# LSI INDUSTRIES INC (LYTS) FY 2023 MD&A

Verbatim Item 7 Management's Discussion and Analysis from LSI INDUSTRIES INC's 10-K for fiscal year 2023.

SEC filing source: https://www.sec.gov/Archives/edgar/data/763532/000143774923025488/lyts20230630_10k.htm
Accession: 0001437749-23-025488
Filing date: 2023-09-08
Report date: 2023-06-30
Extracted from a later financial-section MD&A body after the formal Item 7 span was a short reference.
Confidence: high

Company profile: /company/LYTS/
All MD&A years: /company/LYTS/mda/
Previous year: /company/LYTS/mda/fy2022/ (FY 2022)
Next year: /company/LYTS/mda/fy2024/ (FY 2024)

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 the Company’s operations and financial condition. 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, 2023, compared to the year ended June 30, 2022. For a discussion of the year ended June 30, 2022, compared to the year ended June 30, 2021, 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, 2022. 

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 and indoor 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

[[GREPCENT_TABLE]]
[["Net Sales by Business Segment"],["(In thousands)","","2023","","","2022"],["Lighting Segment","","$","272,451","","","$","233,449"],["Display Solutions Segment","","","224,528","","","","221,671"],["Total Net Sales","","$","496,979","","","$","455,120"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["Operating Income (Loss) by Business Segment"],["(In thousands)","","2023","","","2022"],["Lighting Segment","","$","31,633","","","$","20,942"],["Display Solutions Segment","","","24,920","","","","17,589"],["Corporate and Eliminations","","","(19,525",")","","","(17,330",")"],["Total Operating Income","","$","37,028","","","$","21,201"]]
[[/GREPCENT_TABLE]]

Fiscal 2023 net sales of $497.0 million increased $41.9 million or 9.2% as compared to fiscal 2022 net sales of $455.1 million. Net sales were favorably influenced by increased net sales in the Lighting Segment (an increase of $39.0 million or 16.7%) and primarily driven by increased net sales in the Display Solutions Segment (an increase of $2.9 million or 1.3%). The increase in sales is attributed to continued strength and focus in the key market verticals the Company serves.

Fiscal 2023 operating income of $37.0 million represents a $15.8 million increase from fiscal 2022 operating income of $21.2 million. Non-GAAP adjusted operating income in fiscal 2023 of $42.0 million increased $17.0 million or 68% from adjusted fiscal 2022 operating income of $25.0 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, sustained price disciplines, a higher-value sales mix, and strong operational execution.

- 23 -

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, long-term performance based compensation expense, severance costs, and commercial growth opportunity expense, 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 to adjusted EBITDA. 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 to adjusted EBITDA. 

Reconciliation of net income to adjusted net income

[[GREPCENT_TABLE]]
[["(In thousands, except per share data)","","2023","","","2022"],["","","","","","","","","","","Diluted EPS","","","","","","","","","","","Diluted EPS"],["Net Income as reported","","$","25,762","","","","","","","$","0.88","","","$","15,032","","","","","","","$","0.54"],["Acquisition costs","","","-","","","","","","","","-","","","","373","","","","(4",")","","","0.01"],["Long-Term Performance Based Compensation","","","2,879","","","","(1",")","","","0.10","","","","2,594","","","","(5",")","","","0.09"],["Severance costs","","","51","","","","(2",")","","","-","","","","4","","","","(6",")","","","-"],["Consulting Expense: Commercial Growth Opportunities","","","707","","","","(3",")","","","0.02","","","","-","","","","","","","","-"],["Net Tax impact due to the Distribution of Shares from the Company's Long-Term Performance Based Compensation Plan","","","(402",")","","","","","","","(0.01",")","","","-","","","","","","","","-"],["Net Income adjusted","","$","28,997","","","","","","","$","0.99","","","$","18,003","","","","","","","$","0.64"]]
[[/GREPCENT_TABLE]]

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:

[[GREPCENT_TABLE]]
[["(1)","$1,119"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(2)","$15"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(3)","$157"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(4)","$100"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(5)","$694"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(6)","$7"]]
[[/GREPCENT_TABLE]]

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

- 24 -

[[GREPCENT_TABLE]]
[["Reconciliation of operating income to adjusted operating income: (In thousands)","","2023","","","2022"],["Operating Income as reported","","$","37,028","","","$","21,201"],["Acquisition costs","","","-","","","","473"],["Long-Term Performance Based Compensation","","","3,998","","","","3,288"],["Severance costs","","","66","","","","11"],["Consulting Expense: Commercial Growth Opportunities","","","864","","","","-"],["Adjusted Operating Income","","$","41,956","","","$","24,973"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["Reconciliation of net income to EBITDA and Adjusted EBITDA (In thousands)","","2023","","","2022"],["Net Income - Reported","","$","25,762","","","$","15,032"],["Income Tax","","","7,564","","","","4,053"],["Interest Expense, net","","","3,687","","","","1,968"],["Other expense (income)","","","15","","","","148"],["Operating Income as reported","","$","37,028","","","$","21,201"],["Depreciation and Amortization","","","9,664","","","","10,118"],["EBITDA","","$","46,692","","","$","31,319"],["Acquisition costs","","","-","","","","473"],["Long-Term Performance Based Compensation","","","3,998","","","","3,288"],["Severance costs","","","66","","","","11"],["Consulting Expense: Commercial Growth Initiatives","","","864","","","","-"],["Adjusted EBITDA","","$","51,620","","","$","35,091"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["Reconciliation of cash flow from operations to free cash flow (In thousands)","","2023","","","2022"],["Cash Flow from Operations","","$","49,588","","","$","(3,863",")"],["Capital expenditures","","","(3,208",")","","","(2,122",")"],["Free Cash Flow","","$","46,380","","","$","(5,985",")"]]
[[/GREPCENT_TABLE]]

- 25 -

[[GREPCENT_TABLE]]
[["Net Debt to Adjusted EBITDA"],["(In thousands)","","June 30,","","","June 30,"],["","","2023","","","2022"],["Debt as reported","","$","35,200","","","$","79,596"],["Less:"],["Cash and cash equivalents as reported","","","1,828","","","","2,462"],["Net Debt","","$","33,372","","","$","77,134"],["Adjusted EBITDA","","$","51,620","","","$","35,091"],["Net Debt to Adjusted EBITDA","","","0.65","","","","2.20"]]
[[/GREPCENT_TABLE]]

Results of Operations

2023 Compared to 2022         

[[GREPCENT_TABLE]]
[["Lighting Segment"],["(In thousands)","","2023","","","2022"],["Net Sales","","$","272,451","","","$","233,449"],["Gross Profit","","$","86,761","","","$","70,120"],["Operating Income","","$","31,633","","","$","20,942"]]
[[/GREPCENT_TABLE]]

Lighting Segment net sales of $272.5 million in fiscal 2023 increased 16.7% from fiscal 2022 net sales of $233.4 million. The sales growth was across all key vertical markets, with significant contributions from new and enhanced products.

Gross profit of $86.8 million in fiscal 2023 increased $16.6 million or 23.7% from fiscal 2022. Gross profit as a percentage of net sales was 31.8% in fiscal 2023 compared to 30.0% in fiscal 2022. Contributors to the improvement of gross profit as a percentage of sales include an accelerated adoption of recently introduced products, sustained price disciplines, a higher value sales mix, and improved operational execution.

Operating expenses of $55.1 million in fiscal 2023 increased $5.9 million or 12.1% from fiscal 2022 operating expenses of $49.2 million, primarily driven by higher commission expense as a result of higher sales.

Fiscal 2023 Lighting Segment operating income of $31.6 million increased $10.7 million or 51.1% from operating income of $20.9 million in fiscal 2022 and operating income as a percentage of sales also increased from 9.1% to 11.6%. Both increases were primarily driven by sales volume and an improvement in gross profit as a percentage of sales.

[[GREPCENT_TABLE]]
[["Display Solutions Segment"],["(In thousands)","","2023","","","2022"],["Net Sales","","$","224,528","","","$","221,671"],["Gross Profit","","$","50,179","","","$","39,076"],["Operating Income","","$","24,920","","","$","17,589"]]
[[/GREPCENT_TABLE]]

Display Solutions Segment net sales of $224.5 million in fiscal 2023 increased $2.9 million or 1.3% from fiscal 2022 net sales of $221.7 million. The net increase in sales in the grocery and refueling/c-store market verticals was partially offset by the near completion of a $100 million QSR digital menu board program.

Gross profit of $50.2 million in fiscal 2023 increased $11.1 million or 28.4% from fiscal 2022. Gross profit as a percentage of net sales increased to 22.3% in fiscal 2023 compared from 17.6% in fiscal 2022. The increase in gross profit as a percentage of net sales was driven by improved program pricing and favorable customer mix.

- 26 -

Operating expenses of $25.3 million in fiscal 2023 increased $3.8 million or 17.6% from fiscal 2022. The increase of $3.8 million was driven by several factors including compensation, benefits, and commercial sales and marketing program costs to support sales growth, along with an increase in short-term performance based incentive plan expenses driven by improved business performance.

Fiscal 2023 Display Solutions Segment operating income of $24.9 million increased $7.3 million or 41.7% million from operating income of $17.6 million in fiscal 2022. The increase of $7.3 million was primarily driven by an increase in sales and an improvement in gross profit as a percentage of sales.

[[GREPCENT_TABLE]]
[["Corporate and Eliminations"],["(In thousands)","","2023","","","2022"],["Gross Profit","","$","5","","","$","12"],["Operating (Loss)","","$","(19,525",")","","$","(17,330",")"]]
[[/GREPCENT_TABLE]]

The gross profit relates to the intercompany profit in inventory elimination.

Operating expenses of $19.5 million in fiscal 2023 increased $2.2 million or 12.7% from fiscal 2022. The increase was primarily the result of an increase in short-term and long-term performance-based incentive plan expense driven by improved business performance and by commercial growth initiative consulting expense of $0.9 million for which there was no comparable expense in fiscal 2022.

Consolidated Results

Net interest expense of $3.7 million in fiscal 2023 compared to $2.0 million net interest expense in fiscal 2022. The increase in interest expense is primarily the results of increased borrowing costs. The Company also recorded a negligible amount of other expense in fiscal 2023 and $0.1 million of other expense in fiscal 2022, respectively, related to net foreign exchange currency transaction net losses through our Mexican and Canadian subsidiaries.

The $7.6 million of tax expense in fiscal 2023 reflects a consolidated effective tax rate of 22.7%. The $4.1 million of income tax expense in fiscal 2022 represents a consolidated effective tax rate of 21.2%. The increase in the effective tax rate is primarily driven by an increase in pre-tax profits in the higher taxing jurisdiction of Puerto Rico.

Reported net income of $25.8 million in fiscal 2023 compared to net income of $15.0 million in fiscal 2022. Non-GAAP adjusted net income was $29.0 million in fiscal 2023 compared to adjusted net income of $18.0 million in fiscal 2022 (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 and an improvement of gross profit as a percentage of sales. Diluted earnings per share of $0.88 was reported in fiscal 2023 compared to $0.54 diluted earnings per share in fiscal 2022. The weighted average common shares outstanding for purposes of computing diluted earnings per share in fiscal 2023 were 29,316,000 shares compared to 27,993,000 shares in fiscal 2022.

Liquidity and Capital Resources

The Company considers 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.

Working capital was $73.3 million at June 30, 2023, compared to $81.8 million at June 30, 2022. The ratio of current assets to current liabilities was 1.96 to 1 as of June 30, 2023, compared to a ratio of 2.06 to 1 as of June 30, 2022. The $8.5 million decrease in working capital from June 30, 2022, to June 30, 2023, is primarily driven by a $10.7 million decrease in inventory, partially offset by a $2.1 million increase in refundable income taxes.

Net accounts receivable were $77.7 million and $77.8 million at June 30, 2023, and June 30, 2022, respectively. Net accounts receivable remained relatively flat from prior year. Days Sales Outstanding (DSO) was 57 days and 54 days as of June 30, 2023, and June 30, 2022, respectively. We believe that our receivables are ultimately collectible or recoverable, net of certain reserves, and that aggregate allowances for credit losses are adequate.

- 27 -

Net inventories of $63.7 million at June 30, 2023, decreased $10.7 million from $74.4 million at June 30, 2022. The decrease of $10.7 million is the primarily the result of a combination of decrease in gross inventory of $9.9 million and an increase of $0.8 million in obsolescence reserves. Lighting Segment net inventory decreased $7.8 million, and net inventory in the Display Solutions Segment decreased $2.9 million.

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, 2023, $58.5 million of the line of credit was available. As of June 30, 2023, 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.

The Company generated $49.6 million of cash from operating activities in fiscal 2023 compared to a use of cash of $3.8 million in fiscal 2022. The $53.4 million increase in net cash flows from operating activity is primarily the result of strong improvement of cash flow generated from effective working capital management and from cash flow from earnings.

The Company used $3.2 million of cash from investing activities in fiscal 2023 compared to a use of cash of $1.6 million in fiscal 2022. Capital expenditures were $3.2 million in fiscal 2023 compared to $2.1 million in fiscal 2022. The Company received $0.5 million of cash related to the settlement of working capital adjustments from the acquisition of JSI in fiscal 2022 with no comparable event in fiscal 2023.

The Company had a use of cash of $47.1 million related to financing activities in fiscal 2023 compared to a source of cash of $5.6 million in fiscal 2022. The $52.7 million change in cash flow was primarily the result of cash generated from improved working capital management and from improved earnings, which was used to pay down the Company’s line of credit in fiscal 2023. Also contributing to the reduction of debt was $3.9 million of cash received from the exercise of stock options in the second and third quarters of fiscal 2023

The Company has on its 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 2023, the Board of Directors declared a regular quarterly cash dividend of $0.05 per share payable September 5, 2023, to shareholders of record as of August 28, 2023. The indicated annual cash dividend rate for fiscal 2023 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 of 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 policy that management believes is critical to the understanding and evaluating our reported financial results is the warranty reserve. 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

- 28 -

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. Warranty reserves are subject to large reserve adjustments when actual warranty costs differ significantly from cost estimates. The Company also periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amount as necessary which can also cause large reserve adjustments. These adjustments may be required in the future, which could adversely affect our gross profit and results of operations. The same methodology was used for calculating warranty reserves in fiscal 2022 and fiscal 2023.

- 29 -