LSI INDUSTRIES INC (LYTS) FY 2022 MD&A

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand the results of operations and financial condition of Microsoft Corporation. MD&A is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying Notes to Financial Statements (Part II, Item 8 of this Form 10-K). This section generally discusses the results of our operations for the year ended June 30, 2022, compared to the year ended June 30, 2021. For a discussion of the year ended June 30, 2021, compared to the year ended June 30, 2020, please refer to Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended June 30, 2021.

Overview

LSI is a leading producer of non-residential lighting and retail display solutions. Non-residential lighting consists of high-performance, American-made lighting products. The Company’s strength in outdoor lighting applications creates opportunities for it to introduce additional solutions to its customers. Retail display solutions consist of graphics solutions, digital signage, and technically advanced food display equipment for strategic vertical markets. LSI’s team of internal specialists also provide comprehensive project management services in support of large-scale rollouts.

Summary of Consolidated Results

Fiscal 2022 net sales of $455.1 million increased $139.5 million or 44.2% as compared to fiscal 2021 net sales of $315.6 million. Net sales were favorably influenced by increased net sales in the Lighting Segment (up $44.4 million or 23.5%) and favorably influenced by increased net sales in the Display Solutions Segment (up $95.1 million or 75.1%). The growth can be attributed to continued strengthening demand in the Company’s core markets and from the acquisition of JSI.

Fiscal 2022 operating income of $21.2 million represents a $13.2 million increase from fiscal 2021 operating income of $8.0 million. Current year results include $0.5 million of transaction costs related to the acquisition of JSI. Prior year results were also unfavorably impacted by $2.9 million transaction costs related to the acquisition of JSI. Non-GAAP adjusted operating income in fiscal 2022 of $25.0 million increased $12.0 million or 93% from adjusted fiscal 2021 operating income of $13.0 million. Refer to “Non-GAAP Financial Measures” below for a reconciliation of Non-GAAP financial measures to U.S. GAAP measures. The increase in adjusted operating income was the net result of an increase in net sales, higher-value sales mix resulting from targeted pricing actions, and lower selling and administrative expenses.

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Non-GAAP Financial Measures

We believe it is appropriate to evaluate our performance after making adjustments to the as-reported U.S. GAAP operating income, net income, and earnings per share. Adjusted operating income, net income, and earnings per share, which exclude the impact of acquisition costs, stock compensation expense, severance costs and restructuring and plant closure (gains) costs are Non-GAAP financial measures. Also included below are Non-GAAP financial measures including Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA and Adjusted EBITDA), Free Cash Flow and Net Debt. We believe that these adjusted supplemental measures are useful in assessing the operating performance of our business. These supplemental measures are used by our management, including our chief operating decision maker, to evaluate business results. We exclude these items because they are not representative of the ongoing results of operations of our business. These Non-GAAP measures may be different from Non-GAAP measures used by other companies. In addition, the Non-GAAP measures are not based on any comprehensive set of accounting rules or principles. Non-GAAP measures have limitations, in that they do not reflect all amounts associated with our results as determined in accordance with U.S. GAAP. Therefore, these measures should only be used to evaluate our results in conjunction with corresponding GAAP measures. Below is a reconciliation of these non-GAAP measures to operating income, net income, and earnings per share for the periods indicated along with the calculation of EBITDA and Adjusted EBITDA, Free Cash Flow, and Net Debt.

The following represents the income tax effects of the adjustments in the tables above, which were calculated using the estimated combined U.S., Canada and Mexico effective income tax rates for the periods indicated:

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The reconciliation of reported earnings per share to adjusted earnings per share may not produce identical amounts due to rounding differences.

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Results of Operations

2022 Compared to 2021

Lighting Segment net sales of $233.4 million in fiscal 2022 increased 23.5% from fiscal 2021 net sales of $189.0 million. The sales growth was across all key vertical markets, with significant contributions from new and enhanced products.

Gross profit of $70.1 million in fiscal 2022 increased $13.1 million or 23.0% from fiscal 2021. Gross profit as a percentage of net sales was 30.0% in fiscal 2022 compared to 30.2% in fiscal 2021. Gross profit as a percentage of sales was relatively flat as selling price increase realization offset the majority of rapid cost increases to material input costs and transportation costs.

Operating expenses of $49.2 million in fiscal 2022 increased $5.5 million or 12.6% from fiscal 2021 operating expenses of $43.7 million, primarily driven by higher commission expense as a result of higher sales.

Fiscal 2022 Lighting Segment operating income of $20.9 million increased $7.6 million or 57.1% from operating income of $13.3 million in fiscal 2021 and operating income as a percentage of sales also increased from 7.1 to 9.0%. Both increases were primarily driven by sales volume and price realization..

Display Solutions Segment net sales of $221.7 million in fiscal 2022 increased $95.1 million or 75.1% from fiscal 2021 net sales of $126.6 million. The increase reflects the acquisition of JSI and continued growth in the grocery and quick-service-restaurant markets.

Gross profit of $39.1 million in fiscal 2022 increased $17.1 million or 77.7% from fiscal 2021. Gross profit as a percentage of net sales increased to 17.6% in fiscal 2022 compared from 17.4% in fiscal 2021. Gross profit as a percentage of net sales reflects both the accretive effect of the JSI acquisition and improvements to core business margins, partially offset by the impact of input costs.

Operating expenses of $21.5 million in fiscal 2022 increased $9.4 million or 77.2% from fiscal 2021, primarily driven by the inclusion of 12 months of results for JSI.

Fiscal 2022 Display Solutions Segment operating income of $17.6 million increased $7.7 or 78.3% million from operating income of $9.9 million in fiscal 2021. The increase of $7.7 million was primarily driven by an increase in sales.

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The gross profit (loss) relates to the intercompany profit in inventory elimination.

Operating expenses of $17.3 million in fiscal 2022 increased $2.2 million or 14.3% from fiscal 2021. The increase is primarily due an increase in stock compensation expense and incentive plan expenses as the result of improved business performance.

Consolidated Results

We reported $2.0 million net interest expense in fiscal 2022 compared to $0.3 million net interest expense in fiscal 2021. The increase in interest expense from fiscal 2021 to fiscal 2022 is the result of higher levels of debt outstanding on our credit facility which is the result of partially funding of the JSI acquisition. We also recorded other expense/(income) $0.1 and ($0.2) in fiscal 2022 and fiscal 2021, respectively, related to net foreign exchange currency transaction losses and gains through our Mexican and Canadian subsidiaries.

The $4.1 million of tax expense in fiscal 2022 reflects a consolidated effective tax rate of 21.2%. The $2.0 million of income tax expense in fiscal 2021 represents a consolidated effective tax rate of 25.9%. The effective tax rate in fiscal 2021 was higher as a result of non-deductible transaction costs related to the acquisition of JSI.

We reported net income of $15.0 million in fiscal 2022 compared to net income of $5.9 million in fiscal 2021. Non-GAAP adjusted net income was $18.0 million in fiscal 2022 compared to adjusted net income of $9.8 million in fiscal 2021 (Refer to the Non-GAAP tables above). The increase in Non-GAAP adjusted net income is primarily the result of an increase in net sales. Diluted earnings per share of $0.54 was reported in fiscal 2022 compared to $0.21 diluted earnings per share in fiscal 2021. The weighted average common shares outstanding for purposes of computing diluted earnings per share in fiscal 2022 were 27,993,000 shares compared to 27,440,000 shares in fiscal 2021.

Liquidity and Capital Resources

We consider our level of cash on hand, borrowing capacity, current ratio and working capital levels to be our most important measures of short-term liquidity. For long-term liquidity indicators, we believe our ratio of long-term debt to equity and our historical levels of net cash flows from operating activities to be the most important measures.

At June 30, 2022, we had working capital of $84.3 million, compared to $54.1 million at June 30, 2021. The ratio of current assets to current liabilities was 2.13 to 1 as of June 30, 2022, compared to a ratio of 1.76 to 1 as of June 30, 2021. The $30.2 million increase in working capital from June 30, 2021, to June 30, 2022, is primarily driven by a $15.5 million increase in inventory, a $20.1 million increase in accounts receivable offset by a $1.8 million increase in accounts payable and the $3.8 million current portion of the $25.0 million term loan.

Net accounts receivable were $77.8 million and $57.7 million at June 30, 2022, and June 30, 2021, respectively. The increase in accounts receivable is due primarily to an increase in sales. DSO was 54 days and 56 days as of June 30, 2022, and June 30, 2021, respectively. We believe that our receivables are ultimately collectible or recoverable, net of certain reserves, and that aggregate allowances for credit losses are adequate.

Net inventories of $74.4 million at June 30, 2022, increased $15.5 million from $58.9 million at June 30, 2021. The increase of $15.5 million is the primarily the result of an increase in gross inventory of $15.5 million and a negligible increase in obsolescence reserves. Lighting Segment net inventory increased $12.0 million, in anticipation of an increase in market demand and to mitigate escalating supply chain challenges in the first half of fiscal 2022. Net inventory in the Display Solutions Segment increased $3.5 million to support several on-going programs.

Cash generated from operations and borrowing capacity under our credit facility is our primary source of liquidity. In September 2021, we amended our previous $100 million secured line of credit, to a $25 million term loan and the remaining $75 million as a secured revolving line of credit. Both facilities expire in the third quarter of fiscal 2026. As of June 30, 2022, $17.7 million of the line of credit was available. As of June 30, 2022, we are in compliance with all of our loan covenants. We believe that our $100 million credit facility plus cash flows from operating activities are adequate for operational and capital expenditure needs for the next 12 months. We have on file with the SEC a shelf registration statement which allows us to sell any combination of common stock, preferred stock warrants, senior or subordinated debt securities or other securities in one or more offerings if we choose to do so in the future.

We used $3.8 million of cash from operating activities in fiscal 2022 compared to a source of cash of $28.0 million in fiscal 2021. The $31.8 million decrease in net cash flows from operating activity is the result of increases in inventory and accounts receivable and decreases in accrued expense and customer prepayments, partially offset by improved earnings and an increase in accounts payable.

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We used $1.6 million of cash from investing activities in fiscal 2022 compared to a use of cash of $93.0 million in fiscal 2021. Capital expenditures were approximately $2.0 million in both fiscal years. The primary difference between cash flow from investing activities is the acquisition of JSI.

We had a source of cash of $5.6 million related to financing activities in fiscal 2022 compared to a source of cash of $63.6 million in fiscal 2021. The $58.0 million change in cash flow was the net result of an increase in the borrowings on the line of credit to support the growth in working capital and due to the acquisition of JSI. Most of the growth in working capital can be attributed to the increase in inventory to ensure product availability for critical sales growth initiatives and to mitigate supply chain challenges.

We have on our balance sheet 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.

Off-Balance Sheet Arrangements

We have no financial instruments with off-balance sheet risk.

Cash Dividends

In August 2022, the Board of Directors declared a regular quarterly cash dividend of $0.05 per share payable September 6, 2022, to shareholders of record as of August 29, 2022. The indicated annual cash dividend rate for fiscal 2022 was $0.20 per share. The Board of Directors has adopted a policy regarding dividends which indicates that dividends will be determined by the Board of Directors at its discretion based upon its evaluation of earnings, cash flow requirements, financial conditions, debt levels, stock repurchases, future business developments and opportunities, and other factors deemed relevant.

Critical Accounting Policies and Use of Estimates

We have adopted various accounting policies to prepare the consolidated financial statements in accordance with U.S. GAAP. Our significant accounting policies are described in Note 1. "Summary if Significant accounting Policies" of the Notes to Consolidated Financial Statements. Some of those significant accounting policies require us to make difficult, subjective, or complex judgments or estimates. An accounting estimate is considered to be critical if it meets both of the following criteria: (i) the estimate requires assumptions about matters that are highly uncertain at the time the accounting estimate is made, and (ii) different estimates reasonably could have been used, or changes in the estimate that are reasonably likely to occur may have a material impact on our financial condition or results of operations. The significant accounting policies that management believes are critical to the understanding and evaluating our reported financial results include the following: income taxes, warranty, goodwill and intangible assets, stock-based compensation, and revenue recognition. For further information see Note 1. “Summary of Significant accounting Policies " of the Notes to Consolidated Financial Statements in this Annual Report on Form 10-K

Warranty Reserves:

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 amount as necessary. If actual warranty costs differ significantly from these estimates, adjustments may be required in the future, which could adversely affect our gross profit and results of operations.

Revenue Recognition:

The Company recognizes revenue when it satisfies the performance obligation in its customer contracts or purchase orders. Most of the Company’s products have a single performance obligation which is satisfied at a point in time when control is transferred to the customer. Control is generally transferred at time of shipment when title and risk of ownership passes to the customer. For customer contracts with multiple performance obligations, the Company allocates the transaction price and any discounts to each performance obligation based on relative standalone selling prices. Payment terms are typically within 30 to 90 days from the shipping date, depending on the terms with the customer. The Company offers standard warranties that do not represent separate performance obligations. Provisions for discounts, rebates, sales incentives, returns, and other adjustments are generally provided for in the period the related sales are recorded, based on management’s assessment of historical trends and projection of future results.

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Goodwill and Intangible Assets:

Goodwill represents the excess of purchase price over the fair value of the net assets of businesses acquired. The 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 the reporting unit 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 unit 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 the 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 relies upon a number of factors, judgments and estimates when conducting its impairment testing including, but not limited to, the Company’s stock price, 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.

Income Tax Valuation Allowances:

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. Changes in the expectations regarding the realization of deferred tax assets and any related valuation allowances, the development of the Company’s income tax provision, and the estimation of the liability for uncertain tax positions, could materially impact income tax expense in future periods.

Stock-Based Compensation:

The Company accounts for stock-based compensation to certain employees and its directors in accordance with accounting guidance for stock-based compensation. The accounting guidance requires companies to measure the cost of employee and director services received in exchange for an award of equity instruments, including stock options, restricted stock units, and performance stock units, based on the grant date fair value of the award and to recognize it as compensation expense over the period the employee is required to provide service in exchange for the award, usually the vesting period. Equity award forfeitures are recognized at the date of employee termination. If any of the assumptions used in the Black-Scholes pricing model changes significantly, stock-based compensation expense may differ materially in the future from that recorded in the current period

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