LSI INDUSTRIES INC - Quarter Report: 2017 March (Form 10-Q)

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		Three Months Ended								Nine Months Ended
		March 31								March 31
(In thousands, except per share data)		2017				2016				2017				2016
Net sales		$	78,156			$	70,740			$	247,973			$	241,352
Cost of products and services sold			59,445				54,191				185,877				177,528
Restructuring costs			312				--				1,455				--
Gross profit			18,399				16,549				60,641				63,824
Impairment of intangible asset			479				--				479				--
Acquisition Deal Costs			1,480				--				1,480				--
Restructuring costs (gain)			(1,301	)			--				(1,091	)			--
Selling and administrative expenses			18,515				15,817				56,663				51,949
Operating income (loss)			(774	)			732				3,110				11,875
Interest (income)			(25	)			(28	)			(80	)			(54	)
Interest expense			188				9				209				27
Income (loss) before income taxes			(937	)			751				2,981				11,902
Income tax (benefit) expense			(406	)			229				677				3,848
Net income (loss)		$	(531	)		$	522			$	2,304			$	8,054
Earnings (loss) per common share (see Note 4)
Basic		$	(0.02	)		$	0.02			$	0.09			$	0.32
Diluted		$	(0.02	)		$	0.02			$	0.09			$	0.32
Weighted average common shares outstanding
Basic			25,452				25,080				25,346				24,918
Diluted			25,452				25,700				25,909				25,494

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		March 31,				June 30,
(In thousands, except shares)		2017				2016
ASSETS
Current Assets
Cash and cash equivalents		$	4,375			$	33,835
Accounts receivable, less allowance for doubtful accounts of $399 and $226, respectively			48,740				46,975
Inventories			48,460				44,141
Assets held for sale			1,463				--
Other current assets			3,852				2,792
Total current assets			106,890				127,743
Property, Plant and Equipment, at cost
Land			6,422				6,978
Buildings			35,430				39,317
Machinery and equipment			82,058				82,628
Construction in progress			1,721				838
			125,631				129,761
Less accumulated depreciation			(79,511	)			(82,299	)
Net property, plant and equipment			46,120				47,462
Goodwill			58,376				10,508
Other Intangible Assets, net			38,859				5,586
Other Long-Term Assets, net			5,671				4,261
Total assets		$	255,916			$	195,560

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		March 31,				June 30,
(In thousands, except shares)		2017				2016
LIABILITIES & SHAREHOLDERS’ EQUITY
Current Liabilities
Accounts payable		$	16,003			$	13,892
Accrued expenses			23,880				25,341
Total current liabilities			39,883				39,233
Long-Term Debt			54,966				--
Other Long-Term Liabilities			1,490				807
Commitments and Contingencies (Note 12)
Shareholders’ Equity
Preferred shares, without par value; Authorized 1,000,000 shares, none issued			—				—
Common shares, without par value; Authorized 40,000,000 shares; Outstanding 25,375,142 and 24,982,219 shares, respectively			119,178				113,653
Retained earnings			40,399				41,867
Total shareholders’ equity			159,577				155,520
Total liabilities & shareholders’ equity		$	255,916			$	195,560

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(In thousands)		Nine Months Ended
		March 31
		2017				2016
Cash Flows from Operating Activities
Net income		$	2,304			$	8,054
Non-cash items included in net income:
Depreciation and amortization			5,689				4,903
Intangible asset impairment			479				--
Deferred income taxes			(947	)			(126	)
Deferred compensation plan			196				328
Stock compensation expense			2,292				2,542
Issuance of common shares as compensation			331				168
(Gain) loss on disposition of fixed assets			52				(87	)
(Gain) on sale of building			(1,361	)			--
Fixed asset impairment and accelerated depreciation			354				--
Allowance for doubtful accounts			248				162
Inventory obsolescence reserve			981				1,351
Changes in certain assets and liabilities, net of acquisition:
Accounts receivable			5,189				5,588
Inventories			3,190				(4,440	)
Refundable income taxes			(143	)			(531	)
Accounts payable			(965	)			(3,176	)
Accrued expenses and other			(5,119	)			812
Customer prepayments			174				(310	)
Net cash flows provided by operating activities			12,944				15,238
Cash Flows from Investing Activities
Purchases of property, plant and equipment			(3,534	)			(8,410	)
Acquisition of business, net of cash received and warrants issued			(95,077	)			--
Proceeds from sale of fixed assets			3,081				124
Net cash flows (used in) investing activities			(95,530	)			(8,286	)
Cash Flows from Financing Activities
Payments of long-term debt			(14,882	)			--
Borrowings of long-term debt			69,649				--
Cash dividends paid			(3,772	)			(2,959	)
Exercise of stock options			2,401				3,604
Purchase of treasury shares			(446	)			(317	)
Issuance of treasury shares			176				90
Net cash flows provided by financing activities			53,126				418
Increase (decrease) in cash and cash equivalents			(29,460	)			7,370
Cash and cash equivalents at beginning of period			33,835				26,409
Cash and cash equivalents at end of period		$	4,375			$	33,779

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NOTE 1 -  INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

The interim condensed consolidated financial statements are unaudited and are prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information, and rules and regulations of the Securities and Exchange Commission.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the interim financial statements include all normal adjustments and disclosures necessary to present fairly the Company’s financial position as of March 31, 2017, the results of its operations for the three and nine month periods ended March 31, 2017 and 2016, and its cash flows for the nine month periods ended March 31, 2017 and 2016. These statements should be read in conjunction with the financial statements and footnotes included in the fiscal 2016 Annual Report on Form 10-K.  Financial information as of June 30, 2016 has been derived from the Company’s audited consolidated financial statements.

NOTE 2  -  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Consolidation:

 

The consolidated financial statements include the accounts of LSI Industries Inc. (an Ohio corporation) and its subsidiaries (collectively, the “Company”), all of which are wholly owned.  All intercompany transactions and balances have been eliminated in consolidation.

 

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 collectability is reasonably assured. Sales are recorded net of estimated returns, rebates and discounts. 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 has five 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 commissioning of lighting controls; revenue from the management of media content and digital hardware related to active digital signage; and revenue from shipping and handling.

 

Product revenue is recognized on product-only orders upon passing of title and risk of loss, generally at time of shipment. In certain arrangements with customers, as is the case with the sale of some of our solid-state LED (light emitting diode) video screens, revenue is recognized upon customer acceptance of the video screen at the job site. Product revenue related to orders where the customer requires the Company to install the product is recognized when the product is installed.  The Company provides product warranties and certain post-shipment service, support and maintenance of certain solid state LED video screens.

 

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 responsibilities, other than normal warranties.

 

Service revenue from integrated design, project and construction management, and site permitting is recognized when all products at a customer site have been installed.

 

Revenue from the management of media content and digital hardware related to active digital signage is recognized evenly over the service period with the customer. Media content service periods with most customers range from one month to one year.

 

Shipping and handling revenue coincides with the recognition of revenue from sale of the product.

 

 

In situations where the Company is responsible for re-imaging programs with multiple sites, each site is viewed as a separate unit of accounting and has stand-alone value to the customer. Revenue is recognized upon the Company’s complete performance at the location, which may include a site survey, graphics products, lighting products, and installation of products. The selling price assigned to each site is based upon an agreed upon price between the Company and its customer and reflects the estimated selling price for that site relative to the selling price for sites with similar image requirements.

 

The Company also evaluates the appropriateness of revenue recognition in accordance with the accounting standards on software revenue recognition. Our solid-state LED video screens and active digital signage contain software elements which the Company has determined are incidental.

 

Credit and Collections:

 

The Company maintains allowances for doubtful accounts receivable for probable 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 collectability problems of customers’ accounts, and then applying certain percentages against the various aging categories based on the due date 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.  Receivables deemed uncollectable are written-off against the allowance for doubtful accounts receivable after all reasonable collection efforts have been exhausted. The Company also establishes allowances, at the time revenue is recognized, for returns, discounts, pricing and other possible customer deductions.  These allowances are based upon historical trends.

 

The following table presents the Company’s net accounts receivable at the dates indicated.

 

 

Cash and Cash Equivalents:

 

The cash balance includes cash and cash equivalents which have original maturities of less than three months. Cash and cash equivalents consist primarily of bank deposits and a bank money market account that is stated at cost, which approximates fair value. The Company maintains balances at financial institutions in the United States.  In the United States, the FDIC limit for insurance coverage on non-interest bearing accounts is $250,000. As of March 31, 2017 and June 30, 2016, the Company had bank balances of $6,852,000 and $37,883,000, respectively, without insurance coverage.

 

Inventories and Inventory Reserves:

 

Inventories are stated at the lower of cost or market.  Cost of inventories includes the cost of purchased raw materials and components, direct labor, as well as manufacturing overhead which is generally applied to inventory based on direct labor and on material content. Cost is determined on the first-in, first-out basis.

 

The Company maintains an inventory reserve for obsolete and excess inventory. The Company first determines its obsolete inventory reserve by considering specific known obsolete items, and then by applying certain percentages to specific inventory categories based upon inventory turns. The Company uses various tools, in addition to inventory turns, to identify which inventory items have the potential to become obsolete. Judgment is used to establish excess and obsolete inventory reserves and management adjusts these reserves as more information becomes available about the ultimate disposition of the inventory item.  

 

 

Property, Plant and Equipment and Related Depreciation:

 

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.  Leasehold improvements are depreciated over the shorter of fifteen years or the remaining term of the lease.

 

The Company recorded $1,725,000 and $1,603,000 of depreciation expense in the third quarter of fiscal 2017 and 2016, respectively, and $5,122,000 and $4,524,000 of depreciation expense in the first nine months of fiscal 2017 and 2016, respectively.

 

The Company is in the process of selling its facility in Woonsocket, Rhode Island. This Graphics Segment facility, which is not expected to be sold at a loss, has been separately disclosed on the balance sheet as an asset held for sale as of March 31, 2017. The Company sold its Kansas City facility and certain manufacturing equipment in the third quarter of fiscal 2017. Refer to Note 14 for more information regarding the closure of these facilities.

 

Goodwill and Intangible Assets:

 

Intangible assets consisting of customer relationships, trade names and trademarks, patents, technology and software, and non-compete agreements are recorded on the Company's balance sheet.  The definite-lived intangible assets are being amortized to expense over periods ranging between seven and twenty years.  The Company evaluates definite-lived intangible assets for possible impairment when triggering events are identified. Neither indefinite-lived intangible assets nor the excess of cost over fair value of assets acquired ("goodwill") are amortized, however they are subject to review for impairment.  See additional information about goodwill and intangibles in Note 7.

 

Fair Value:

 

The Company has financial instruments consisting primarily of cash and cash equivalents, revolving lines of credit, accounts receivable, accounts payable, and on occasion, 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.

 

Fair value measurements of nonfinancial assets and nonfinancial liabilities are primarily used in goodwill and other intangible asset impairment analyses, long-lived asset impairment analyses, in the purchase price of acquired companies, and in the valuation of the contingent earn-out. The accounting guidance on fair value measurement was used to measure the fair value of these nonfinancial assets and nonfinancial liabilities.

 

Product Warranties:

 

The Company offers a limited warranty that its products are free from defects in workmanship and materials.  The specific terms and conditions vary somewhat by product line, but generally cover defective products returned within one to five years, with some exceptions where the terms extend to 10 years, from the date of shipment.  The Company records warranty liabilities to cover the estimated future costs for repair or replacement of defective returned products as well as products that need to be repaired or replaced in the field after installation.  The Company calculates its liability for warranty claims by applying estimates based upon historical claims as a percentage of sales to cover unknown claims, as well as estimating the total amount to be incurred for known warranty issues.  The Company periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary.

 

 

Changes in the Company’s warranty liabilities, which are included in accrued expenses in the accompanying consolidated balance sheets, during the periods indicated below were as follows:

 

 

 

Research and Development Costs:

 

Research and development costs are directly attributable to new product development, including the development of new technology for both existing and new products, and consist of salaries, payroll taxes, employee benefits, materials, outside legal costs and filing fees related to obtaining patents, supplies, depreciation and other administrative costs.   The Company expenses as research and development all costs associated with development of software used in solid-state LED products.  All costs are expensed as incurred and are included in selling and administrative expenses. Research and development costs related to both product and software development totaled $1,447,000 and $1,562,000 for the three months ended March 31, 2017 and 2016, respectively, and $4,117,000 and $4,193,000 for the nine months ended March 31, 2017 and 2016, respectively.

 

Cost of Products and Services Sold:

 

Cost of products sold is primarily comprised of direct materials and supplies consumed in the manufacture of products, as well as manufacturing labor, depreciation expense and direct overhead expense necessary to acquire and convert the purchased materials and supplies into finished product. Cost of products sold also includes the cost to distribute products to customers, inbound freight costs, internal transfer costs, warehousing costs and other shipping and handling activity. Cost of services sold is primarily comprised of the internal and external labor costs required to support the Company’s service revenue along with the management of media content.

 

Earnings Per Common Share:

 

The computation of basic earnings per common share is based on the weighted average common shares outstanding for the period net of treasury shares held in the Company’s nonqualified deferred compensation plan.  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, restricted stock units, stock warrants, contingently issuable shares and common shares to be issued under a deferred compensation plan, all of which totaled 297,000 and 893,000 shares for the three month ended March 31, 2017 and 2016, respectively, and 853,000 shares and 846,000 shares for the nine months ended March 31, 2017 and 2016, respectively. See further discussion of earnings per share in Note 4.

 

Income Taxes:

  

The Company accounts for income taxes in accordance with the accounting guidance for income taxes.  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 are reported on the Company’s balance sheet.  Significant management judgment is required in developing the Company’s income tax provision, including the estimation of taxable income and the effective income tax rates in the multiple taxing jurisdictions in which the Company operates, the estimation of the liability for uncertain income tax positions, the determination of deferred tax assets and liabilities, and any valuation allowances that might be required against deferred tax assets.

 

 

 

New Accounting Pronouncements:

 

In June 2014, the Financial Accounting Standards Board issued ASU 2014-09, “Revenue from Contracts with Customers.” This amended guidance supersedes and replaces all existing U.S. GAAP revenue recognition guidance. The guidance established a new revenue recognition model, changes the basis for deciding when revenue is recognized, provides new and more detailed guidance on specific revenue topics, and expands and improves disclosures about revenue. In April 2016, the FASB issued ASU 2016-10, “Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing.” In May 2016, the FASB issued ASU 2016-12, “Revenue from Contracts with Customers: Narrow Scope Improvements and Practical Expedients.” In December 2016, the FASB issued ASU 2016-20, “Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers.” These three standards clarify or improve guidance from ASU 2014-09 and are effective for fiscal years and interim periods within those years, beginning after December 15, 2017, or the Company’s fiscal year 2019. The Company will adopt these standards no later than July 1, 2018. While the Company is currently assessing the impact of the new standards, the Company’s revenue is primarily generated from the sale of finished products to customers. Those sales predominantly contain a single delivery element and revenue is recognized at a single point in time when ownership, risks, and rewards transfer. The recognition of revenue from most product sales is largely unaffected by the new standard. However, with respect to certain product sales requiring installation, revenue is currently not recognized until the installation is complete. While the Company does not expect this new guidance to have a material impact on the amount of overall sales recognized, the timing of recognition of revenues from sales on certain projects may be affected. The Company has not yet quantified this potential impact.

 

In November 2015, the FASB issued ASU 2015-17, “Balance Sheet Classification of Deferred Taxes,” which eliminates the current requirement to separate deferred income tax liabilities and assets into current and noncurrent amounts in the statement of financial position. This update requires that deferred tax liabilities and assets be classified as noncurrent. This update is effective for financial statements issued for fiscal years beginning April 1, 2017. This update may be applied either prospectively or retrospectively. However, early adoption is permitted and the Company has chosen to adopt the standard retrospectively as of June 30, 2016. As a result, prior periods have been adjusted to reflect this change. This update affected the presentation, but not the measurement of deferred tax liabilities and assets.

 

In February 2016, the Financial Accounting Standards Board issued ASU 2016-02, “Leases.” The amended guidance requires an entity to recognize assets and liabilities that arise from leases. The amended guidance is effective for financial statements issued for fiscal years and interim periods within those years, beginning after December 15, 2018, or the Company’s fiscal year 2020, with early adoption permitted. The Company has not yet determined the impact the amended guidance will have on its financial statements.  

  

Comprehensive Income:

 

The Company does not have any comprehensive income items other than net income.

 

Subsequent Events:

 

The Company has evaluated subsequent events for potential recognition and disclosure through the date the consolidated financial statements were filed.  No items were identified during this evaluation that required adjustment to or disclosure in the accompanying consolidated financial statements.

 

Reclassifications:

 

Certain prior year balance sheet amounts have been reclassified to conform to new accounting guidance on balance sheet classification of deferred taxes. These reclassifications have no impact on net income, earnings per share, or operating cash flows.

 

Use of Estimates:

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes.  Actual results could differ from those estimates.

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NOTE 3 - SEGMENT REPORTING INFORMATION

 

The accounting guidance on Segment Reporting establishes standards for reporting information regarding operating segments in annual financial statements and requires selected information of those segments to be presented in financial statements. Operating segments are identified as components of an enterprise for which separate discrete financial information is available for evaluation by the chief operating decision maker (the Company’s Chief Executive Officer or “CODM”) in making decisions on how to allocate resources and assess performance. The Company’s three operating segments are Lighting, Graphics, and Technology, each of which has a president who is responsible for that business and reports to the CODM. Corporate and Eliminations, which captures the Company’s corporate administrative activities, will also be reported in the segment information.

 

The Lighting Segment includes outdoor and indoor lighting utilizing both traditional and LED light sources that have been fabricated and assembled for the commercial, industrial market, the petroleum / convenience store market, the automotive dealership market, the quick service restaurant market, along with other markets the Company serves.

 

The Graphics Segment designs, manufactures and installs exterior and interior visual image elements such as traditional graphics, active digital signage along with the management of media content related to digital signage, LED video screens, and menu board systems that are either digital or traditional by design. These products are used in visual image programs in several markets including, but not limited to the petroleum / convenience store market, multi-site retail operations, banking, and restaurants. The Graphics Segment implements, installs and provides program management services related to products sold by the Graphics Segment and by the Lighting Segment.

 

LED video screens that were previously reported in the Technology Segment in prior years’ results have been reclassified to the Graphics Segment. The movement of the LED video screen product line was the result of a change in management responsibility of this product line to the Graphics Segment president during the first quarter of fiscal 2017. This movement aligns the product line with other digital visual image elements sold to graphics customers and is consistent with how the Company’s CODM manages the business. The movement of the video screen product line resulted in a reclassification of $96,000 of operating loss from the Technology Segment to the Graphics Segment in the third quarter of fiscal 2016, and $99,000 of operating loss in the first nine months of fiscal 2016.

 

The Technology Segment designs, engineers, and manufactures electronic circuit boards, assemblies and sub-assemblies, and various control system products used in other applications (primarily the control of solid-state LED lighting). This operating segment sells its products directly to customers (primarily in the transportation, original equipment manufacturers, sports, and medical markets) and also has significant inter-segment sales to the Lighting Segment.

 

The Company’s corporate administration activities are reported in the Corporate and Eliminations line item.  These activities primarily include intercompany profit in inventory eliminations, expense related to certain corporate officers and support staff, the Company’s internal audit staff, expense related to the Company’s Board of Directors, stock option expense for options granted to corporate administration employees, certain consulting expenses, investor relations activities, and a portion of the Company’s legal, auditing and professional fee expenses. Corporate identifiable assets primarily consist of cash, invested cash (if any), refundable income taxes (if any), and deferred income taxes.

 

There was no concentration of consolidated net sales in the three and nine months ended March 31, 2017 or March 31, 2016. There was no concentration of accounts receivable at March 31, 2017 or June 30, 2016.

 

 

Summarized financial information for the Company’s operating segments is provided for the indicated periods and as of March 31, 2017 and June 30, 2016:

 

 

 

 

The segment net sales reported above represent sales to external customers.  Segment operating income, which is used in management’s evaluation of segment performance, represents net sales less all operating expenses. Identifiable assets are those assets used by each segment in its operations.

 

 

The Company records a 10% mark-up on intersegment revenues. Any intersegment profit in inventory is eliminated in consolidation. Intersegment revenues were eliminated in consolidation as follows:

 

 

 

The Company’s operations are located solely within the United States. As a result, the geographic distribution of the Company’s net sales and long-lived assets originate within the United States.

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NOTE 4 - EARNINGS PER COMMON SHARE

 

The following table presents the amounts used to compute basic and diluted earnings per common share, as well as the effect of dilutive potential common shares on weighted average shares outstanding (in thousands, except per share data):

 

 

(a)

Includes shares accounted for like treasury stock included in the Company’s non-qualified deferred compensation plan. (See Note 10.)

 

(b)

Calculated using the “Treasury Stock” method as if dilutive securities were exercised and the funds were used to purchase common shares at the average market price during the period.

 

(c)

Options to purchase 1,032,250 common shares at March 31, 2016, and options to purchase 1,683,883 common shares and 1,391,300 common shares at March 31, 2017 and 2016, respectively were not included in the computation of the three month and nine month periods for diluted earnings per share, respectively, because the exercise price was greater than the average fair market value of the common shares. For the three months ended March 31, 2017, the effect of dilutive securities was not included in the calculation of diluted earnings per share because there was a net operating loss for the period.

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NOTE 5 - INVENTORIES

 

The following information is provided as of the dates indicated:

 

NOTE 6 - ACCRUED EXPENSES

 

The following information is provided as of the dates indicated:

 

NOTE 7 - GOODWILL AND OTHER INTANGIBLE ASSETS

 

Carrying values of goodwill and other intangible assets with indefinite lives are reviewed at least annually for possible impairment. The Company may first assess qualitative factors in order to determine if goodwill and indefinite-lived intangible assets are impaired. If through the qualitative assessment it is determined that it is more likely than not that goodwill and indefinite-lived assets are not impaired, no further testing is required. If it is determined more likely than not that goodwill and indefinite-lived assets are impaired, or if the Company elects not to first assess qualitative factors, the Company’s impairment testing continues with the estimation of the fair value of reporting units and indefinite-lived intangible assets using a combination of a market approach and an income (discounted cash flow) approach, at the reporting unit level. The estimation of the fair value of reporting units and intangible assets 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.

 

The Company identified its reporting units in conjunction with its annual goodwill impairment testing.  The Company relies upon a number of factors, judgments and estimates when conducting its impairment testing including, but not limited to operating results, forecasts, anticipated future cash flows and marketplace data.  There are inherent uncertainties related to these factors and judgments in applying them to the analysis of goodwill impairment.

 

As of March 1, 2017, the Company performed its annual goodwill impairment test on the three reporting units that contain goodwill (excluding Atlas Lighting Products). The preliminary goodwill impairment test on one reporting unit in the Lighting Segment passed with a business enterprise value that was $60.0 million or 80% above the carrying value of this reporting unit including goodwill. The preliminary goodwill impairment test of the one reporting unit with goodwill in the Graphics Segment passed with an estimated business enterprise value that was $4.2 million or 423% above the carrying value of the reporting unit including goodwill. The preliminary goodwill impairment test of the reporting unit in the Technology Segment that contains goodwill passed with an estimated business enterprise value that was $23.2 million or 95% above the carrying value of this reporting unit including goodwill. The impairment test is expected to be completed in the fourth quarter of fiscal 2017. It is anticipated that the results of the test will not change when the test is complete.

 

 

The Company acquired all of the capital stock of Atlas Lighting Products, Inc., on February 21, 2017 (see Note 16). The total purchase price exceeded the estimated fair value of net assets by approximately $47.9 million, which was allocated to goodwill. A preliminary valuation of the goodwill and intangible assets was completed in March 2017, and preliminary purchase price allocations have been made at February 21, 2017. While identified intangible assets related to the Atlas acquisition are being amortized effective February 21, 2017 over appropriate lives, goodwill will not be amortized on the Company’s financial statements. Goodwill and intangible assets related to Atlas Lighting Products are included in the assets of the Lighting Segment. It is anticipated that the valuation analysis will be fully complete in the fourth quarter of fiscal 2017. Refer to Note 16 for additional information on the intangible assets of Atlas Lighting Products.

 

In March 2017, a customer relationship intangible asset with a net book value of $479,000 related to the LED video screen product line in the Graphics Segment was determined to be fully impaired. The Company deemed that distribution channels and corresponding projected future cash flows that support the customer list intangible asset are not adequate to support the asset.

 

The following table presents information about the Company's goodwill on the dates or for the periods indicated:

 

 

The Company performed its annual review of indefinite-lived intangible assets (excluding the intangible assets of Atlas Lighting Products) as of March 1, 2017 and determined there was no impairment. The preliminary indefinite-lived intangible impairment test passed with a fair market value that was $15.2 million or 445% above its carrying value. The impairment test is expected to be completed in the fourth quarter of fiscal 2017. It is anticipated that the results of the test will not change when the test is complete.

 

The gross carrying amount and accumulated amortization by major other intangible asset class is as follows:

 

 

 

 

 

 

The Company expects to record annual amortization expense as follows:

 

 

NOTE 8  -  REVOLVING LINE OF CREDIT AND LONG-TERM DEBT

 

In February, 2017 the Company amended its line of credit to increase it to a $100 million secured revolving line of credit, increased from the $30 million line of credit that was previously in place. The increased credit line was required for the funding of the acquisition of Atlas Lighting Products, Inc. The line of credit expires in the third quarter of fiscal 2022. Interest on the revolving line of credit is charged based upon an increment over the LIBOR rate as periodically determined, or at the bank’s base lending rate, at the Company’s option.  The increment over the LIBOR borrowing rate, as periodically determined, fluctuates between 125 and 250 basis points depending upon the ratio of indebtedness to earnings before interest, taxes, depreciation and amortization (“EBITDA”), as defined in the line of credit agreement. The increment over LIBOR borrowing rate will remain at 175 basis points for the next twelve months.  The fee on the unused balance of the $100 million committed line of credit is 15 basis points.  Under the terms of this line of credit, the Company has agreed to a negative pledge of real estate assets and is required to comply with financial covenants that limit the ratio of indebtedness to EBITDA and require a minimum fixed charge coverage ratio. As of March 31, 2017, there was $55.0 million borrowed against the line of credit, and $45.0 million was available as of that date. Based on the terms of the line of credit and the final principal due date, the debt has been classified as long term. The line of credit closing fees and legal fees of $199,000 have been recorded as a long term asset and are being amortized over the term of the line of credit.

 

 

The Company is in compliance with all of its loan covenants as of March 31, 2017.

NOTE 9 - CASH DIVIDENDS

 

The Company paid cash dividends of $3,772,000 and $2,959,000 in the nine months ended March 31, 2017 and 2016, respectively. Dividends on restricted stock units in the amount of $24,120 and $7,860 were accrued as of March 31, 2017 and 2016, respectively. These dividends will be paid upon the vesting of the restricted stock units when shares are issued to the award recipients. In April 2017, the Board of Directors declared a regular quarterly cash dividend of $0.05 per share payable May 16, 2017 to shareholders of record as of May 8, 2017. The indicated annual cash dividend rate is $0.20 per share.

NOTE 10 - EQUITY COMPENSATION 

 

Stock Based Compensation 

 

The Company has an equity compensation plan that was approved by shareholders in November 2012 and that covers all of its full-time employees, outside directors and certain advisors.  This 2012 Stock Incentive Plan replaced all previous equity compensation plans. The Company’s shareholders approved amendments to the 2012 Stock Incentive Plan that added 1,600,000 shares to the plan and implemented the use of a fungible share ratio that consumes 2.5 available shares for every 1 full value share awarded by the Company as stock compensation. The options granted or stock awards made pursuant to this plan are granted at fair market value at the date of grant or award.  Service-based options granted to non-employee directors become exercisable 25% each ninety days (cumulative) from the date of grant and options granted to employees generally become exercisable 25% per year (cumulative) beginning one year after the date of grant. Performance-based options granted to employees become exercisable 33.3% per year (cumulative) beginning one year after the date of grant. The maximum contractual term of the Company’s stock options is ten years.  If a stock option holder’s employment with the Company terminates by reason of death, disability or retirement, as defined in the Plan, the Plan generally provides for acceleration of vesting.  The number of shares reserved for issuance is 1,669,003 shares, all of which were available for future grant or award as of March 31, 2017.  This plan allows for the grant of incentive stock options, non-qualified stock options, stock appreciation rights, restricted and unrestricted stock awards, performance stock awards, stock warrants and other stock awards. Service based and performance based stock options were granted and restricted stock units (“RSU’s”) were awarded during the nine months ended March 31, 2017. As of March 31, 2017, a total of 3,631,155 options for common shares were outstanding from this plan as well as one previous stock option plan (which has also been approved by shareholders), and of these, a total of 1,423,528 options for common shares were vested and exercisable.  As of March 31, 2017, the approximate unvested stock option expense that will be recorded as expense in future periods is $3,508,348.  The weighted average time over which this expense will be recorded is approximately 24 months. Additionally, as of March 31, 2017, a total of 135,585 RSU’s were outstanding. The approximate unvested stock compensation expense that will be recorded as expense in future periods for the RSU’s is $752,231. The weighted average time over which this expense will be recorded is approximately 37 months.

 

Stock Warrants

 

The Company issued 200,000 fully vested stock warrants in the third quarter of fiscal 2017 in conjunction with the acquisition of Atlas Lighting Products, Inc., with the fair value of the warrants being included in the purchase price of that company rather than being expensed. See further discussion in Note 16. These 200,000 stock warrants were outstanding as of March 31, 2017. The fair value of the warrants on the date of grant was estimated using the Black-Scholes option pricing model. The below listed weighted average assumptions were used for the warrants.

 

 

The stock warrants issued during the quarter ended March 31, 2017 had an exercise price of $9.95, and a fair value of $2.87. As of March 31, 2017, the warrants had a remaining contractual life of 4.9 years.

 

 

Stock Options

 

The fair value of each option on the date of grant was estimated using the Black-Scholes option pricing model. The below listed weighted average assumptions were used for grants in the periods indicated.

 

 

At March 31, 2017, the 1,256,623 options granted during the first nine months of fiscal 2017 to employees had exercise prices ranging from $9.48 to $11.06 per share, fair values ranging from of $3.22 to $3.83 per share, and remaining contractual lives of between 9.3 and 10 years.

 

At March 31, 2016, the 1,026,800 options granted during the first nine months of fiscal 2016 to employees had exercise prices ranging from $8.84 to $11.87 per share, fair values ranging from of $3.28 to $4.52 per share, and remaining contractual lives of between 9.3 and 9.9 years.

 

The Company calculates stock option expense using the Black-Scholes model.  Stock option expense is recorded on a straight line basis, or sooner if the grantee is retirement eligible as defined in the 2012 Stock Incentive Plan, with an estimated 3.3% forfeiture rate effective January 1, 2017. Previous estimated forfeiture rates were between 2.0% and 3.5% between the periods January 1, 2013 through December 31, 2016. The expected volatility of the Company’s stock was calculated based upon the historic monthly fluctuation in stock price for a period approximating the expected life of option grants.  The risk-free interest rate is the rate of a five year Treasury security at constant, fixed maturity on the approximate date of the stock option grant.  The expected life of outstanding options is determined to be less than the contractual term for a period equal to the aggregate group of option holders’ estimated weighted average time within which options will be exercised.  It is the Company’s policy that when stock options are exercised, new common shares shall be issued.  

 

The Company recorded $510,851 and $360,952 of expense related to stock options in the three months ended March 31, 2017 and 2016, respectively, and recorded $1,806,860 and $2,191,659 of expense related to stock options in the nine months ended March 31, 2017 and 2016, respectively.  The lower stock option expense in fiscal 2017 was the result of expectations that the performance criteria related to performance based options will not be met. As of March 31, 2017, the Company had 3,148,352 stock options that were vested and that were expected to vest, with a weighted average exercise price of $9.20 per share, an aggregate intrinsic value of $4,515,257 and weighted average remaining contractual terms of 7.2 years.

 

Information related to all stock options for the nine months ended March 31, 2017 and 2016 is shown in the following tables:

 

 

 

 

 

 

The following table presents information related to unvested stock options:

 

 

 

The weighted average grant date fair value of options granted during the nine month periods ended March 31, 2017 and 2016 was $3.71 and $3.64, respectively. The aggregate intrinsic value of options exercised during the nine months ended March 31, 2017 and 2016 was $1,094,696 and $1,474,444, respectively. The aggregate grant date fair value of options that vested during the nine months ended March 31, 2017 and 2016 was $2,260,014 and $1,149,022, respectively. The Company received $2,612,578 and $3,737,233 of cash from employees who exercised options in the nine month periods ended March 31, 2017 and 2016, respectively. For the nine months ended March 31, 2017, the $2,612,578 cash received from stock options was partially offset by $138,793 related to the tax effect of disqualifying dispositions of stock options along with $72,399 related to the net tax effect of other stock option exercises. For the nine months ended March 31, 2016, the $3,737,233 cash received from stock options was partially offset by $133,172 related to the tax effect of disqualifying dispositions of stock options. In the first nine months of fiscal 2017 the Company recorded $465,521as a reduction of federal income taxes payable, $138,793 as a decrease in common stock, $109,140 as a reduction of income tax expense, and $495,175 as a reduction of the deferred tax asset related to the issuance of RSU’s and the exercises of stock options in which the employees sold the common shares prior to the passage of twelve months from the date of exercise. In the first nine months of fiscal 2016 the Company recorded $518,515 as a reduction of federal income taxes payable, $133,172 as a decrease in common stock, $95,543 as a reduction of income tax expense, and $556,144 as a reduction of the deferred tax asset related to the exercises of stock options in which the employees sold the common shares prior to the passage of twelve months from the date of exercise.

 

Restricted Stock Units

 

A total of 96,210 RSU’s with a weighted average fair value of $10.84 per share were awarded to employees during the nine months ended March 31, 2017. A total of 72,000 RSU’s with a fair value of $9.39 per share were awarded to employees during the nine months ended March 31, 2016. The Company determined the fair value of the awards based on the closing price of the Company stock on the date the RSU’s were awarded. The RSU’s have a four year ratable vesting period. The RSU’s are non-voting, but accrue cash dividends at the same per share rate as those cash dividends declared and paid on LSI’s common stock. Dividends on RSU’s in the amount of $24,120 and $7,860 were accrued as of March 31, 2017 and 2016, respectively. Accrued dividends are paid to the holder upon vesting of the RSU’s and issuance of shares.

 

 

The following table presents information related to RSU’s:

            

                                                                                                                  

As of March 31, 2017, the 135,585 RSU’s had a remaining weighted average contractual life of 6.2 years. Of the 135,585 RSU’s outstanding as of March 31, 2017, 130,316 are vested or expected to vest in the future. An estimated forfeiture rate of 3.4% was used in the calculation of expense related to the RSU’s. The Company recorded $93,905 and $486,102 of expense related to RSU’s in the three and nine month periods ended March 31, 2017, respectively.

 

As of March 31, 2016, the 65,500 outstanding RSU’s had a remaining weighted average contractual life of 9.25 years. Of the 65,500 RSU’s outstanding as of March 31, 2016, 63,369 were vested or expected to vest in the future. An estimated forfeiture rate of 3.3% was used in the calculation of expense related to the RSU’s. The Company recorded $30,387 and $350,369 of expense related to RSU’s in the three and nine month periods ended March 31, 2016, respectively.

 

Director and Employee Stock Compensation Awards

 

The Company awarded a total of 31,782 and 17,240 common shares in the nine months ended March 31, 2017 and 2016, respectively, as stock compensation awards. These common shares were valued at their approximate $331,000 and $168,000 fair market values based on their stock price at dates of issuance multiplied by the number of common shares awarded, respectively, pursuant to the compensation programs for non-employee directors who receive a portion of their compensation as an award of Company stock and for employees who received a nominal recognition award in the form of Company stock. Stock compensation awards are made in the form of newly issued common shares of the Company.

 

Deferred Compensation Plan 

 

The Company has a non-qualified deferred compensation plan providing for both Company contributions and participant deferrals of compensation. This plan is fully funded in a Rabbi Trust. All plan investments are in common shares of the Company. As of March 31, 2017, there were 29 participants, all with fully vested account balances. A total of 255,119 common shares with a cost of $2,437,880, and 228,103 common shares with a cost of $2,167,717 were held in the plan as of March 31, 2017 and June 30, 2016, respectively, and, accordingly, have been recorded as treasury shares. The change in the number of shares held by this plan is the net result of share purchases and sales on the open stock market for compensation deferred into the plan and for distributions to terminated employees. The Company does not issue new common shares for purposes of the non-qualified deferred compensation plan. The Company used approximately $446,251 and $316,900 to purchase 45,335 and 32,696 common shares of the Company in the open stock market during the nine months ended March 31, 2017 and 2016, respectively, for either employee salary deferrals or Company contributions into the non-qualified deferred compensation plan. For fiscal year 2017, the Company estimates the Rabbi Trust for the Nonqualified Deferred Compensation Plan will make net repurchases in the range of 48,000 to 53,000 common shares of the Company. The Company does not currently repurchase its own common shares for any other purpose.

NOTE 11 -  SUPPLEMENTAL CASH FLOW INFORMATION

 

 

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NOTE 12 - COMMITMENTS AND CONTINGENCIES

 

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. The Company does not disclose a range of potential loss because the likelihood of such a loss is remote. 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 Company may occasionally issue a standby letter of credit in favor of third parties. As of March 31, 2017, there were no standby letter of credit agreements.

NOTE 13 – SEVERANCE COSTS

 

The Company recorded severance expense of $222,000 and $401,000 in the nine months ended March 31, 2017 and 2016, respectively. This severance expense was related to reductions in staffing not related to plant restructuring. See further discussion of restructuring expenses in Note 14.

 

The activity in the Company’s accrued severance liability is as follows for the periods indicated:

 

 

 

NOTE 14 – RESTRUCTURING COSTS

 

On September 22, 2016, the Company announced plans to close its lighting facility in Kansas City, Kansas. The decision was based upon the market shift away from fluorescent and other technologies and the rapid movement to LED lighting which is produced at other LSI facilities. The Company expects to continue to meet the demand for products containing fluorescent light sources as long as these products are commercially viable. All operations at the Kansas City facility ceased prior to December 31, 2016. Total restructuring costs related to the closure of the Kansas City facility were $944,000. These costs primarily included employee-related costs (primarily severance), the impairment of manufacturing equipment, plant shut down costs, costs related to the preparation of the facility for sale, legal costs, and other related costs. In addition, there was also an inventory write-down of $432,000 recorded in the first nine months of fiscal 2017. The write-down was related to inventory that was previously realizable until the decision in the first quarter of fiscal 2017 to shut down the Kanas City plant due to the planned curtailment of the manufacturing of fluorescent light fixtures. The Company owned the facility in Kansas City and realized a $1,361,000 gain when the facility was sold.

 

The Company also announced the consolidation of the Beaverton, Oregon facility into other LSI facilities. The light assembly of products in the Beaverton facility was moved to the Company’s Columbus, Ohio facility, and administration and engineering functions were moved to the Company’s Cincinnati, Ohio facility. This consolidation was completed September 30, 2016. As a result of this consolidation, restructuring charges of $363,000 were recorded in the first nine months of fiscal 2017, with the majority of this representing the costs related to the remaining period of the facility’s lease and severance costs for employees who formerly worked in the Beaverton facility.

 

In November 2016, the Company announced the consolidation of the Woonsocket, Rhode Island manufacturing operation into its North Canton, Ohio operation. The manufacturing operations in Woonsocket ceased prior to December 31, 2016. The Company owns the facility in Woonsocket and expects to realize a gain when the facility is sold. The facility is presented on the balance sheet as an asset held for sale. Total restructuring costs related to the consolidation of the Woonsocket facility are expected to be approximately $464,000. These costs primarily include employee-related costs (severance), plant shut down costs, costs related to the preparation of the facility for sale, legal costs, and other related costs.

 

 

The following table presents information about restructuring costs for the periods indicated:

 

 

 

Impairment and accelerated depreciation expense of $354,000 was recorded in the first nine months of fiscal 2017 related to machinery and equipment at the Kansas City and Beaverton facilities. There was no impairment expense related to the closure of the Woonsocket facility. Of the $354,000 of impairment and accelerated depreciation expense, $322,000 was recorded in the Lighting Segment and $32,000 was recorded in the Technology Segment. The fair value of the equipment evaluated for impairment was determined by comparing the future undiscounted cash flows to the carrying value of the assets. The future cash flows are from the remaining use of the assets as well as the cash flows expected to result from the future sale of the assets.

 

The following table presents restructuring costs incurred by line item in the consolidated statement of operations in which the costs are included:

 

 

 

The following table presents information about restructuring costs by segment for the periods indicated:

 

 

 

The above tables include the gain on the sale of the Kansas City facility, and exclude the expected gain on the Woonsocket facility. Additionally, the above tables do not include expense of $432,000 recorded during the first nine months of fiscal 2017 related to the write-down of inventory included as cost of sales as part of the Kansas City facility closure.   

 

The following table presents a roll forward of the beginning and ending liability balances related to the restructuring costs:

 

 

 

The above table does not include fixed asset impairment and accelerated depreciation expense of $354,000 recorded in the first nine months of fiscal 2017 or the gain on the sale of the Kansas City facility recorded in the three months ended March 31, 2017.

 

Refer to Note 13 for information regarding additional severance expenses that are not included in the restructuring costs identified in this footnote.