Business Context and Reporting Period
LSI Industries Inc. filed this unaudited Form 10-Q for the quarter ended September 30, 2017, the first quarter of fiscal 2018. The company operates primarily through Lighting and Graphics segments. The Technology segment was merged into Lighting for fiscal 2018 reporting. Results include Atlas Lighting Products, acquired February 21, 2017; comparable sales excluding Atlas declined year over year.
Key Financial Metrics
| Metric | Q1 FY2018 | Q1 FY2017 | Change |
|---|---|---|---|
| Net sales | $87.5 million | $84.2 million | 3.9% increase |
| Gross profit | $23.7 million | $20.8 million | 13.8% increase |
| Gross margin | 27.1% | 24.8% | Up approximately 230 basis points |
| Operating income (loss) | $(24.8) million | $1.1 million | Primarily affected by $28.0 million goodwill impairment |
| Adjusted operating income | $3.2 million | $2.3 million | 41% increase |
| Net income (loss) | $(15.6) million | $0.8 million | Declined to a loss |
| Diluted EPS | $(0.61) | $0.03 | Declined |
| Operating cash flow | $(3.4) million | $0.3 million | Outflow increased by $3.7 million |
Lighting sales increased 4.8% to $68.4 million, while Graphics sales increased 0.8% to $19.0 million. Lighting LED fixture sales rose 22.7% to approximately $53.0 million and represented 84.8% of Lighting product sales, compared with 71.5% in the prior-year quarter. Graphics operating income increased to $1.5 million from $1.0 million.
As reported, consolidated net margin was approximately negative 17.9%, compared with approximately 1.0% in the prior-year quarter. Adjusted net income was $1.7 million, or $0.07 per diluted share, compared with adjusted net income of $1.6 million, or $0.06 per diluted share, in the prior-year quarter.
Liquidity, Debt and Balance Sheet
- Cash and cash equivalents were $2.1 million at September 30, 2017, down from $3.0 million at June 30, 2017 and $30.7 million at September 30, 2016.
- Working capital was $67.6 million, compared with $61.7 million at June 30, 2017; the current ratio was 2.64 to 1.
- Accounts receivable increased to $54.3 million from $48.9 million at June 30, 2017, and reported DSO increased to 53 days from 52 days.
- Inventory declined to $49.2 million from $50.0 million at June 30, 2017.
- Long-term debt was $51.9 million, with $48.1 million available under the secured $100 million revolving credit facility. The facility expires in the third quarter of fiscal 2022.
- The company reported compliance with all loan covenants as of September 30, 2017.
- Capital expenditures were $0.5 million. Investing cash flow was positive $1.0 million, including $1.5 million of proceeds from the sale of the Woonsocket facility.
- Financing cash flow was positive $1.5 million, reflecting $24.4 million of borrowings, $22.2 million of debt repayments, and $1.3 million of dividends paid.
Material Changes Versus the Prior Comparable Period
- The company recorded a $28.0 million pre-tax goodwill impairment charge in the Lighting segment after a sustained and significant decline in its stock price triggered an interim impairment test. Lighting goodwill declined from $57.4 million to $29.4 million.
- The impairment produced a $10.7 million deferred tax asset and contributed to a $9.6 million income tax benefit. The reported effective tax rate was 38.0%, compared with 23.2% in the prior-year quarter.
- No restructuring costs were recorded in Q1 FY2018, compared with $0.7 million in the prior-year quarter. Management stated that previously announced restructuring projects were completed in fiscal 2017 and no significant fiscal 2018 restructuring charges were expected.
- Reported gross margin improved, primarily due to product mix, Atlas sales, manufacturing efficiencies, and savings from facility closures, partly offset by commodity inflation and competitive pricing pressure.
- Interest expense increased to $0.4 million from negligible net interest income because the company borrowed under its revolving credit facility.
- Operating cash flow turned negative, primarily because accounts receivable increased and accounts payable and accrued expenses declined.
Outlook, Commentary, Risks and Unusual Items
Management stated that the revolving credit facility and operating cash flows were expected to be adequate for fiscal 2018 operating and capital expenditure needs. The filing does not provide formal revenue or earnings guidance.
- Goodwill impairment testing remains a key risk. Management planned another impairment analysis in the third quarter of fiscal 2018, and the valuation depends on forecasts, discount rates, stock price, and expected cash flows.
- Comparable sales excluding Atlas declined materially, including a 12.1% decline in comparable Lighting sales. Traditional lighting sales continued to decline as customers converted to LED products.
- Risks include product demand and acceptance, competition, customer concentration and credit quality, cyclical and seasonal demand, commodity costs, litigation and regulatory compliance, acquisition integration, key employee retention, and economic conditions.
- Warranty liabilities were $6.7 million at September 30, 2017. The company also maintains estimates for doubtful accounts, inventory obsolescence, returns, rebates, and customer deductions.
- The company stated that pending negotiations, customer bankruptcies, and legal proceedings were not expected to have a material adverse effect, although loss ranges were not disclosed because management considered the likelihood of material loss remote.
- The company adopted share-based payment guidance on July 1, 2017 and recorded an $81,000 excess tax benefit in income tax expense. Revenue recognition guidance and lease accounting changes were still under evaluation.
- The company declared a quarterly dividend of $0.05 per share, implying an indicated annual rate of $0.20 per share, subject to board discretion and financial conditions.
- Management excluded Atlas from its internal-control evaluation; Atlas represented 31% of consolidated assets at September 30, 2017. The filing text contains an apparent date inconsistency referring to the control evaluation as of September 30, 2016.
Investor Verification Priorities
- Verify whether Lighting operating performance and cash generation improve after excluding the one-time goodwill impairment and prior-year restructuring charges.
- Monitor comparable sales excluding Atlas, LED adoption, traditional-lighting declines, product pricing, and Lighting segment margins.
- Review the next goodwill impairment test and the assumptions supporting the remaining $30.5 million of net goodwill.
- Assess accounts receivable collection, DSO, inventory levels, and operating cash flow conversion.
- Confirm compliance with debt covenants and the availability and pricing of the revolving credit facility.
- Evaluate whether the $0.20 annualized dividend remains supported by earnings, cash flow, debt levels, and liquidity.
- Review the integration and control environment for Atlas, which was excluded from the internal-control evaluation.