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LSI Industries (NASDAQ:LYTS)
Q2 2021 Earnings Call
Jan 21, 2021, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Greetings, and welcome to LSI Industries fiscal second-quarter 2021 conference call. [Operator instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jim Galeese, chief financial officer. Thank you.

You may begin.

Jim Galeese -- Chief Financial Officer

Good morning, everyone. 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. 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 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.

Jim Clark -- President and Chief Executive Officer

Good morning all, and Happy New Year. Thank you for joining today's call. In 2019, we sat down as a team to transform our company with the purpose of developing and refining our focus in creating a growth-oriented, competitive, and defensible position in the marketplace. The underpinning of our strategy has been around the development of vertical markets where we can better serve and understand the needs of our customers with the goal of adding value to differentiate ourselves from our competitors and general market commoditization.

This differentiation is achieved not only through our product offerings, but how we design and package those products along with the services we offer. In this aspect, LSI is unique in the way we work with our agents and partners and how we use lighting, graphics, and our installation services to better serve our customers. I'm happy to say that our results in this quarter, in the midst of a pretty challenging environment, go to underlying the progress we are making on this strategy. Sales are up sequentially quarter over quarter.

Margins are up, operating income is up, net income is up and earnings per share are up versus the prior year. This progress cautiously emboldens us as a team to continue a responsible investment in our strategy and acceleration of our plans. Over the last few quarters, I have talked about the investments we're making, including the release of new products, the increasing use of intelligence and controls in our devices, and the investments of additional and commercial resources, along with the expansion of our vertical market focus. Now in some cases, our vertical market focus is simply a matter of refreshing or adjusting our position in certain markets to accommodate for overall change.

In others, it's an expansion in our existing markets with new services or products and yet another introduction of entirely new markets. In several of our established markets, we enjoy strong preference and brand awareness based on decades of experience and an understanding of the market needs and opportunities. We work closely with our niche agents, our general agents, and distribution partners to understand not only the customers' articulated need or request but also the opportunity to see and develop solutions to address the unmet needs. We're able to introduce forward-looking thinking and improvements on the design and specifications of the projects, which increases our value as a partner.

We add value throughout the use of different graphics materials, sensors, controls, optics, light cutoff. And we improve the ease of installation and performance of our products in such areas as uniformity and durability, all resulting in less maintenance, longer operating life, and lower overall cost of ownership. These principles span across our solution sets, whether it's in lighting or graphics. The commercial effort we are investing in is oriented around qualifying our customers' goals, highlighting our strengths, and focusing on those projects where we can create competitive advantages.

Last year, in our automotive vertical, we designed a custom-built large indoor fixture in partnership with one of the world's largest Japanese automakers. The goal was to have a fixture that would properly highlight their product in showrooms across the country with the right color, temperature, intensity, and uniformity. The project was not simply bid out, but instead, it was an engineered solution that leveraged our unique capabilities, including design and manufacturing, along with a network of partners across the country to assure proper application and installation. In this case, LSI worked with the customer as a partner and not simply as a manufacturer or supplier.

Last quarter, I mentioned the contactless payment project with one of the world's largest oil retailers. In this case, we helped design and deploy a payment option, allowing customers to pay at a pump using a mobile application. LSI worked with the customer and a team of their partners to print a QR code and an embedded near-field chip into a series of graphics. And then we managed the deployment and the installation of just over 11,500 locations.

These locations included anywhere from two to 16-plus pumps at each site. The project was in the works for over a year, but the deployment was scheduled to be completed from start to finish in just over three and a half months. I'm happy to say that we're more than 70% through this deployment, and things are moving along well. In fact, just this week, we were awarded another 1,100 locations in addition to the 11,500 locations on the initial project spec.

Last month, we issued a press release announcing our partnership as the official lighting partner of the USA Pickleball. Pickleball is one of the largest growing sports in the United States, and it's part of the sports court industry, which includes tennis, paddle, basketball, and others. As the official lighting partner of the USA Pickleball Association, we'll have much-improved visibility to one of the fastest-growing sports in the U.S. This partnership goes to underline our strength and our offering in the sports court market.

For decades, LSI has provided solutions to this market. And with a refresh product offering in this space and more to come in the future, we see a real growth opportunity ahead of us. This week, we issued a press release announcing that we awarded a $20 million contract to provide an indoor digital menu board system to one of the world's largest fast food retailers. This is a follow-on order to the $100 million awarder announced last year and goes to further illustrate our ability to expand our share of wallet and our overall offering in a key vertical market we compete in.

These projects all go to underlying the strength of our strategy and the opportunities in front of us. Next week, we will be hosting our agent and partner meeting as well as LSI's National Sales Meeting. These meetings will occur virtually. And as of today, we have over 500 agents and partners registered and planning to attend.

We will be sharing a road map of our plans for the future years, including the introduction of 25-plus new products in the upcoming quarters and the expansion of our existing vertical markets. We are all glad to have the calendar year 2020 behind us. Employee and partner safety remains at the top of our list as we start calendar-year '21. I'm proud of how the team at LSI has found a way to not just survive in the current environment, but also to thrive.

With that, I will turn the call back over to Jim Galeese for a closer look at our financials.

Jim Galeese -- Chief Financial Officer

Thank you, Jim. I'll start by highlighting key financial statistics for the fiscal second quarter. Sales were $76 million, increasing 9% sequentially from Q1 and below the prior year as projected. Net income was $2.2 million compared to income of $1.7 million last year.

Non-GAAP or adjusted net income increased 47% to $2.5 million versus $1.7 million in the same period last year. Earnings per diluted share were $0.08 versus $0.07 in Q2 of fiscal 2020. And non-GAAP earnings per diluted share were $0.09 versus $0.07 per share last year. Adjusted EBITDA was $5.1 million or 6.7% of sales, 130 basis points above the prior year.

The company generated $5.3 million of free cash flow in the quarter, increasing our cash balance to $13.6 million as we exit fiscal Q2. The company maintains an existing credit facility of $75 million and continues to have no long-term debt. We continue to effectively manage working capital in the face of constantly changing market conditions due to COVID, with noncash working capital decreasing both sequentially and to the prior year. This also reflects our capability of managing the new product introduction process, launching new products while concurrently phasing out existing lines, minimizing duplicate inventory and obsolescence exposure.

New product activity was very active in Q2 with five new products introduced, and we will continue to accelerate throughout the second half of the fiscal year. This includes a key expansion of our outdoor portfolio and the next generation of several indoor product groups. A regular cash dividend of $0.05 per share was declared payable on February 9 for shareholders of record on February 1st. Now I'll briefly comment on segment operating performance.

As mentioned, sales increased 9% sequentially from Q1, with the graphics segment increasing 27%, while the Lighting segment, more impacted by the resurgence of COVID, was flat to the prior quarter. The graphics increase was driven by the petroleum and grocery verticals, including the petroleum 11,000 site contactless payment project and project activity for several large grocery firms. Development work on potential new programs remains very active. In lighting, project quotation activity remains favorable, realizing quote and inquiry levels above the prior year throughout the quarter, including improved activity in several of our key verticals, including automotive.

But we also observed the quote-to-order conversion period lengthening, indicating the industry challenge in managing project planning and scheduling. The business gross margin rate improved 160 basis points versus the prior year, with multiple factors contributing. Price/mix is favorable, reflecting the ongoing focus on higher-value applications and solutions. Productivity continues to be a major contributor as we align our manufacturing costs to market requirements.

Design savings are a sizable part of productivity as we identify ways to engineer costs out of our product while improving features and ease of contractor use. Both segments generated improved gross margins compared to prior year, with graphics improving 280 basis points and Lighting 140 basis points. The lighting gross margin rate, again, finished above 30%. Q2 operating expenses declined 7% versus prior year, reflecting our strong focus on priorities, which includes investment in key commercial initiatives, notably sales resources and targeted marketing programs, balanced with ongoing identification of cost savings, and leverage.

Looking forward to the second half of the fiscal year, we are encouraged with improving trends in market activity and the impact our commercial initiatives can generate. But we also recognize that market conditions may remain inconsistent in the near term. Therefore, we'll continue to balance our diligent focus on execution with investing in initiatives to generate growth. I'll now return the call back to the moderator.

Questions & Answers:


Operator

[Operator instructions] Our first question comes from the line of Craig Irwin with ROTH Capital. Please proceed with your question.

Andrew Scutt -- ROTH Capital Partners -- Analyst

Good morning. This is Andrew on for Craig. I just want to say congrats on the quarter. A great start to 2021.

My first question is about margins. You guys have exhibited strong margins this quarter in both segments with a strong year-over-year increase. Can you guys just comment on the sustainability of margins at these levels and then just the dynamics in each segment?

Jim Clark -- President and Chief Executive Officer

Yes, Andrew. Good morning. Thank you. Craig, we miss him.

We've been very focused on our margin improvement quarter over quarter. We talk about it. We believe we still have room to work within margins. We are affecting it through a number of programs.

It's not just our cost-out initiatives. It's aligning ourselves with the right markets and the right mix. It's capitalizing on the strengths that we have. And it's working with customers that respect the products we're delivering, the solutions we're delivering as opposed to getting into the bid environments and things like that.

And so I think it's a culmination of all of those efforts. And I think that we still have room to run there. We may not see quite the ramp up of improvement from where we are right now going forward that we have seen in the past, but we still think we can continue to turn that wheel.

Andrew Scutt -- ROTH Capital Partners -- Analyst

Great. That was very helpful. And one quick follow-up. Can you guys just provide some insights into what you're seeing in the March quarter, specifically with the seasonality? And then just also any commentary on quote rate levels? I know you guys said they were increasing the past few quarters.

I was just curious if this has continued past few months, I apologize.

Jim Clark -- President and Chief Executive Officer

Right. Quote activity has definitely picked up. We have also noticed kind of a lengthening between quote to conversion, I think that there's pent-up demand and there's some release relative to projects, and people are getting the quotes and refreshing quotes. And we're waiting for those to convert to orders.

But we've definitely seen a little expansion in that quote-to-conversion time. But the good news also is we're seeing a very good uptake in the customers that do end up quoting with us, the number that actually convert to orders so that's been very positive. Generally, as you saw in the release this morning, Q2 over Q1, we've had sequential improvement. We expect that to remain in Q3.

So we're looking for improvement in Q3 over Q2. How March ends up breaking out? I can't tell you right now. But based on our quote activity and based on the projects we see on the chalkboard, so to speak, we're very encouraged about robust March. Because of our quote-to-order-to-shipment cycle, we didn't see a lot of impact from COVID in March of last year minus our distribution business.

Atlas did feel it a little bit quicker, but we believe that even though we didn't feel a lot of impact, we should do very well on a year-over-year comparative coming into Q3 and into March.

Andrew Scutt -- ROTH Capital Partners -- Analyst

Great. Well, thank you for taking my questions. And once again, congratulations on the strong recall.

Jim Clark -- President and Chief Executive Officer

Thank you, Andrew.

Operator

[Operator instructions] Our next question comes from the line of Sameer Joshi with H.C. Wainwright. Please proceed with your question.

Sameer Joshi -- H.C. Wainwright -- Analyst

Yes. Thanks. Thanks for taking my questions, and congratulations on a nice quarter. My first question is, we understand COVID could be a headwind for next few quarters.

So is the cadence of the revenues still on an upward trajectory for the next two quarters, especially given your seasonal performance last year?

Jim Clark -- President and Chief Executive Officer

Well, we always have some seasonality, and I think that we're seeing some activities that may be out of season, so to speak, where things are -- orders or projects that had been delayed, they're coming in the third quarter where typically they would have come in, in the second quarter or may be deferred to the fourth quarter. So that's very encouraging for us the way we're looking at the third quarter. And then the fourth quarter, if we get back into the seasonality plus mixing it with the pent-up demand, we could see a very strong fourth quarter. And there's certainly some early indicators, particularly around the quote activity that, that's very possible that could happen.

Sameer Joshi -- H.C. Wainwright -- Analyst

And is this from -- like what segment is this from, the Lighting segment where you expect these times to shrink, or is it from petroleum graphics, that kind of --

Jim Clark -- President and Chief Executive Officer

It's cheaply from the Lighting side of things. Petroleum definitely does -- the graphics side, particularly in the petroleum side, does have a reset in the month of January and February typically. And that's all planned in -- that's all baked into our plans. But we think that as we talk about that quote-to-order cycle, we believe there's two things that are going to affect that.

They're both oriented around Lighting. And so we're hoping to see a better third quarter than we would see from a seasonality standpoint. And then the second is on our graphics from digital, Burger King specifically, they've really ramped up the speed to meet with some project timing that they want to make sure that they get in. So on the digital side, we definitely see some opportunity there in the third quarter.

Sameer Joshi -- H.C. Wainwright -- Analyst

So just stepping back on a larger macro-scale level. Do you expect benefits coming over the next six to 12 months from higher infrastructure spending capital expenditures by the companies?

Jim Clark -- President and Chief Executive Officer

Well, we've definitely been paying attention to a lot of the discussion, particularly from the incoming administration about investments in infrastructure. From a lighting standpoint, we play very solidly in that and could be a benefactor of that. I think that some of that -- we're starting to see some of that in terms of the quotes that are coming in, in the project activity that is being looked at. But it's still a little early to tell how that's going to all shake out right now.

I think on whole, it's important to just remember that we do have stops and starts that we're still dealing with. We have supply chain challenges where COVID is affecting them or things like that. So we remain very bullish, but there's a lot of pieces to this whole puzzle.

Sameer Joshi -- H.C. Wainwright -- Analyst

Understood. You have spoken about the 10% increase in sales force. Do you have a sense of time line? Is it beginning, or is it already done? Can you give us some color on that?

Jim Clark -- President and Chief Executive Officer

And I'm sorry, you cut out just slightly in the beginning part and I missed it. Jim, did you get that?

Jim Galeese -- Chief Financial Officer

Yes.

Sameer Joshi -- H.C. Wainwright -- Analyst

The sales force, yes.

Jim Clark -- President and Chief Executive Officer

Sales force increase, OK. I'm sorry, yes. And the question was, have we started that yet?

Jim Galeese -- Chief Financial Officer

Where we're at?

Jim Clark -- President and Chief Executive Officer

Where we're at. It completely cut out on my side. Yes. So we've talked about it over the last few quarters, we are certainly making investment in our commercial activities.

That is, from a marketing standpoint, you saw our announcement about our partnership with Pickleball, and it goes right along in lines when we were talking about our vertical market development. From a true commercial standpoint, talking sales resources on the street, right now, we're targeting a 10% improvement. And we're probably 80% through that in terms of actually getting folks onboard. There is some ramp-up time to that.

You bring on a new resource, we've got to get them trained up and get them knowledge specific to our company. We've also added some resources that may not qualify directly under the commercial side, but on our services business, which we referenced quite a bit with this rollout of the contactless payment also with the digital menu board systems that we're rolling out. Our services side of the business has experienced pretty good growth, and we are investing some resources there too. And there, again, we're kind of 80%, 90% of our planned investment.

But we're continuing to -- we watch this real-time, live. And as long as the opportunities are there, we'll continue to make those investments and expand those resources. We don't have any constraint or cap relative to what we're willing to invest in if we can show the return.

Sameer Joshi -- H.C. Wainwright -- Analyst

Understood. And just one clarification on the cost side. When you mentioned that you're continuing to cost out of the engineer costs out, are you also doing any cost controls at the operating level that should mean that, of course, you are spending on sales? But are there any other efficiencies that you are able to derive?

Jim Clark -- President and Chief Executive Officer

Yes. I mean, I think that number one, from a cost control standpoint, I think we have a very good team of people here that recognize what investment and return looks like. We don't have systems that are inflexible. We're always looking for opportunities, and we'll always kind of invest ahead of the curve if it puts anything at risk or it creates an opportunity or anything like that.

We do believe that there are still some opportunities, and this comes back to the margin thing. But we do believe we still have turns on the wheel here that we can continue to implement. It's just a matter of doing it that doesn't disrupt any commitments that we have to our customers or things like that. But the answer is, yes, we do believe we still have some opportunity.

Sameer Joshi -- H.C. Wainwright -- Analyst

You got it. Thanks for the color. Thanks for taking my question.

Operator

Thank you. Our next question comes from the line of Jed Dorsheimer with Canaccord Genuity. Please proceed with your question.

Jed Dorsheimer -- Canaccord Genuity -- Analyst

Hey. Thanks. I joined a little bit late, so apologize in advance if you've already addressed this. But I was wondering if you think through some of the changes, sort of large scale, so you're seeing further pressure on sort of that petroleum market segment, which you're strong in, and some of the auto in terms of -- or maybe you're not.

So I guess, first question, are you seeing pressure kind of equally spread across end markets for lighting between quick stop in service station and automotive?

Jim Clark -- President and Chief Executive Officer

Well, so in terms of the petroleum retailers, we've seen a continued investment from those folks. They are not easily disrupted. Their plans are usually well thought out. They're put out ahead of them in terms of years.

And we didn't have much of a disruption in terms of their commitment during this whole COVID side of things. Frankly, the challenges were just electrical permits, construction permits, inspections, things like that from a timing perspective. And we anticipate it to continue to be relatively strong. I think that some of the oil retailers have been talking about their activities and the things that they've been doing to control their costs and investment cycles and things like that, and they remain fairly committed.

On the automotive, I'll just make a point to say on the last day of the year, we had a very large commitment from a customer. And then on the first day of the calendar year, we had another. So we look at it from the outside, like many would probably say, the buying cycles have changed. People are buying more online.

There's less going on in the showroom. But we're also seeing some of the larger automotive customers taking advantage of the downtime in the showrooms and then the lots and making investments right now, maybe preparatory type of things, being ready when COVID kind of gets under control if you will. So we're seeing pretty steady activity, it would be the answer, Jed.

Jim Galeese -- Chief Financial Officer

Jed.

Jed Dorsheimer -- Canaccord Genuity -- Analyst

Yes. I mean, yes. Go ahead.

Jim Galeese -- Chief Financial Officer

I was just going to add to that, back to the petro side. As you know, those are generally very large multi-year programs. And so they go through various phases of the cycle. But it's important to note, we watch the potential development work on few potential future programs very closely.

And that development work pipeline right now remains very strong. So these are the programs then that would start affecting us maybe in later calendar year this year and then on through the next couple of years. So we have both the current programs that we monitor our activity on future development programs very closely.

Jed Dorsheimer -- Canaccord Genuity -- Analyst

Gotcha. So it's a little counterintuitive, but it seems like there's a lot of headline risk, but the actual activity in the market seems much stronger. On the auto side, COVID is -- the feedback we're getting is COVID is actually a positive for auto sales because nobody is taking public transportation anymore. And most retailers have seen that there's been an increase.

So that kind of makes sense. One last question for you just on the lighting and maybe for commercial. Have you seen a change over the past couple of years in terms of the influence of spectral tuning or the ability to tune on-prem with the light, or is it still mostly static?

Jim Clark -- President and Chief Executive Officer

I think there's a lot of conversation about it. The whole concept of selectable color temperatures and things like that has definitely taken hold. It allows our customers, our installers, and such to -- it allows us to reduce inventory and SKU diversity, proliferation.

Jim Galeese -- Chief Financial Officer

Same with lumen output.

Jim Clark -- President and Chief Executive Officer

Yes. Same with lumen output. But spectral is kind of -- it's complicated because it starts with the LEDs and it is impacted by the lensing that you're putting on it. And that may not be something that we kind of get any time soon, but it is certainly something that's talked about.

But I don't expect to see it rolling out into the field anytime soon. It's just that the cost for that flexibility is too high right now.

Jed Dorsheimer -- Canaccord Genuity -- Analyst

Got it. Got it. Thanks, guys. I appreciate it.

Jim Clark -- President and Chief Executive Officer

Jed, thank you.

Operator

There are no further questions in the queue. I'd like to hand the call back to Mr. Clark for closing remarks.

Jim Clark -- President and Chief Executive Officer

I just want to say thank you, again, for everybody that tuned in. We're happy with the quarter, the way it has developed. I think we're coming into the new calendar year with a certain degree of momentum, and we're looking forward to trying to keep up that momentum and capitalize on it. I just want to say thank you again for calling in, and we'll look forward to talking to you soon.

Take care.

Operator

[Operator signoff]

Duration: 32 minutes

Call participants:

Jim Galeese -- Chief Financial Officer

Jim Clark -- President and Chief Executive Officer

Andrew Scutt -- ROTH Capital Partners -- Analyst

Sameer Joshi -- H.C. Wainwright -- Analyst

Jed Dorsheimer -- Canaccord Genuity -- Analyst

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