LSI Industries Inc. — Fiscal 2016 Second-Quarter Form 10-Q
Reporting period: Three and six months ended December 31, 2015, compared with the corresponding periods ended December 31, 2014. The interim financial statements are unaudited. LSI operates through Lighting, Graphics and Technology segments.
Financial Highlights
| Metric | Q2 FY2016 | Q2 FY2015 | Six Months FY2016 | Six Months FY2015 |
|---|---|---|---|---|
| Net sales | $84.7 million | $84.7 million | $170.6 million | $163.2 million |
| Gross profit | $23.9 million | $20.6 million | $47.3 million | $39.2 million |
| Gross margin | 28.3% | 24.3% | 27.7% | 24.0% |
| Operating income | $5.4 million | $2.2 million | $11.1 million | $4.8 million |
| Operating margin | 6.4% | 2.6% | 6.5% | 2.9% |
| Net income | $3.8 million | $1.6 million | $7.5 million | $3.1 million |
| Diluted EPS | $0.15 | $0.06 | $0.30 | $0.13 |
Segment Performance
- Lighting: Q2 sales were $59.6 million, down 0.3%; operating income increased 26.7% to $5.2 million. Six-month sales increased 2.7% to $118.7 million and operating income increased 30.6% to $10.9 million.
- Graphics: Q2 sales increased 3.8% to $21.0 million and operating income increased 91% to $2.0 million. Six-month sales increased 17.9% to $42.8 million and operating income increased to $4.2 million from $1.1 million.
- Technology: Q2 sales declined 12.9% to $4.1 million, while operating income rose 99% to $1.0 million. Six-month sales declined 19.3% to $9.1 million, while operating income increased to $2.3 million from $1.1 million, aided by higher intersegment sales.
- LED activity: Q2 LED-related sales were $42.3 million, up 13.1%; first-half LED sales were $81.2 million, up 18.9%. LED fixtures represented 69.5% of Lighting sales in Q2 and 63.3% in the first half.
Cash Flow, Liquidity and Capital Structure
- Six-month operating cash flow was $5.5 million, down from $10.7 million. The decline primarily reflected increased inventories, refundable income taxes and lower accounts payable, partially offset by higher net income and stock-option expense.
- Cash and cash equivalents were $28.8 million at December 31, 2015, compared with $26.4 million at June 30, 2015.
- Working capital was $93.7 million, compared with $84.0 million at June 30, 2015; the current ratio improved to 3.91 from 3.28.
- Capital expenditures were $3.4 million, compared with $2.4 million in the prior-year period. Investing cash flow was an outflow of $3.4 million.
- The company had no borrowings under its $30 million unsecured revolving credit facility. The full facility was available as of January 29, 2016, and the company was in compliance with its covenants.
- Six-month financing cash flow was positive $0.2 million, including $1.7 million of dividends and $2.2 million of proceeds from stock-option exercises.
- The January 2016 quarterly dividend was increased to $0.05 per share, implying an indicated annual rate of $0.20, up 25% from $0.16.
Material Changes and Unusual Items
- Profitability improved substantially despite essentially flat Q2 revenue, driven by procurement improvements, manufacturing efficiencies, product mix and higher gross margins.
- First-half results benefited from the absence of the prior-year $565,000 loss on the sale of LSI Saco Technologies and were not comparable to the prior-year $343,000 gain on the sale of a facility.
- The company recorded $223,000 of severance costs in the first half of fiscal 2016, principally in Graphics. Adjusted first-half operating income was $11.4 million versus reported operating income of $11.1 million.
- Stock-option expense increased to $1.8 million in the first half from $0.9 million. Diluted weighted-average shares increased to 25.4 million from 24.5 million.
- Warranty liabilities increased to $4.3 million from $3.4 million at June 30, 2015. Inventory increased to $45.9 million from $43.1 million.
- A petroleum/convenience-store customer represented approximately 10% of first-half consolidated sales and 11% of accounts receivable at December 31, 2015.
Outlook, Risks and Contingencies
Management stated that the $30 million credit facility and operating cash flow were adequate for fiscal 2016 operating and capital expenditure needs. No formal revenue or earnings guidance was provided in the filing.
- Key risks include competitive products, product demand and market acceptance, customer concentration and customer financial difficulties, cyclical and seasonal operations, collectability of receivables, warranty exposure, litigation and regulatory compliance.
- Goodwill and intangible-asset impairment testing depends on forecasts, future cash flows, growth rates and discount rates. Net goodwill was $10.5 million, substantially reduced by accumulated impairment losses.
- The maximum potential undiscounted Virticus earn-out liability was $2 million for fiscal 2016–2017, although management considered payment unlikely.
- LSI was involved in ordinary-course negotiations, customer bankruptcies and legal proceedings; management stated that these matters were not expected to materially affect financial position, results, cash flows or liquidity.
- No standby letters of credit or off-balance-sheet arrangements were outstanding. Disclosure controls were effective as of December 31, 2015, with no material changes in internal control reported.
Investor Verification Items
- Verify whether gross-margin gains and improved segment profitability are sustainable amid competitive pricing and the transition from traditional lighting to LED.
- Monitor Technology customer sales, intersegment dependence and the concentration of sales with petroleum/convenience-store customers.
- Assess operating-cash-flow conversion, inventory growth, accounts-payable reductions and the adequacy of working-capital controls.
- Review warranty reserves, customer credit quality and the potential impact of customer disputes or bankruptcies.
- Evaluate dilution from outstanding stock options and RSUs, including the increased stock-compensation expense.
- Confirm the effect of the higher dividend rate on future cash requirements and capital allocation.
- Track future impairment testing for goodwill and indefinite-lived intangible assets, as well as the potential Virticus earn-out liability.