FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Commission File No. 0-13375
LSI Industries Inc.
State of Incorporation - - Ohio IRS Employer I.D. No. 31-0888951
10000 Alliance Road
Cincinnati, Ohio 45242
(513) 793-3200
Indicate by checkmark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by checkmark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES [X] NO [ ]
As of October 29, 2004 there were 19,772,714 shares of the Registrant’s common stock outstanding.
LSI INDUSTRIES INC. FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2004INDEX
“Safe Harbor” Statement under the Private Securities Litigation Reform Act of 1995
This documentcontains certain forward-looking statements thatare subject to numerous assumptions, risks oruncertainties. The Private Securities Litigation ReformAct of 1995 provides a safe harborfor forward-looking statements. Forward-looking statementsmay be identified by words such as“estimates,” “anticipates,” “projects,”“plans,” “expects,” “intends,”“believes,” “should” and similarexpressions, and the negative version thereof,and by the context in which they areused. Such statements are based uponcurrent expectations of the Company and speakonly as of the date made. Risksand uncertainties include, but are not limitedto, the impact of competitive productsand services, product demand and marketacceptance risks, reliance on key customers,financial difficulties experienced by customers, theadequacy of reserves and allowances for doubtfulaccounts, fluctuations in operating results orcosts, unexpected difficulties in integrating acquiredbusinesses, and the ability to retain key employees of acquired businesses. The Companyhas no obligation to update any forward-lookingstatements to reflect subsequent events orcircumstances.
Page 2
LSI INDUSTRIES INC.CONSOLIDATED INCOME STATEMENTS(Unaudited)
The accompanying Notes to Financial Statements are an integral part of these financial statements.
Page 3
LSI INDUSTRIES INC.
CONSOLIDATED BALANCE SHEETS(Unaudited)
Page 4
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Page 5
NOTES TO FINANCIAL STATEMENTS
NOTE 1: INTERIM FINANCIAL STATEMENTS
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements include the accounts of LSI Industries Inc. (an Ohio corporation) and its subsidiaries, all of which are wholly owned. All significant intercompany transactions and balances have been eliminated.
The Company has four sources of revenue: revenue from product sales; revenue from installation of products; service revenue generated from providing integrated design, project and construction management, site engineering and site permitting; and revenue from shipping and handling.
Product revenue is recognized on product-only orders at the time of shipment. Product revenue related to orders where the customer requires the Company to install the product is generally recognized when the product is installed. In some situations, product revenue is recognized when the product is shipped, before it is installed, because by agreement the customer has taken title to and risk of ownership for the product before installation has been completed. Other than normal product warranties or the possibility of installation, the Company has no post-shipment responsibilities.
Installation revenue is recognized when the products have been fully installed. The Company is not always responsible for installation of products it sells and, other than normal warranties, has no post-installation service contracts or responsibilities.
Service revenue from integrated design, project and construction management, site engineering and permitting is recognized at the completion of the contract with the customer. With larger customer contracts involving multiple sites, the customer may require progress billings for completion of identifiable, time-phased elements of the work, in which case revenue is recognized at the time of the progress billing which coincides with the completion of the earnings process.
Page 6
Shipping and handling revenue coincides with the recognition of revenue from sale of the product.
Amounts received from customers prior to the recognition of revenue are accounted for as customer pre-payments and are included in accrued expenses.
The Company periodically receives either grants or credits against state income taxes when it expands a facility and/or its level of employment in certain states within which it operates. A grant is amortized to income over the time period that the state could be entitled to return of the grant if the expansion or job growth were not maintained, and is recorded as a reduction of either manufacturing overhead or administrative expenses. A credit is amortized to income over the time period that the state could be entitled to return of the credit if the expansion were not maintained, is recorded as a reduction of state income tax expense, and is subject to a valuation allowance review if the credit cannot immediately be utilized.
Inventories are stated at the lower of cost or market. Cost is determined on the first-in, first-out basis.
Property, plant and equipment are stated at cost. Major additions and betterments are capitalized while maintenance and repairs are expensed. For financial reporting purposes, depreciation is computed on the straight-line method over the estimated useful lives of the assets as follows:
Costs related to the purchase, internal development, and implementation of the Company’s fully integrated enterprise resource planning/business operating software system are either capitalized or expensed in accordance with the American Institute of Certified Public Accountants’ Statement of Position 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” The capitalized implementation costs are depreciated over an eight year life from the date placed in service. Other purchased computer software is being depreciated over periods ranging from three to five years.
Intangible assets consisting of customer lists, trade names, patents and trademarks are recorded on the Company’s balance sheet and are being amortized to expense over periods ranging between fifteen and forty years. The excess of cost over fair value of assets acquired (“goodwill”) is not amortized but is subject to review for impairment. See additional information about goodwill and intangibles in Note 6. The Company periodically evaluates intangible assets, goodwill and other long-lived assets for permanent impairment. Impairments have been recorded only with respect to goodwill (see Note 6).
Page 7
The Company has financial instruments consisting primarily of cash and cash equivalents, revolving lines of credit, and long-term debt. The fair value of these financial instruments approximates carrying value because of their short-term maturity and/or variable, market-driven interest rates. The Company has no financial instruments with off-balance sheet risk.
The Company is party to various negotiations, customer bankruptcies, and legal proceedings arising in the normal course of business. The Company provides reserves for these matters when a loss is probable and reasonably estimable. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company’s financial position, results of operations, cash flows or liquidity.
The computation of basic earnings per common share is based on the weighted average common shares outstanding for the period. The computation of diluted earnings per share is based on the weighted average common shares outstanding for the period and includes common share equivalents. Common share equivalents include the dilutive effect of stock options, contingently issuable shares (for which issuance has been determined to be probable), and common shares to be issued under a deferred compensation plan, all of which totaled 235,000 shares and 270,000 shares for the three months ended September 30, 2004 and 2003, respectively. See also Note 4.
The company applies the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” Accordingly, no compensation expense has been reflected in the financial statements as the exercise price of options granted to employees and non-employee directors is equal to the fair market value of the Company’s common shares on the date of grant. The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123 (SFAS No. 123), “Accounting for Stock Based Compensation.”
If the Company had adopted the expense recognition provisions of SFAS No. 123, net income and earnings per share for the three month periods ended September 30, 2004 and 2003 would have been as follows:
Page 8
Since SFAS No. 123 has not been applied to options granted prior to December 15, 1994, the resulting compensation cost shown above may not be representative of that expected in future years.
The Company does not have any comprehensive income items other than net income.
Certain reclassifications may have been made to prior year amounts in order to be consistent with the presentation for the current year.
The preparation of the financial statements in conformity with generally accepted accounting principles requires the Company to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
NOTE 3: BUSINESS SEGMENT INFORMATION
Page 9
The following information is provided for the following periods:
NOTE 4: EARNINGS PER COMMON SHARE
Page 10
NOTE 5: BALANCE SHEET DATA
The following information is provided as of the dates indicated (in thousands):
Page 11
NOTE 6: GOODWILL AND OTHER INTANGIBLE ASSETS
page 12
NOTE 7: REVOLVING LINES OF CREDIT AND LONG-TERM DEBT
NOTE 8: CASH DIVIDENDS
Page 13
NOTE 9: SHAREHOLDERS’ EQUITY
Net Sales by Business Segment (In thousands, unaudited)
page 14
Net sales of $68,335,000 in the first quarter of fiscal 2005 increased 16% from first quarter fiscal 2004 net sales of $59,099,000. Lighting Segment net sales increased 23% to $44.7 million and Graphics Segment net sales increased 3% to $23.6 as compared to the prior year. Sales to the petroleum / convenience store market represented 23% and 29% of total net sales in the quarters ended September 30, 2004 and 2003, respectively. Net sales to this, the Company’s largest market, are reported in both the Lighting and Graphics Segments, depending upon the product or service sold, and were down 8% from the first quarter of fiscal 2004 to $15.8 million. The petroleum / convenience store market has been, and will continue to be, a very important niche market for the Company.
The $8.6 million increase in Lighting Segment net sales is primarily the result of an approximate $0.5 million increase in sales to the commercial / industrial lighting markets (resulting, in part, from a slight improvement in the economy, as well as good response from the Company’s new independent commercial sales representatives), and an aggregate increase of $7.9 million of lighting sales to our niche markets of petroleum / convenience store, automotive dealerships, quick service restaurants, and retail national accounts (including significantly increased sales to a major national retailer).
The $0.7 million increase in Graphics Segment net sales is primarily the result of the net effect of decreased graphics net sales to the petroleum / convenience store market ($2.5 million), increased menu board system sales (approximately $1.4 million) and increased net sales to retail store customers (approximately $1.8 million).
Image and brand programs, whether full conversions or enhancements, are important to the Company’s strategic direction. Image programs include situations where our customers refurbish their retail sites around the country by replacing some or all of the lighting, graphic elements, menu board systems and possibly other items they may source from other suppliers. These image programs often take several quarters to complete and involve both our customers’ corporate-owned sites as well as their franchisee-owned sites, the latter of which involve separate sales efforts by the Company with each franchisee. Brand programs typically occur as new products are offered or new departments are created within an existing retail store. Relative to net sales to a customer before and after an image or brand program, net sales during the program are typically significantly higher, depending upon how much of the lighting, graphics or menu board business is awarded to the Company. Sales related to a customer’s image or brand program are reported in either the Lighting Segment and/or the Graphics Segment, depending upon the product and/or service provided.
While sales prices in some markets that the Company serves were increased in the second half of fiscal year 2004, inflation did not have a significant impact on sales in first quarter of fiscal 2005. The Company experienced competitive pricing pressures in most markets, thereby holding price increases to a minimum. In some markets the Company was able to increase sales prices to recover increased raw material costs, but generally with little or no increase in gross profit. The rise in steel and aluminum prices caused a reduction in the gross profit margin.
Page 15
Gross profit of $17,805,000 in first quarter of fiscal 2005 increased 17% from last year, and increased as a percentage of net sales to 26.1% in first quarter of fiscal 2005 as compared to 25.8% last year. The increase in amount of gross profit is due primarily to the 16% increase in net sales, product mix and efficiencies, partially offset by higher installation, freight and distribution expenses. While the Company instituted sales price increases in the second half of fiscal 2004, manufacturing wages and compensation increases, competitive pricing pressures and increased material costs partially offset the favorable influences on the Company’s gross profit margin. Selling and administrative expenses in the first quarter of fiscal year 2005 increased $1.3 million and decreased as a percentage of net sales to 18% from 18.6% in the same period last year. First quarter of fiscal 2005 had increased employee compensation ($0.6 million due to increased salary rates, and increased staffing levels and incentive compensation), increase sales commissions in line with the increased net sales ($0.3 million) and increased depreciation expense ($0.2 million, primarily related to the Company’s business operating system).
The Company completed its annual goodwill impairment test as of July 1, 2004 as required by Statement of Financial Accounting Standards No. 142 (SFAS No. 142), “Goodwill and Other Intangible Assets,” and recorded an impairment of $186,000 in the first quarter of fiscal 2005. There was no impairment in fiscal 2004. See Note 6 to the financial statement for additional information.
The Company reported interest expense of $63,000 in first quarter of fiscal 2005 as compared to $84,000 last year. The average interest rate on the Company’s line of credit has increased in the first quarter of fiscal 2005 as compared to the same period last year. The effective tax rate in first quarter of both fiscal 2005 and 2004 was 37.0%.
Net income in the first quarter of fiscal 2005 was $3,316,000 as compared to $2,601,000 in the same period last year, a 27% increase. The increase is primarily the result of increased gross profit on increased net sales, partially offset by increased operating expenses, goodwill impairment and income taxes. Diluted earnings per share was $0.17 in first quarter of fiscal 2005 as compared to $0.13 per share in fiscal 2004. The weighted average common shares outstanding for purposes of computing diluted earnings per share in first quarter of fiscal 2005 was 19,993,000 shares as compared to 19,968,000 shares last year.
The Company considers its level of cash on hand, its borrowing capacity, its current ratio and working capital levels to be its most important measures of short-term liquidity. For long-term liquidity indicators, the Company believes its ratio of long-term debt to equity and its historical levels of net cash flows from operating activities to be the most important measures.
At September 30, 2004 the Company had working capital of $71.2 million, compared to $64.7 million at June 30, 2004. The ratio of current assets to current liabilities increased to 3.39 to 1 from 3 to 1. The $6.5 million increase in working capital is primarily attributed to increased cash, accounts receivable, inventories and other current assets, and decreased accounts payable and accrued expenses. The $0.8 million increase in accounts receivable is due to higher first quarter fiscal 2005 net sales as compared to fourth quarter fiscal 2004, as well as an increase in days sales outstanding (DSO). The DSO was 60 days at September 30, 2004, up from 59 days at June 30, 2004. Inventories, primarily raw materials and finished goods, have increased $2.2 million in 2005. Raw materials and work in process are down $0.6 million, and finished goods are up approximately $2.8 million since the end of fiscal 2004.
Page 16
The Company used $0.8 million of cash from operating activities in first quarter of fiscal 2005 as compared to a generation of cash of $0.7 million in the same period last year. The $1.5 million decrease in net cash flows from operating activities in first quarter of fiscal 2005 is primarily the net result of increased net income ($0.7 million favorable), less of an increase in accounts receivable (favorable change of $2.5 million), more of an increase in inventories (unfavorable change of $1.2 million), an aggregate $2.9 million decrease in accounts payable and accrued expenses in first quarter of fiscal 2005 as compared to an aggregate $0.9 million increase last year (net $3.8 million unfavorable), more depreciation, amortization and goodwill impairment in the first quarter of fiscal 2005 ($0.5 million favorable), and an unfavorable change of $0.3 million related to distributions out of the Company’s non-qualified deferred compensation plan.
Net accounts and notes receivables were $43.3 million and $42.5 million at September 30, 2004 and June 30, 2004, respectively. The 2% increase in receivables is due primarily to the increased sales of the first quarter of fiscal 2005 as compared to the fourth quarter of fiscal 2004 as well as the timing of customer payments. The Company converted the majority of one Graphics Segment customer’s account (petroleum / convenience store customer) into a collateralized note receivable during fiscal 2002. The balance of the note and unsecured receivable, net of reserves, was $0.6 million as of both September 30, 2004 and June 30, 2004. The Company has three of this customer’s retail sites as collateral on the note receivable. The Company is currently in litigation with this customer to obtain collection of all amounts owed to the Company. The Company believes that its receivables are ultimately collectible or recoverable, net of certain reserves, and that aggregate allowances for doubtful accounts are adequate.
Inventories at September 30, 2004 are up $2.2 million from June 30, 2004. The inventory increase occurred in the Graphics Segment in support of shipping requirements of various customer programs, primarily that of a large national retailer. The $2.1 million reduction of accrued expenses from June 30, 2004 to September 30, 2004 is related to first quarter fiscal 2005 payments of employee compensation and benefit accruals.
Cash generated from operations and borrowing capacity under its line of credit agreement are the Company’s primary source of liquidity. In addition, the Company has an unsecured $50 million revolving line of credit with its bank group. As of October 24, 2004 there was approximately $36 million available on this line of credit. This line of credit is composed of a $30 million three year committed credit facility expiring in fiscal 2007 and a $20 million credit facility with an annual renewal in the third quarter of fiscal 2005. The Company believes that the total of available lines of credit plus cash flows from operating activities is adequate for the Company’s fiscal 2005 operational and capital expenditure needs. The Company is in compliance with all of its loan covenants.
Capital expenditures of $1.0 million in first quarter of fiscal 2005 compare to $0.7 million in the same period of fiscal 2004. First quarter of fiscal 2005 spending is primarily for tooling and equipment. Total capital expenditures in fiscal 2005 are expected to be in the range of $5 to 6 million, exclusive of business acquisitions.
The Company generated $2.4 million in financing activities in first quarter of fiscal 2005 as compared to a use of $0.1 million in the same period of fiscal 2004. The change between years is primarily the net result of increased borrowing on the Company’s line of credit (favorable $2.5 million), increased dividend payments (unfavorable $0.5 million) pursuant to the Company’s increased indicated annual dividend payment amount, and increased cash flow from the exercise of stock options and issuance of common shares pursuant to compensation programs (favorable $0.3 million).
Page 17
On October 26, 2004 the Board of Directors declared a regular quarterly cash dividend of $0.072 per share (approximately $1,424,000), payable November 16, 2004 to shareholders of record on November 9, 2004. During first quarter of fiscal 2005, the Company paid cash dividends of $1,424,000, as compared to $945,000 in the same period of fiscal 2004. The declaration and amount of dividends will be determined by the Company’s Board of Directors, in its discretion, based upon its evaluation of earnings, cash flow, capital requirements and future business developments and opportunities, including acquisitions.
Carefully selected acquisitions have long been an important part of the Company’s strategic growth plans. The Company continues to seek out, screen and evaluate potential acquisitions that could add to the lighting or graphics product lines or enhance the Company’s position in selected markets. The Company believes adequate financing for any such investments or acquisitions will be available through future borrowings or through the issuance of common or preferred shares in payment for acquired businesses.
The Company is required to make estimates and judgments in the preparation of its financial statements that affect the reported amounts of assets, liabilities, revenues and expenses, and related footnote disclosures. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. The Company continually reviews these estimates and their underlying assumptions to ensure they remain appropriate. The Company believes the items discussed below are among its most significant accounting policies because they utilize estimates about the effect of matters that are inherently uncertain and therefore are based on management’s judgment. Significant changes in the estimates or assumptions related to any of the following critical accounting policies could possibly have a material impact on the financial statements.
Revenue Recognition
The Company recognizes revenue in accordance with Securities Exchange Commission Staff Accounting Bulletin No. 104, “Revenue Recognition.” Revenue is recognized when title to goods and risk of loss have passed to the customer, there is persuasive evidence of a purchase arrangement, delivery has occurred or services have been rendered, and collectibility is reasonably assured. Revenue is typically recognized at time of shipment. Sales are recorded net of estimated returns, rebates and discounts. Any cash received from customers prior to the recognition of revenue is accounted for as a customer pre-payment and is included in accrued expenses.
The Company has four sources of revenue: revenue from product sales; revenue from installation of product; service revenue generated from providing integrated design, project and construction management, site engineering, and site permitting; and revenue from shipping and handling. Product revenue is recognized on product-only orders at the time of shipment. Product revenue related to orders where the customer requires the Company to install the product is generally recognized when the product is installed. In some situations, product revenue is recognized when the product is shipped, before it is installed, because by agreement the customer has taken title to and risk of ownership for the product before installation has been completed. Other than normal product warranties or the possibility of installation, the Company has no post-shipment responsibilities.Installation revenue is recognized when the products have been fully installed. The Company is not always responsible for installation of products it sells and has no post-installation service contracts or responsibilities. Service revenue from integrated design, project and construction management, site engineering and permitting is recognized at the completion of the contract with the customer. With larger customer contracts involving multiple sites, the customer may require progress billings for completion of identifiable, time-phased elements of the work, in which case revenue is recognized at the time of the progress billing. Shipping and handling revenue coincides with the recognition of revenue from sale of the product.
Page 18
Asset Impairment
Carrying values of goodwill and other intangible assets with indefinite lives are reviewed at least annually for possible impairment in accordance with Statement of Financial Accounting Standards No. 142 (SFAS No. 142), “Goodwill and Other Intangible Assets,” which was adopted on July 1, 2002. The Company’s impairment review involves the estimation of the fair value of goodwill and indefinite-lived intangible assets using a discounted cash flow approach, at the reporting unit level, that requires significant management judgment with respect to revenue and expense growth rates, changes in working capital and the selection and use of an appropriate discount rate. The estimates of fair value of reporting units are based on the best information available as of the date of the assessment. The use of different assumptions would increase or decrease estimated discounted future operating cash flows and could increase or decrease an impairment charge. Company management uses its judgment in assessing whether assets may have become impaired between annual impairment tests. Indicators such as unexpected adverse business conditions, economic factors and unanticipated technological change or competitive activities may signal that an asset has become impaired. An impairment charge of $186,000 related to goodwill was recorded as an operating expense in the first quarter of fiscal 2005. See Note 6 to the financial statements for further discussion.
Carrying values for long-lived tangible assets and definite-lived intangible assets, excluding goodwill, are reviewed for possible impairment as circumstances warrant in connection with Statement of Financial Accounting Standards No. 144 (SFAS No. 144), “Accounting for the Impairment or Disposal of Long-Lived Assets,” which was adopted on July 1, 2002. Impairment reviews are conducted at the judgment of Company management when it believes that a change in circumstances in the business or external factors warrants a review. Circumstances such as the discontinuation of a product or product line, a sudden or consistent decline in the forecast for a product, changes in technology or in the way an asset is being used, a history of operating or cash flow losses, or an adverse change in legal factors or in the business climate, among others, may trigger an impairment review. The Company’s initial impairment review to determine if a potential impairment charge is required was based on an undiscounted cash flow analysis at the lowest level for which identifiable cash flows exist. The analysis requires judgment with respect to changes in technology, the continued success of product lines and future volume, revenue and expense growth rates, and discount rates. There were no impairment charges related to long-lived tangible assets or definite-lived intangible assets recorded by the Company during 2003 or 2004.
Credit and Collections
The Company maintains allowances for doubtful accounts receivable for estimated losses resulting from either customer disputes or the inability of its customers to make required payments. If the financial condition of the Company’s customers were to deteriorate, resulting in their inability to make the required payments, the Company may be required to record additional allowances or charges against income. The Company determines its allowance for doubtful accounts by first considering all known collectibility problems of customers’ accounts, and then applying certain percentages against the various aging categories of the remaining receivables. The resulting allowance for doubtful accounts receivable is an estimate based upon the Company’s knowledge of its business and customer base, and historical trends. The Company also establishes allowances, at the time revenue is recognized, for returns and allowances, discounts, pricing and other possible customer deductions. These allowances are based upon historical trends.
Page 19
Nothing to report.
a) Exhibits
[All other items required in Part II have been omitted because they are not applicable or are not required.]
Page 20
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
November 4, 2004