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 [ ]
Indicate by checkmark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) YES [ ] NO [X]
As of November 1, 2005 there were 20,178,664 shares of the Registrant’s common stock outstanding.
LSI INDUSTRIES INC. FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2005INDEX
This document contains certain forward-looking statements that are subject to numerous assumptions, risks or uncertainties. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. Forward-looking statements may be identified by words such as “estimates,” “anticipates,” “projects,” “plans,” “expects,” “intends,” “believes,” “seeks,” “may,” “will,” “should” or the negative versions of those words and similar expressions, and by the context in which they are used. Such statements are based upon current expectations of the Company and speak only as of the date made. Actual results could differ materially from those contained in or implied by such forward-looking statements as a result of a variety of risks and uncertainties. These risks and uncertainties include, but are not limited to, the impact of competitive products and services, product demand and market acceptance risks, reliance on key customers, financial difficulties experienced by customers, the adequacy of reserves and allowances for doubtful accounts, potential asset impairments, fluctuations in operating results or costs, the outcome of pending litigation, unexpected difficulties in integrating acquired businesses, and the ability to retain key employees of acquired businesses. The Company has no obligation to update any forward-looking statements to reflect subsequent events or circumstances.
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LSI INDUSTRIES INC.CONSOLIDATED INCOME STATEMENTS(Unaudited)
The accompanying Notes to Financial Statements are an integral part of these financial statements.
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LSI INDUSTRIES INC.
CONSOLIDATED BALANCE SHEETS(Unaudited)
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CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
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NOTES TO FINANCIAL STATEMENTS
NOTE 1: INTERIM FINANCIAL STATEMENTS
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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NOTE 3: MAJOR CUSTOMER CONCENTRATIONS
NOTE 4: BUSINESS SEGMENT INFORMATION
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The following information is provided for the following periods:
NOTE 5: EARNINGS PER COMMON SHARE
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NOTE 6: BALANCE SHEET DATA
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NOTE 7: GOODWILL AND OTHER INTANGIBLE ASSETS
Amortization Expense of Other Intangible Assets
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NOTE 8: REVOLVING LINES OF CREDIT AND LONG-TERM DEBT
NOTE 9: CASH DIVIDENDS
NOTE 10: EQUITY COMPENSATION
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NOTE 11: LOSS CONTINGENCY RESERVE
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Net Sales by Business Segment(In thousands, unaudited)
Net sales of $70,900,000 in the first quarter of fiscal 2006 increased 4% from fiscal 2005 first quarter net sales of $68,335,000. Lighting Segment net sales increased 10% to $49,383,000 and Graphics Segment net sales decreased 9% to $21,517,000 as compared to the prior year. Sales to the petroleum / convenience store market represented 25% and 23% of fiscal 2006 and 2005 first quarter net sales, 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 up 11% in the first quarter from last year’s same period to $17.6 million. The petroleum / convenience store market has been, and will continue to be, a very important niche market for the Company; however, if sales to other markets and customers increase more than net sales to this market, then the percentage of net sales to the petroleum / convenience store market would be expected to decline.
The $4.6 million increase in Lighting Segment net sales is primarily the result of an aggregate increase of $3.2 million of lighting sales to our niche markets of petroleum / convenience stores, automotive dealerships, quick service restaurants, and retail national accounts (including significantly increased sales to Wal-Mart Stores, Inc.), as well as a $1.8 million increase in commissioned net sales to the commercial and industrial lighting market. Net sales to Wal-Mart Stores, Inc. were approximately $7.5 million or 11% of the Company’s total net sales in the first quarter of fiscal 2006.
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The $2.1 million decrease in Graphics Segment net sales is primarily the net result of the effect of increased graphics net sales to the petroleum / convenience store market ($1.6 million), decreased menu board sales for two large fast food restaurant systems ($1.4 million), and decreased net sales to certain retail store customers (approximately $2.6 million, with about $0.7 million of this decrease related to a national drug store retailer for its re-branding program that is now complete). Decreases in net sales for these customers generally means that a larger roll out graphics program has been completed and sales are now reflective of ongoing business levels.
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. The Company may not always be able to replace net sales immediately when a large image conversion program has concluded. 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.
Gross profit of $18,712,000 in the first quarter of fiscal 2006 increased 5% from last year, and increased as a percentage of net sales to 26.4% in fiscal 2006 as compared to 26.1% in the same period last year. The increase in amount of gross profit is due primarily to the 4% net increase in net sales (made up of a 10% increase in the Lighting Segment and a 9% decrease in the Graphics Segment), product mix resulting in a lower content of material in cost of sales, substantially improved performance in the Company’s New York facility, partially offset by lower margins on installation revenue. While the Company instituted sales price increases on select lighting products in fiscal 2005, increased manufacturing wages ($0.7 million), competitive pricing pressures, unabsorbed manufacturing costs in the Company’s New York facility, and increased manufacturing expenses ($0.2 million of factory supplies, and $0.1 million of repairs & maintenance) partially offset the favorable influences on the Company’s gross profit margin.
Selling and administrative expenses in the first quarter of fiscal year 2006 increased $0.7 million and increased as a percentage of net sales to 18.3% from 18.0% in the same period last year. The first quarter of fiscal 2006 had two new non-cash charges: (1) a $573,000 expense related to variable accounting treatment for the Deferred Compensation Plan as the investments of this Plan in common shares of the Company were “marked-to-market” through September 9, 2005 when the Plan was amended to eliminate this variable accounting treatment and any similar charge in the future; and (2) stock option expense, which will be ongoing in future periods, of $118,000 as the Company implemented Statement of Financial Accounting Standards No. 123(R) on Share Based Payments. Otherwise, employee compensation and benefits expense decreased $0.5 million in the first quarter of fiscal 2006 as compared to the same period last year. Increased sales commissions ($0.4 million) and increased professional and legal fees ($0.3 million) were partially offset by reductions of other expenses in the first quarter of fiscal 2006.
The Company completed its annual goodwill impairment test as of July 1, 2005 as required by Statement of Financial Accounting Standards No. 142 (SFAS No. 142), “Goodwill and Other Intangible Assets,” and determined there was no impairment of goodwill. The Company did record an impairment of $186,000 in the first quarter of fiscal 2005. See Note 7 to the financial statements for additional information.
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The Company reported interest income of $96,000 in the first quarter of fiscal 2006 from short term cash investments as there was no debt during the period. The Company was in a borrowing position in fiscal 2005 and recorded $63,000 of interest expense in the first quarter of fiscal 2005. The effective tax rate in the first quarters of both fiscal 2006 and 2005 was 37.0%.
Net income increased 11% in the first quarter of fiscal 2006 to $3,669,000 as compared to $3,316,000 in the same period last year. The increase is primarily the result of increased gross profit on increased net sales, and net interest income as compared to net interest expense last year, partially offset by increased operating expenses, and income taxes. Diluted earnings per share was $0.18 in the first quarter of fiscal 2006 as compared to $0.17 per share in the same period last year, a 6% increase. The weighted average common shares outstanding for purposes of computing diluted earnings per share in the first quarter of fiscal 2006 were 20,344,000 shares as compared to 19,993,000 shares in the same period 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, 2005 the Company had working capital of $69.4 million, compared to $67.2 million at June 30, 2005. The ratio of current assets to current liabilities was 3.07 to 1 as compared to a ratio of 3.13 to 1 at June 30, 2005. The increase in working capital was primarily related to a significant increase in cash ($3.0 million), increased inventories ($2.4 million), increased other current assets ($0.1 million) and decreased accrued expenses ($2.2 million), partially offset by decreased accounts receivable ($1.5 million), and increased accounts payable ($4.1 million). The $1.5 million decrease in accounts receivable is due to higher fourth quarter fiscal 2005 net sales as compared to first quarter fiscal 2006 and a reduction in the Company’s DSO (days sales outstanding), which was 55 days at September 30, 2005 as compared to 59 days at June 30, 2005. As a result of the various customer programs the Company is currently working on, inventory increased in the first quarter of fiscal 2006 by $2.4 million. Raw materials inventories increased $0.1 million, work in process increased $0.5 million, and finished goods inventories increased about $1.8 million since the end of fiscal 2005.
The Company generated $6.7 million of cash from operating activities in the first quarter of fiscal 2006 as compared to a use of cash of $0.8 million in the same period last year. The $7.5 million increase in net cash flows from operating activities in the first quarter of fiscal 2006 is primarily the net result of increased net income ($0.4 million favorable), a decrease in accounts receivable (favorable change of $2.2 million), more of an increase in inventories (unfavorable change of $0.2 million), a net increase in accounts payable and accrued expenses rather than a decrease last year (favorable change of $3.8 million), a larger increase in net deferred income tax liabilities ($0.3 million favorable), and a favorable change of $1.0 million related to non-cash charges for the Company’s non-qualified deferred compensation plan and stock option expense.
Net accounts receivable were $45.3 million and $46.7 million at September 30, 2005 and June 30, 2005, respectively. The 3% decrease in receivables is due to the net result of decreased sales of the first quarter of fiscal 2006 as compared to the fourth quarter of fiscal 2005 as well as the timing of customer payments. The Company believes that its receivables
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are ultimately collectible or recoverable, net of certain reserves, and that aggregate allowances for doubtful accounts are adequate.
Inventories at September 30, 2005 increased $2.4 million from June 30, 2005 levels. An inventory increase of about $0.6 million occurred in the Lighting Segment, and Graphics Segment inventories increased about $1.8 million in the first quarter of fiscal 2006. The $4.1 million increase in accounts payable from June 30, 2005 to September 30, 2005 is related to the timing of both purchases of inventory and payments to suppliers.
Cash generated from operations and borrowing capacity under a line of credit agreement are the Company’s primary source of liquidity. The Company has an unsecured $50 million revolving line of credit with its bank group, all of which was available as of November 1, 2005. This line of credit consists of a $30 million three year committed credit facility expiring in fiscal 2008 and a $20 million credit facility with an annual renewal in the third quarter of fiscal 2006. The Company believes that the total of available lines of credit plus cash flows from operating activities is adequate for the Company’s fiscal 2006 operational and capital expenditure needs. The Company is in compliance with all of its loan covenants.
Capital expenditures of $0.9 million in the first quarter of fiscal 2006 compare to $1.0 million in the same period of fiscal 2005. Fiscal 2006 spending is primarily for tooling and equipment. The Company intends to expand its graphics facility in Rhode Island late in fiscal 2006, thereby increasing expected fiscal 2006 capital expenditures to the range of $7.0 to $8.0 million, exclusive of business acquisitions.
The Company used $2.8 million of cash related to financing activities in the first quarter of fiscal 2006 as compared to a generation of $2.4 million in the same period of fiscal 2005. The $5.2 million change between years is primarily the net result of no borrowings on the Company’s line of credit (unfavorable $3.5 million), increased cash dividend payments (unfavorable $2.6 million) pursuant to the Company’s increased indicated annual dividend payment amount, and increased net cash flow from the exercise of stock options and issuance or purchase of common shares pursuant to compensation programs (favorable $0.7 million).
On October 25, 2005 the Board of Directors declared a regular quarterly cash dividend of $0.12 per share (approximately $2,397,000) payable November 15, 2005 to shareholders of record on November 8, 2005. During the first quarter of fiscal 2006, the Company paid cash dividends of $3,980,000, as compared to $1,424,000 in the same period last year. 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
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circumstances, 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.
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 the installation of product; service revenue generated from providing the 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 typically recognized when the product is installed. In a few isolated situations or programs, product revenue is recognized when the product is shipped rather than after it has been installed, because by signed agreement the customer has taken title to and risk of ownership for the product at the time of shipment. 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, which coincides with the revenue recognition criteria. Shipping and handling revenue coincides with the recognition of revenue from sale of the product.
The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109 (SFAS No. 109), accordingly deferred income taxes are provided on items that are reported as either income or expense in different time periods for financial reporting purposes than they are for income tax purposes. Deferred income tax assets and liabilities are reported on the Company’s balance sheet. Significant management judgment is required in developing the Company’s income tax provision, including the determination of deferred tax assets and liabilities and any valuation allowances that might be required against deferred tax assets. Management has determined that no valuation allowances are required.
The Company operates in multiple taxing jurisdictions and is subject to audit in these jurisdictions. The Internal Revenue Service and other tax authorities routinely review the Company’s tax returns. These audits can involve complex issues which may require an extended
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period of time to resolve. The impact of these examinations on the Company’s liability for income taxes cannot be presently determined. In management’s opinion, adequate provision has been made for potential adjustments arising from these examinations.
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 adverse business conditions, economic factors and technological change or competitive activities may signal that an asset has become impaired. A goodwill impairment charge of $186,000 was recorded in fiscal 2005 resulting from the Company’s fiscal 2005 SFAS No. 142 annual review. See Note 7 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 negative operating cash flow, 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 is 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 have been no impairment charges related to long-lived tangible assets or definite-lived intangible assets recorded by the Company.
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.
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In November 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 151, “Inventory Costs.” This statement amends Accounting Research Board (ARB) No. 43, “Inventory Pricing,” to clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials should be recognized as current-period charges. In addition, this statement requires that allocation of fixed production overheads to the cost of conversion be based on the normal capacity of the production facilities. SFAS No. 151 is effective for fiscal years beginning after June 15, 2005, or the Company’s 2006 fiscal year beginning July 1, 2005. The Company did not have any significant impact on its financial condition or results of operations when it was implemented.
In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 123(R) (revised 2004), “Share-Based Payment.” This statement establishes standards for the accounting of transactions in which an entity exchanges its equity instruments for goods or services, primarily when it obtains employee services in share-based payment transactions. SFAS No. 123(R) (revised 2004) supersedes the Accounting Principles Board Opinion No. 25, Accounting for Stock issued to Employees. This Statement requires public entities to measure the cost of employee services received in exchange for an award of equity instruments based upon the grant date fair value of the award, with this cost being recognized over the period during which an employee is required to provide the services. This statement is effective for the first fiscal year beginning after June 15, 2005, or the Company’s first quarter of fiscal 2006 which begins July 1, 2005. The Company implemented SFAS No. 123(R) in the first quarter of fiscal 2006 and recorded stock option expense consistent with what had previously been reported in a proforma manner in a note to the financial statements. See Note 10 for further discussion.
In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 153, “Exchanges of Nonmonetary Assets.” This statement addresses the measurement of exchanges of nonmonetary assets and is effective for fiscal periods beginning after June 15, 2005. The Company implemented this statement, but does not have any nonmonetary transactions and therefore there was no impact on its financial condition or results of operations.
In May 2005, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 154, “Accounting Changes and Error Corrections.” This statement replaces Accounting Principles Board (APB) Opinion No. 20, “Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements,” and changes the requirement for the accounting for and reporting of a direct effect of a voluntary change in accounting principle. It also applies to changes required by an accounting pronouncement in the instance that the pronouncement does not include specific transition provisions. SFAS No. 154 requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. This statement also requires that a change in depreciation, amortization, or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate affected by a change in accounting principle. This statement is effective for accounting changes and error corrections made in fiscal years beginning after December 15, 2005, or the Company’s first quarter of fiscal year 2007 which begins July 1, 2006. The Company will comply with the provisions of this statement for any accounting changes or error corrections that occur after June 30, 2006.
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Nothing to report.
An evaluation was performed as of September 30, 2005 under the supervision and with the participation of the Registrant’s management, including its principal executive officer and principal financial officer, of the effectiveness of the design and operation of the Registrant’s disclosure controls and procedures pursuant to Rule 13a-15(b) and 15d-15(b) promulgated under the Securities Exchange Act of 1934. Based upon this evaluation, these disclosure controls and procedures were found to be effective.
There have been no changes in the Registrant’s internal control over financial reporting that occurred during the most recently ended fiscal period of the Registrant or in other factors that have materially affected or are reasonably likely to materially affect the Registrant’s internal control over financial reporting.
ISSUER PURCHASES OF EQUITY SECURITIES
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a) Exhibits
31.1 Certification of Principal Executive Officer required by Rule 13a-14(a)
31.2 Certification of Principal Financial Officer required by Rule 13a-14(a)
32.1 Section 1350 Certification of Principal Executive Officer
32.2 Section 1350 Certification of Principal Financial Officer
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, 2005
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