LSI Industries Inc. — Fiscal 2017 Form 10-K Summary
Reporting period: Fiscal year ended June 30, 2017. The filing is not a fiscal 2016 Q4 filing; it includes fiscal 2017 annual results and unaudited quarterly data, including the quarter ended June 30, 2017.
Business Context
LSI provides integrated lighting, graphics, digital signage, technology, installation, engineering and project-management solutions. Fiscal 2017 net sales were generated primarily by Lighting, which represented 72% of sales, followed by Graphics at 22% and Technology at 6%. Approximately 30% of sales came from the petroleum and convenience-store market.
On February 21, 2017, LSI acquired Atlas Lighting Products, a manufacturer of LED lighting products sold through electrical distribution. Atlas contributed $17.8 million of sales and $1.8 million of operating income after acquisition.
Key Financial Metrics
| Metric | FY2017 | FY2016 | Change |
|---|---|---|---|
| Net sales | $331.4 million | $322.2 million | Up 2.9% |
| Gross profit | $81.9 million | $83.7 million | Down 2.1% |
| Gross margin | 24.7% | 26.0% | Down 130 basis points |
| Operating income | $3.6 million | $14.0 million | Down 74.1% |
| Net income | $3.0 million | $9.5 million | Down 68.4% |
| Diluted EPS | $0.12 | $0.37 | Down $0.25 |
| Cash flow from operations | $21.0 million | $17.8 million | Up $3.2 million |
| Capital expenditures | $6.6 million | $10.2 million | Down $3.6 million |
Reported FY2017 adjusted operating income was $7.3 million versus $14.4 million in FY2016. Adjusted net income was $5.0 million, or $0.19 per diluted share, versus $9.8 million, or $0.38 per diluted share, in FY2016. These non-GAAP measures exclude selected restructuring, severance, acquisition, impairment and inventory-adjustment items.
Segment Performance
| Segment | FY2017 Sales | FY2017 Operating Income | Change in Sales | Change in Operating Income |
|---|---|---|---|---|
| Lighting | $239.0 million | $10.6 million | Up 5.3% | Down 33.1% |
| Graphics | $72.4 million | $2.4 million | Down 7.1% | Down 53.5% |
| Technology | $20.0 million | $3.9 million | Up 15.3% | Down 0.4% |
LED lighting sales increased 20.0% to $186.5 million and represented 78.0% of Lighting sales, compared with 68.5% in FY2016. However, Lighting sales excluding Atlas declined 2.5%, reflecting a soft market, particularly in the second half of the year. Graphics sales declined because of lower petroleum/convenience-store, drug-store and grocery-market activity.
Liquidity, Debt and Cash Flow
- Cash and cash equivalents were $3.0 million at June 30, 2017, compared with $33.8 million a year earlier.
- Working capital declined to $61.7 million from $88.5 million; the current ratio declined to 2.36 from 3.26.
- Long-term debt was $49.7 million at year-end, compared with no long-term debt in FY2016. The debt was drawn primarily to fund the Atlas acquisition.
- LSI had a secured $100 million revolving credit facility expiring in the third quarter of fiscal 2022. Approximately $50.3 million was available at June 30, 2017 and $49.9 million was available as of August 25, 2017.
- The Company reported compliance with all loan covenants and stated that operating cash flow and available borrowing capacity were adequate for fiscal 2018 operating and capital needs.
- Investing cash outflow was $98.6 million, including $95.1 million for Atlas and $6.6 million of capital expenditures. Financing activities provided $46.8 million, primarily from net debt borrowings.
- Net accounts receivable increased to $48.9 million, and days sales outstanding increased to 52 days from 47 days. Inventory increased to $50.0 million from $44.1 million.
- The indicated annual dividend rate was $0.20 per share, or $0.05 quarterly.
Material Changes, Unusual Items and Outlook
- Operating performance was pressured by 5% to 6% material inflation, especially in steel, aluminum, copper and other commodities. Customer price increases did not fully offset the cost increases.
- FY2017 included $1.5 million of restructuring costs in cost of sales, a $0.5 million finite-lived intangible impairment, $1.6 million of acquisition deal costs and $0.5 million of non-restructuring severance costs. The Company also recorded a $1.4 million gain on the sale of the Kansas City facility.
- LSI closed its Kansas City fluorescent-lighting facility, consolidated its Beaverton, Oregon facility and began consolidating the Woonsocket, Rhode Island graphics operation into North Canton, Ohio. The Woonsocket facility was classified as held for sale at $1.5 million.
- Management stated that lighting and graphics market softness continued into the first months of fiscal 2018. Elevated material prices were also expected to continue in the short term.
- The FY2017 effective tax rate was unusually low at 2.6%, compared with 32.3% in FY2016, due to permanent book-tax differences, tax benefits related to uncertain tax positions and disqualifying dispositions, and a valuation-reserve reduction associated with the Kansas City facility sale.
- Goodwill impairment testing resulted in no goodwill impairment. A $479,000 customer-relationship intangible asset impairment was recorded in the Graphics Segment.
- Management and the independent auditor concluded that internal control over financial reporting was effective as of June 30, 2017. However, Atlas, representing 39% of consolidated assets and 5% of fiscal sales, was excluded from management’s internal-control evaluation because it was acquired during the year.
- The Company expects to adopt the new revenue-recognition standard no later than July 1, 2018. It expects limited impact on total revenue, but timing could change for certain installation-related projects.
Principal Risks
- Economic, cyclical and seasonal conditions affecting commercial, industrial, retail, petroleum and convenience-store markets.
- Competitive pricing pressure and the risk that commodity inflation or supply shortages reduce margins.
- Concentration in the petroleum/convenience-store market and dependence on major customers and re-imaging programs.
- Risks associated with integrating Atlas, realizing expected acquisition benefits and managing increased goodwill and intangible assets.
- Potential inventory write-offs for customer-specific graphics and image-conversion programs if customers cancel or change programs.
- Warranty, product-development, technology-obsolescence, credit-collection, litigation, environmental, cybersecurity and key-personnel risks.
Investor Verification Checklist
- Verify Atlas’s post-acquisition sales, operating contribution, purchase accounting and the $49.7 million year-end debt balance.
- Assess whether Lighting and Graphics market softness and 5% to 6% material inflation persisted beyond the filing date.
- Review normalized earnings excluding restructuring, acquisition, impairment, severance and tax-related items, while considering which costs may recur.
- Monitor leverage, covenant compliance, cash conversion, receivables days and inventory levels following the acquisition.
- Evaluate the sustainability of the $0.20 annual dividend against reduced earnings and increased debt service.
- Review the effectiveness and integration of Atlas’s internal controls, which were excluded from the fiscal year-end control assessment.
- Confirm the status and expected proceeds from the Woonsocket facility held for sale and any remaining restructuring obligations.