LSI Industries Inc. — Fiscal 2018 Second-Quarter Form 10-Q
Reporting period: Quarter and six months ended December 31, 2017; comparisons are primarily with the periods ended December 31, 2016. The interim financial statements are unaudited. LSI operates through Lighting and Graphics segments and primarily serves commercial, industrial, petroleum, retail, restaurant, automotive, and other markets in the United States.
Key financial metrics
| Metric | Q2 FY2018 | Q2 FY2017 | Six months FY2018 | Six months FY2017 |
|---|---|---|---|---|
| Net sales | $92.3 million | $85.7 million | $179.8 million | $169.8 million |
| Gross profit | $25.3 million | $21.4 million | $49.0 million | $42.2 million |
| Gross margin | 27.4% | 25.0% | 27.3% | 24.9% |
| Operating income (loss) | $4.5 million | $2.8 million | $(20.3) million | $3.9 million |
| Operating margin | 4.9% | 3.3% | (11.3)% | 2.3% |
| Net income (loss) | $(1.5) million | $2.0 million | $(17.1) million | $2.8 million |
| Diluted EPS | $(0.06) | $0.08 | $(0.66) | $0.11 |
- Segment sales: Q2 Lighting sales were $69.2 million, up 6.3%; Graphics sales were $23.1 million, up 12.4%. Six-month sales increased 5.5% in Lighting and 6.8% in Graphics.
- LED transition: Lighting solid-state LED fixture sales increased 25.1% to $57.7 million in Q2 and represented 91.7% of lighting product sales, compared with 78.2% a year earlier. Six-month LED sales increased 24.0% to $110.7 million.
- Adjusted results: Management reported adjusted operating income of $4.6 million for Q2 versus $3.5 million a year earlier, and adjusted net income of $3.3 million, or $0.12 per diluted share, versus $2.5 million, or $0.10 per share. For the first six months, adjusted operating income was $7.8 million versus $5.8 million, and adjusted net income was $5.0 million, or $0.19 per share, versus $4.1 million, or $0.16 per share.
- Cash flow: Operating activities used $0.8 million in the first six months, compared with $4.6 million provided in the prior-year period. Investing activities provided $0.3 million, including $1.5 million of proceeds from a facility sale, while capital expenditures were $1.2 million. Financing activities provided $0.6 million.
- Liquidity: Cash was $3.2 million at December 31, 2017. Working capital was $72.8 million, with a current ratio of 2.71 to 1. The secured revolving credit facility is $100 million; $52.1 million was drawn and $47.9 million was available at December 31. Management stated that the facility and operating cash flow are adequate for fiscal 2018 needs.
- Debt and dividends: Long-term debt was $52.1 million, compared with $49.7 million at June 30, 2017. The company was in compliance with all loan covenants. Cash dividends paid in the first half were $2.6 million; the indicated annual dividend rate was $0.20 per share.
Material changes versus the prior comparable period
- Reported Q2 operating income increased 61.4%, aided by higher sales and margins and the absence of $0.7 million of prior-year restructuring costs.
- Reported six-month operating results shifted to a $20.3 million loss primarily because of a $28.0 million goodwill impairment charge in the first quarter. The impairment followed a sustained and significant decline in the company’s stock price and affected a Lighting reporting unit.
- Net income was also affected by a $4.7 million one-time deferred tax expense from revaluing deferred tax balances after enactment of the Tax Cuts and Jobs Act. The statutory U.S. rate for fiscal 2018 is expected to be 27.7%, declining to 21% thereafter.
- The acquisition of Atlas Lighting Products contributed to reported sales and expenses. Excluding Atlas, comparable sales declined 8.5% in Q2 and 8.8% for the first six months.
- Accounts receivable increased to $59.7 million from $48.9 million at June 30, 2017, and days sales outstanding increased to 56 days from 52 days. Inventory declined to $48.7 million from $50.0 million.
- Corporate operating losses increased to $3.0 million in Q2 and $6.3 million for the first six months, primarily due to employee compensation and other administrative costs.
Outlook, commentary, risks, and unusual items
- Management expects no significant restructuring charges in fiscal 2018; previously announced facility closures and consolidations were completed in fiscal 2017.
- Management highlighted continued conversion from traditional lighting to LED, improved product mix, manufacturing efficiencies, competitive pricing pressure, commodity inflation, and continued softness in the lighting industry.
- The company plans to adopt the new revenue recognition standard on July 1, 2018 using the modified retrospective method. Management expects limited impact on overall sales, but timing may change for certain installation-related projects.
- Goodwill impairment testing involves significant assumptions regarding revenue growth, expenses, working capital, discount rates, stock price, forecasts, and future cash flows. The company planned another impairment analysis in the third quarter of fiscal 2018 as part of its annual test.
- Key disclosed risks include competitive products, product demand and market acceptance, reliance on key customers, customer financial difficulties, cyclical and seasonal operations, collectability of receivables, warranty and inventory reserves, litigation and regulatory costs, acquisition integration, employee retention, economic conditions, tax and accounting uncertainty, and asset impairment.
- The company stated that normal-course legal proceedings and customer bankruptcies were not expected to have a material adverse effect. No standby letters of credit were outstanding at December 31, 2017.
- Disclosure controls were deemed effective. Management excluded Atlas from its internal-control evaluation; Atlas represented 31% of consolidated assets at December 31, 2017.
Facts investors should verify
- Whether the substantial increase in LED sales can offset declines in traditional lighting and the reported decline in comparable sales excluding Atlas.
- Whether the Lighting reporting unit will incur additional goodwill or other asset impairments in the annual fiscal 2018 testing.
- Progress in reducing receivables and DSO, given the use of operating cash in the first half.
- Compliance with debt covenants and the company’s ability to maintain liquidity while carrying approximately $52 million of debt and paying dividends.
- The sustainability of reported margin improvement after excluding prior-year restructuring costs, Atlas effects, the goodwill impairment, and the one-time tax charge.
- The eventual effect of the new revenue recognition and lease accounting standards, including any changes to revenue timing or reported liabilities.