LSI Industries Inc. — Fiscal 2015 Second-Quarter Form 10-Q
Business Context and Reporting Period
The filing covers the three and six months ended December 31, 2014, LSI Industries’ fiscal 2015 second quarter and first half. The company operates through Lighting, Graphics, Electronic Components, and an All Other category. The financial statements are unaudited and presented in accordance with U.S. GAAP.
Key Financial Metrics
| Metric | Three Months Ended Dec. 31, 2014 | Three Months Ended Dec. 31, 2013 | Six Months Ended Dec. 31, 2014 | Six Months Ended Dec. 31, 2013 |
|---|---|---|---|---|
| Net sales | $84.7 million | $76.1 million | $163.2 million | $156.6 million |
| Gross profit | $20.6 million | $16.8 million | $39.2 million | $35.9 million |
| Gross margin | 24.3% | 22.0% | 24.0% | 22.9% |
| Operating income | $2.2 million | $1.5 million | $4.8 million | $4.4 million |
| Net income | $1.6 million | $0.9 million | $3.1 million | $2.7 million |
| Diluted EPS | $0.06 | $0.04 | $0.13 | $0.11 |
| Operating cash flow | Not separately provided | Not separately provided | $10.7 million | $8.5 million |
- Second-quarter sales increased 11.3%; first-half sales increased 4.2% year over year.
- Second-quarter operating margin was approximately 2.6%, compared with approximately 2.0% in the prior-year quarter. First-half operating margin was approximately 2.9%, compared with approximately 2.8%.
- The second-quarter effective tax rate was 28.4%, compared with 42.0%; the first-half rate was 34.3%, compared with 36.8%.
- Cash and cash equivalents were $18.1 million at December 31, 2014, compared with $9.0 million at June 30, 2014.
- Working capital was $80.2 million, and the current ratio was 3.61 to 1 at December 31, 2014.
- Capital expenditures were $2.4 million in the first half, compared with $2.7 million in the prior-year period.
- The company had no borrowings under its $30 million unsecured revolving credit facility and was in compliance with all covenants. The facility expires in the third quarter of fiscal 2017.
Material Changes Versus the Prior Comparable Period
- Lighting second-quarter sales rose 4.3% and operating income rose 83.7% to $4.0 million. LED light-fixture sales increased 43.3% to $36.6 million, while traditional lighting and LED video-screen sales declined.
- Graphics second-quarter sales increased 44.7% to $18.7 million, and the segment moved from a $275,000 operating loss to $460,000 of operating income. The first half also improved to $246,000 of operating income from a $112,000 loss.
- Electronic Components sales increased 12.9% in the second quarter and 14.5% in the first half, but operating income declined 40.0% in the quarter and 32.2% in the first half. Lower intersegment demand and outsourcing of certain circuit-board components reduced gross profit.
- Corporate operating losses increased to $3.4 million in the quarter and $5.6 million in the first half, primarily due to higher compensation, legal and outside-service costs and $800,000 of severance expense.
- Operating performance included a $343,000 gain on the sale of a manufacturing facility and a $565,000 loss on the sale of LSI Saco Technologies. The company sold LSI Saco on September 30, 2014 for $1.9 million in cash and exited its Canadian operations.
- Operating cash flow increased by $2.2 million year over year, supported by lower inventory and higher accrued expenses, partly offset by higher receivables and lower customer prepayments.
- The quarterly dividend was reduced to $0.01 per share for the first-quarter fiscal 2015 payment from $0.06 previously. In January 2015, the board declared a $0.02 per-share quarterly dividend, implying an indicated annual rate of $0.08.
Outlook, Commentary, Risks, and Unusual Items
- The filing does not provide formal earnings or revenue guidance. Management states that cash flow from operations and the available $30 million revolving facility are adequate for fiscal 2015 operating and capital-expenditure needs.
- Management highlighted continued customer conversion from traditional lighting to LED products and reported first-half LED sales of approximately $67.9 million, up 28.7% year over year.
- In January 2015, the company initiated a reduction in force and disclosed expected third-quarter fiscal 2015 charges of approximately $543,000 for severance and $33,000 for facility exits. The actions, together with early-third-quarter retirements, affect approximately 8.3% of salaried employees and are expected to reduce annual compensation and benefits by approximately $3.7 million.
- The company recorded an $800,000 second-quarter severance charge related to the former chief executive officer’s management succession agreement; $646,000 remained accrued at December 31, 2014.
- A material weakness existed in internal control over financial reporting involving communication of special customer warranty terms to Accounting. Management began remediation but stated that the weakness was not yet fully remediated and that additional costs were expected.
- Warranty liabilities increased to $3.2 million at December 31, 2014 from $2.7 million at June 30, 2014. Accounts receivable allowances were $355,000, and inventory obsolescence reserves were included in the reported inventory balances.
- The company disclosed an earn-out contingency with a maximum potential undiscounted liability of $3 million through fiscal 2017, although management considers achievement unlikely. Routine legal proceedings and customer matters were not expected to have a material adverse effect.
- Key risks include competitive and demand pressures, customer concentration or financial difficulties, cyclical and seasonal activity, collectability, warranty and inventory estimates, litigation and regulatory matters, acquisition integration, impairment, tax matters, and the effectiveness of control remediation.
Important Facts for Investors to Verify
- Whether LED growth and improved Lighting and Graphics profitability offset declining traditional-lighting, video-screen, and Electronic Components trends.
- The sustainability of reported margins after excluding the $800,000 severance charge and other facility-sale and subsidiary-sale items.
- Progress in remediating the material weakness related to warranty-term communication and the adequacy of the $3.2 million warranty reserve.
- The impact and timing of the January 2015 workforce reduction, expected severance and facility-exit charges, and projected annual cost savings.
- Future dividend policy and cash needs given the reduced fiscal 2015 dividend rate.
- Receivable collectability, inventory levels, warranty claims, and the maximum potential earn-out obligation.
- The company’s continued compliance with credit-facility covenants and availability of its $30 million revolving line.