when that went in the direction it did, it gave some clarity. And I think it opened up the gates for projects and programs that were being held back. We got a big surge in Q2, as you see from the numbers. There was a lot of inefficiency in that, as I mentioned in the comments here, and we mentioned a little bit in the press release. Because we had to ramp back up quickly, we didn't want to leave any orders on the table and that type of thing. What's hard for us to see right now as we sit here on January 23 is sorting out what was surge -- what is the remainder of the pent-up demand look like? And what is the normal run rate look like going forward? So I'm going to need -- we're going to need another quarter to give you a lot of clarity on that. But I mean, the short answer is we do anticipate that we'll remain at an elevated rate on the Display Solutions side, particularly as it relates to grocery. And the work we're doing in the convenience store/refueling side, we anticipate those will remain at an elevated rate through Q3 and Q4, maybe not quite at the same rate as Q2, but still at an elevated rate.

All right. And then on gross margins, I know you've been navigating some issues there for a long time. Can you just maybe talk about the kind of trajectory of growth and EBITDA margins as we move into the back half? You kind of touched on some of those inefficiencies in the quarters. Do we see improvements there as we move forward?

Yes. I mean, I think the whole story that LSI, if I were to kind of tell the 5-year story of LSI, it is about that continual focus on operational efficiency, utilization, effectiveness and that equals margin. Any time we step out of that and we become less efficient, the by-product is an impact on margin. So when you look at what happened in Q2, we had -- we didn't know what the timing would look like. We knew that there was going to be pent-up demand, there was going to be demand related to it. We had a choice of fork in the road, so to speak, absorb the cost and let the clock tick until that opportunity presented itself or have a plan and be ready to execute when those orders came in. We took the latter. We had a plan. We executed it, but there was inherent inefficiencies in it. You have -- you're bringing back a lot of people all at once. We're talking about workforce, scaling up the workforce. We have a new product design that we're not kind of pumping out on a daily basis. So there's some inefficiency in learning how to manufacture that best. There's some challenges around materials to make sure we get the materials in. So those are the inefficiencies that we experienced. And those will carry in into Q3 a bit, too. I don't anticipate that the margins will be lower -- any lower. Not that they were low, by the way, but that they'll probably match Q2, maybe a little bit of incremental improvement. But as we move through this, the consecutive quarters in front of that, we'll get that efficiency back, and we'll start performing back up to that level that we like. There was also a couple of things in there. I know I've mentioned it, but I want to remind everybody. When we brought EMI on board, their performance is lower than LSI's performance. And we knew that, and EMI knows that. And they've done a phenomenal job of moving that needle already. We've done a phenomenal job collectively of moving it. But they're still a little less efficient, and they're still a little less profitable from a margin standpoint, and that's a program that will take us 12 to 18 months to move that needle. And then the last thing, I just want to bring it up because I haven't talked about it out loud. But with the port strikes occurring in -- the potential for port strike, ports went on strike, the East Coast, that gummed up some materials for us. And then there was the potential of another issue here in January. That got settled, but we made the management decision some 4 or 5 months back that we were going to hedge our bet and reroute a lot of materials through the West Coast at an additional cost. If the port strike had happened, we would have had the materials, and we would have executed against that. If it didn't, then we would have burdened ourselves with some extra costs, but it was worth the risk. So we did do that, and we're going to be burning off those additional costs over the last quarter and into the third quarter here. But it was still a bet. We would have made it all over again based on the information we had. But those are things that are impacting our margins a little bit.

Understood. And then, just maybe last for me. Curious of your thoughts on some of the proposed tariffs and what that might mean for your business and maybe competitive position in the market as well.

Well, remember, again, I'll go back to -- if I could retell the whole 5-year story in 30 seconds, but way back even before COVID, we made the decision to kind of onshore. And we're very proud to carry a flag that says American-made, we -- it's not popular to be a U.S. manufacturer of some of -- some products that could be considered commodity like lighting or things like that. But we made that decision back in 2019. We were, at that time, 20% domestic, 80% foreign sourced. Today, we are 70% domestic, 30% foreign sourced. I don't have a crystal ball in terms of what the tariffs will look like and how they'll impact us on any level or anybody else in the mix here. But I will say, because of our domestic focus, the impact should be marginal, and it should be less significant than anybody else would be exposed to. So we don't manufacture in Mexico. We export from the U.S. to Mexico. We do have some final assembly in Mexico, but I think those tariffs would be a reverse situation incoming from Mexico, and we don't do that. We have a Canadian operation. We do move things across the border from Canada to the U.S. and from the U.S. to Canada. So we'll have an eye on that. But the way our Canadian operation works, it can be 100% stand-alone within the country to support Canadian operations and Canadian customers. And we have enough business there, and we have supply relationships already that are stable. If we needed to, we could kind of have minimal trading or minimal inventory moving across the border for our Canadian versus U.S. operations. And then rest of world, most of our activities in the Caribbean and other places that could -- I don't see anything on the board that would impact any of those. But a majority of those or almost all of them are us exporting there. So I don't anticipate any impact. With all of that said, depending on how the cards land and what those tariffs look like, I think we'll be least affected in our sectors and best prepared to manage through whatever those look like.

Aaron, Jim G here. Just to build on what Jim said. First of all, our exposure is limited from the previous actions we've taken, as Jim noted. But in addition to that, we do have a complete contingency plan, both for our Tier 1 suppliers as well as Tier 2, meaning our direct suppliers, but then also our direct suppliers that have -- that they source foreign material from foreign sources as well. So we've got both tiers covered. In fact -- so what we do source from China, which -- that's probably the most visible top of mind of everybody these days. What we do source today, what's remaining, we've already moved about 20% of what's remaining out of there. So as Jim said, we feel very comfortable where we're at, and we were proactive in developing plans to address the situation.

By the way, it doesn't mean that there wouldn't -- it wouldn't be a kick in the knees. It just means we get back up again.

Right. No, understood. Congrats on the quarter. I'll turn it over.

Thank you.

Our next question is from Sameer Joshi with H.C. Wainwright.

Congrats on the quarter. I think, just stepping back, would you give us a refresher on how you launch new products? I think you're planning 40 new products this year. And in terms of your product road map and visibility and agility or quickness, how does that work? Like just give us a quick refresher.

Yes. So what you would see, if you go back and listen to all my calls or you look at anything that we release, I always reference that we have 20-plus new products each year. Last year, my Head of Marketing sat down and said, you're underselling us because there really hasn't been a year in the last 5 years we haven't launched less than 30 new products and close to 40. So I continue to say 20-plus new products, but they're always -- and I've been told, always has been in excess of 30. Our new product launches fall into kind of 3 buckets. There is an existing product, which is refreshed or reengineered, maybe new components, maybe we're able to find more efficiency in it or lower-cost components or whatever it is. So that's one version of a new product. The second is a category change or what I would say is we're expanding within that category. Maybe we have a small, medium and large Wall Sconce, and we're adding some type of feature, a pendant mount for it, or we're adding an extra large Wall Sconce or something like that. So that might be something within a family. And this extends across Refrigeration and Lighting. I'm just using this as a kind of an example. I'm using Lighting, but it extends to all products. And then the third is a totally -- a launch of a totally new product. And the V-LOCITY, as an example, is a brand-new category. We're not -- we try to minimize our cannibalization of existing product. We try to make it complementary. We try to make it serve a new set of targets within the market, new capabilities, that type of thing. It may overlap with some of the capabilities of an existing product, like in this case, I was just mentioning V-LOCITY. It overlaps with Mirada. Mirada has been one of our most successful products we've ever had. But it doesn't overlap in a way where it completely cannibalizes it. Maybe, let's say, 1/3. So 1/3 of it -- 1/3 of our customers are going to stay in the Mirada family, and they're going to be completely -- that's going to serve them for years to come. 1/3 of our customers will be debating, "Hey, do I want to move? Do I want to stay with Mirada or do I want to move to V-LOCITY?" And then 1/3 of our customers will say, "You know what, Mirada wasn't able to handle this, but V-LOCITY is. So I'm definitely going to V-LOCITY." In terms of how we launch it, it is very comprehensive, right? It starts before the product is available. It's education to our own team, which we'll be doing some of it at our upcoming sales meeting next weekend. It is education and preparation to our specifiers, the engineers that work with our products, our agents, our technical resources, meaning our tech support teams, our engineering teams, our manufacturing teams getting ready to manufacture and use that product. And then the last is when the product becomes available is that external launch, which we use social media, LinkedIn. We're not Facebook ad people or anything, but we use all the social media to introduce it, plus advertising, plus all of those. And then there's all the technical background that is going on during that time, sourcing the products, running through manufacturing, looking for the manufacturing efficiencies, and that will keep going on as we gain more and more experience with that product.