LSI INDUSTRIES INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) The Company's condensed consolidated financial statements, accompanying notes and the "Safe Harbor" Statement, each as appearing earlier in this report, should be referred to in conjunction with this Management's Discussion and Analysis of Financial Condition and Results of Operations.

Page 19 -------------------------------------------------------------------------------- Net Sales by Business Segment (In thousands) Three Months Ended Six Months Ended December 31 December 31 2012 2011 2012 2011 Lighting Segment $ 53,743 $ 53,526 $ 109,534 $ 102,697 Graphics Segment 10,532 10,091 21,277 20,579 Electronic Components Segment 4,959 4,215 10,713 8,619 All Other Category 1,848 942 4,277 2,374 $ 71,082 $ 68,774 $ 145,801 $ 134,269 Operating Income (Loss) by Business Segment (In thousands) Three Months Ended Six Months Ended December 31 December 31 2012 2011 2012 2011 Lighting Segment $ 2,477 $ 2,832 $ 6,990 $ 6,136 Graphics Segment (1,140 ) (868 ) (1,495 ) (1,449 ) Electronic Components Segment (1,559 ) 689 (773 ) 1,754 All Other Category (1,429 ) (228 ) (1,431 ) (367 ) Corporate and Eliminations (1,058 ) (1,206 ) (2,973 ) (2,677 ) $ (2,709 ) $ 1,219 $ 318 $ 3,397 Summary Comments Fiscal 2013 second quarter net sales of $71,082,000 increased $2.3 million or 3.4% as compared to second quarter fiscal 2012. Net sales were favorably influenced by increased net sales of the Lighting Segment (up $0.2 million or 0.4%), increased net sales of the Graphics Segment (up $0.4 million or 4.4%), increased net sales of the Electronic Components Segment (up $0.7 million or 17.7%) and increased net sales of the All Other Category (up $0.9 million or 96.2%). Net sales to the petroleum / convenience store market, the Company's largest niche market, were $21,865,000 or 31% of total net sales and $20,791,000 or 30% of total net sales in the second quarter of fiscal 2013 and 2012, respectively.

Fiscal 2013 first half net sales of $145,801,000 increased $11.5 million or 8.6% as compared to the same period of fiscal 2012. Net sales were favorably influenced by increased net sales of the Lighting Segment (up $6.8 million or 6.7%), increased net sales of the Graphics Segment (up $0.7 million or 3.4%), increased net sales of the Electronic Components Segment (up $2.1 million or 24.3%) and increased net sales of the All Other Category (up $1.9 million or 80.2%). Net sales to the petroleum / convenience store market, the Company's largest niche market, were $41,542,000 or 28% of total net sales and $37,569,000 or 28% of total net sales in the first half of fiscal 2013 and 2012, respectively.

The Company's total net sales of products and services related to solid-state LED technology in light fixtures and video screens for sports, advertising and entertainment markets have been recorded as indicated in the table below. In addition, the Company sells certain elements of graphic identification programs that contain solid-state LED light sources.

LED Net Sales (In thousands) FY 2013 FY 2012 % Change First Quarter $ 23,809 $ 15,842 50.3 % Second Quarter 18,724 20,471 (8.5 )% First Half 42,533 36,313 17.1 % Third Quarter 17,285 Nine Months 53,598 Fourth Quarter 19,802 Full Year $ 73,400 Page 20-------------------------------------------------------------------------------- LED net sales include sales of LED lighting products, certain graphics products containing LEDs, and LED video and sports screens. Second quarter fiscal 2013 LED net sales of $18,724,000 were down $1.7 million or 8.5% from the same period of the prior year. The $18,727,000 total LED net sales and the $1.7 million decrease are primarily the net result of Lighting Segment LED net sales of $18.2 million, which is comprised of $17.5 million of light fixtures having solid-state LED technology and $0.7 million related to video screens (down $1.8 million or 9.0%), Graphics Segment LED net sales of $0.3 million and All Other Category LED net sales of $0.1 million (Graphics Segments LED net sales and LED net sales to the All Other Category remained flat when compared to fiscal 2012).

First half fiscal 2013 total LED net sales of $42,533,000 were $6.2 million or 17.1% higher than the same period of the prior year. The $42,533,000 total LED net sales and the $6.2 million increase are primarily the net result of Lighting Segment LED net sales of $41.9 million, which is comprised of $36.9 million of light fixtures having solid-state LED technology and $5.0 million related to video screens (up $6.9 million or 19.6%), Graphics Segment LED net sales of $0.5 million (down $0.2 million or 29.9%), and All Other Category LED net sales of $0.1 million (down $0.4 million or 77.1%).

Non-GAAP Financial Measures The Company believes it is appropriate to evaluate its performance after making adjustments to the as reported U.S. GAAP net income (loss). Adjusted net income (loss) and earnings (loss) per share, which exclude the impact of the reduction of a contingent earn-out liability and goodwill impairments, are non-GAAP financial measures. 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. Below is a reconciliation of this non-GAAP measure to net income (loss) for the periods indicated.

(In thousands, except per share data; unaudited) Second Quarter FY 2013 Second Quarter FY 2012 Diluted Diluted Amount EPS Amount EPS Reconciliation of net income (loss) to adjusted net income (loss): Net income (loss) and earnings (loss) per share as reported $ (2,450 ) $ (0.10 ) $ 772 $ 0.03 Adjustment for the reduction of a contingent Earn-Out liability, inclusive of the income tax effect (511 )(1) (0.02 ) -- -- Adjustment for goodwill impairment, inclusive of the income tax effect $ 1,552 (2) $ 0.06 $ -- $ -- Adjusted net income (loss) and earnings (loss) per share $ (1,409 ) $ (0.06 ) $ 772 $ 0.03 Page 21--------------------------------------------------------------------------------(In thousands, except per share data; unaudited) First Half FY 2013 First Half FY 2012 Diluted Diluted Amount EPS Amount EPS Reconciliation of net income (loss) to adjusted net income (loss): Net income (loss) and earnings (loss) per share as reported $ (620 ) $ (0.03 ) $ 2,096 $ 0.09 Adjustment for the reduction of a contingent Earn-Out liability, inclusive of the income tax effect (511 )(1) (0.02 ) -- -- Adjustment for goodwill impairment, inclusive of the income tax effect $ 1,552 (2) $ 0.06 $ 258 (3) $ 0.01 Adjusted net income and earnings per share $ 421 $ 0.02 $ 2,354 $ 0.10 The income tax effects of the adjustments in the tables above were calculated using the estimated U.S. effective income tax rate for the period indicated. The income tax effects were as follows (in thousands): (1) $194 (2) $(589) (3) 0 Results of Operations THREE MONTHS ENDED DECEMBER 31, 2012 COMPARED TO THREE MONTHS ENDED DECEMBER 31, 2011 Lighting Segment (In thousands) Three Months Ended December 31 2012 2011 Net Sales $ 53,743 $ 53,526 Gross Profit $ 12,105 $ 11,807 Operating Income $ 2,477 $ 2,832 Lighting Segment net sales of $53,743,000 in the second quarter of fiscal 2013 increased 0.4% from fiscal 2012 same period net sales of $53,526,000. The $0.2 million increase in Lighting Segment net sales is primarily the net result of a $0.5 million or 1.7% net increase in lighting sales to our niche and national accounts markets (petroleum / convenience store sales were down 2%, retail national net sales were down 53%, quick-service restaurant market sales were up 116%, and automotive market net sales were up 91%), a $1.1 million or 33.2% increase in lighting sales to the international markets, and a $0.9 million or 4% decrease in commissioned net sales to the commercial / industrial lighting market. Sales of lighting to the petroleum / convenience store market represented 32% and 33% of Lighting Segment net sales in the second quarter of fiscal years 2013 and 2012, respectively. Lighting Segment net sales of lighting to this, the Company's largest niche market, were down 1.6% from last year to $17,135,000. The petroleum / convenience store market has been, and will continue to be, a very important niche market for the Company. The Lighting Segment's net sales of light fixtures having solid-state LED technology totaled $17.5 million in the second quarter of fiscal 2013, representing an 8% decrease from fiscal 2012 second quarter net sales of solid-state LED light fixtures of $19.1 million. The Lighting Segment's net sales related to LED video screens totaled $0.7 million in the second quarter of fiscal 2013, representing a $0.5 million or 36.6% decrease from fiscal 2012 second quarter net sales of $1.2 million.

Page 22 -------------------------------------------------------------------------------- Gross profit of $12,105,000 in the second quarter of fiscal 2013 increased $0.3 million or 0.3% from the same period of fiscal 2012, and increased from 21.8% to 22.2% as a percentage of Lighting Segment net sales (customer plus inter-segment net sales). The increase in amount of gross profit is due to the net effect of increased net sales, an increase in inventory reserves against inventory deemed obsolete and no longer useable ($0.5 million), increased shipping costs, increased overhead absorption, increased employee compensation and wage expense ($0.4 million), increased supplies ($0.1 million), and decreased warranty expense ($0.2 million).

Selling and administrative expenses of $9,628,000 in the second quarter of fiscal year 2013 increased $0.7 million from the same period of fiscal 2012 primarily as the net result of increased employee compensation and benefits expense ($0.4 million), increased research and development expense ($0.1 million), increased sales commission ($0.5 million), and decreased bad debt expense ($0.1 million).

The Lighting Segment second quarter fiscal 2013 operating income of $2,477,000 decreased $0.4 million or 12.5% from operating income of $2,832,000 in the same period of fiscal 2012. This decrease of $0.4 million was primarily the net result of increased net sales, increased overhead absorption, an increase in inventory reserves and increased selling and administrative expenses.

Graphics Segment (In thousands) Three Months Ended December 31 2012 2011 Net Sales $ 10,532 $ 10,091 Gross Profit $ 1,203 $ 1,275 Operating (Loss) $ (1,140 ) $ (868 ) Graphics Segment net sales of $10,532,000 in the second quarter of fiscal 2013 increased 4.4% from fiscal 2012 same period net sales of $10,091,000. The $0.4 million increase in Graphics Segment net sales is the net result of image conversion programs and sales to five petroleum / convenience store customers ($0.2 million net decrease), two grocery retailers ($0.9 million increase), two national drug store retailers ($0.5 million decrease), and changes in volume or completion of several other graphics programs ($0.2 million increase). Sales of graphics products and services to the petroleum / convenience store market represented 48% and 33% of Graphics Segment net sales in the second quarter of fiscal years 2013 and 2012, respectively. Graphics Segment net sales of graphics to this, the Company's largest niche market, were up 40.4% from last year to $4,730,000. The petroleum / convenience store market has been, and will continue to be, a very important niche market for the Company. The Graphics Segment net sales of graphic identification products that contain solid-state LED light sources and LED lighting for signage totaled $0.3 million in the second quarters of both fiscal 2013 and fiscal 2012.

Image and brand programs, whether full conversions or enhancements, are important to the Company's strategic direction. Image programs include situations where our customers refurbish their retail sites around the country by replacing some or all of the lighting, graphic elements, menu board systems and possibly other items they may source from other suppliers. These image programs often take several quarters to complete and involve both our customers' corporate-owned sites as well as their franchisee-owned sites, the latter of which involve separate sales efforts by the Company with each franchisee. Some of these Image and Brand programs can be relatively large and are significant to the Company's operating results when comparing period-over-period results. The Company may not always be able to replace net sales immediately when a large image conversion program has concluded. Further, during periods where customers remain hesitant to initiate large image programs due to economic constraints, the period of time between such programs is lengthened. In the current economy, many of the Company's customers have held off on image programs, thereby providing limited opportunities to replace completed programs with new programs. Sales related to a customer's image or brand program are reported in either the Lighting Segment, Graphics Segment, or the All Other Category depending upon the product and/or service provided.

Gross profit of $1,203,000 in the second quarter of fiscal 2013 is similar to the gross profit of $1,275,000 from the same period of fiscal 2012. Gross profit as a percentage of Segment net sales (customer plus inter-segment net sales) decreased from 12.4% in the second quarter of fiscal 2012 to 11.0% in the second quarter of fiscal 2013. The change in amount of gross profit is due to the net effect of increased overhead absorption, increased freight costs ($0.2 million), and increased employee compensation and benefit expense ($0.3 million).

Selling and administrative expenses of $2,343,000 in the second quarter of fiscal 2013 increased $0.2 million from the same period of fiscal 2012 primarily as a result of increased employee compensation and benefits ($0.2 million).

Page 23 -------------------------------------------------------------------------------- The Graphics Segment second quarter fiscal 2013 operating loss of $(1,140,000) increased $0.3 million from an operating loss of $(868,000) in the same period of fiscal 2012. The $0.3 million increase in operating loss was primarily the result of decreased gross margin as a percentage of sales on similar sales and increased selling and administrative expenses.

Electronic Components Segment (In thousands) Three Months Ended December 31 2012 2011 Net Sales $ 4,959 $ 4,215 Gross Profit $ 1,493 $ 1,121 Operating Income (Loss) $ (1,559 ) $ 689 Electronic Components Segment net sales of $4,959,000 in the second quarter of fiscal 2013 increased 17.7% from fiscal 2012 same period net sales of $4,215,000. The $0.7 million increase in Electronic Components Segment net sales is primarily the result of a $0.3 million increase in sales to the transportation market, a $0.1 million increase in sale to the medical industry, a $0.1 million increase in sales to original equipment manufacturers, and a $0.2 million increase in sales to various other markets. In addition to this segment's increase in customer sales, its inter-segment net sales grew 48% in support of LED lighting sales.

Gross profit of $1,493,000 in the second quarter of fiscal 2013 increased $0.4 million or 33.2% from the same period in fiscal 2012, and decreased from 12.3% to 12.2% as a percentage of net sales (customer plus inter-segment net sales).The $0.4 million increase in amount of gross profit is due to the net effect of increased customer net sales, a lower gross profit margin percentage due to increased inter-segment sales, decreased employee compensation and benefit expense ($0.2 million), and increased warranty expense ($0.2 million).

Selling and administrative expenses of $911,000 in the second quarter of fiscal 2013 increased $0.5 million from the same period in fiscal 2012 primarily as the result of increased employee compensation and benefit expense ($0.1 million) and increased research and development expense related to lighting controls ($0.1 million). In the second quarter of fiscal 2013, the Electronic Components Segment recorded a goodwill impairment expense of $2.1 million with no comparable expense in fiscal 2012.

The Electronic Components Segment second quarter fiscal 2013 operating loss of $(1,559,000) decreased $2.2 million from operating income of $689,000 in the same period of fiscal 2012. The $2.2 million decrease in operating income from income in fiscal 2012 to a loss in fiscal 2013 was the net result of increased net customer and inter-segment sales, increased employee compensation and benefit expense, and a goodwill impairment charge of $2.1 million.

All Other Category (In thousands) Three Months Ended December 31 2012 2011 Net Sales $ 1,848 $ 942 Gross Profit (Loss) $ (819 ) $ 529 Operating (Loss) $ (1,429 ) $ (228 ) All Other Category net sales of $1,848,000 in the second quarter of fiscal 2013 increased 96.2% from fiscal 2012 net sales of $942,000. The $0.9 million increase in the All Other Category net sales is primarily the net result of increased sales of menu board systems ($0.6 million) and increased project management net sales ($0.4 million).

The gross loss of $(819,000) in the second quarter of fiscal 2013 is a $1.3 million decrease compared to the gross profit of $529,000 in the same period of fiscal 2012. The $1.3 million reduction in gross profit is the net result of increased gross profit from increased net sales which was more than offset by an increased inventory reserve of $1.2 million against inventory deemed technologically obsolete and no longer useable at our Canadian operation.

Selling and administrative expenses of $610,000 in the second quarter of fiscal 2013 decreased $0.1 million from the same period in fiscal year 2012. The decrease of $0.1 million is primarily the result of decreased research and development expense ($0.2 million).

Page 24 --------------------------------------------------------------------------------The All Other Category second quarter fiscal 2013 operating loss of $(1,429,000) compares to an operating loss of $(228,000) in the same period of fiscal 2012. This $1.2 million increase in operating loss was the net result of increased customer sales, an increase in an obsolete inventory reserve, and decreased selling and administrative expenses.

Corporate and Eliminations (In thousands) Three Months Ended December 31 2012 2011 Gross Profit (Loss) $ (100 ) $ 194 Operating (Loss) $ (1,058 ) $ (1,206 ) The gross profit relates to the intercompany profit in inventory elimination.

Administrative expenses of $958,000 in the second quarter of fiscal 2013 decreased $0.4 million or 31.6% from the same period of the prior year. The decrease in expense is the net result of increased employee compensation and benefit expense ($0.2 million), decreased depreciation expense ($0.1 million), and a reduction of the contingent earn-out liability related to the Virticus acquisition ($0.7 million as further discussed in Note 12).

Consolidated Results The Company reported net interest income of $18,000 in the second quarter of fiscal 2013 as compared to net interest expense of $37,000 in the same period of fiscal 2012. Commitment fees related to the unused portions of the Company's lines of credit and interest income on invested cash are included in both fiscal years. Two factors contributed to this change: 1) the mortgage associated with the LSI ADL facility in Columbus, Ohio was paid off in fiscal 2012 and 2) the reduction of the accrued interest expense related to the reduction of the contingent earn-out liability associated with the Virticus acquisition.

The $241,000 income tax benefit in the second quarter of fiscal 2013 represents a consolidated effective tax rate of 9.0%. This is the net result of an income tax rate of 41.4% for the Company's U.S. operations influenced by certain permanent book-tax differences that were significant relative to the amount of taxable income, Canadian income tax credits, by a benefit related to uncertain income tax positions, and by a full valuation reserve on the Company's Canadian tax position. The $410,000 income tax expense in the second quarter of fiscal 2012 represents a consolidated effective tax rate of 34.7%. This is the net result of an income tax rate of 35% for the Company's U.S. operations influenced by certain permanent book-tax differences that were significant relative to the amount of taxable income, by a benefit related to uncertain income tax positions, and by a full valuation reserve on the Company's Canadian tax position.

The Company reported a net loss of $(2,450,000) in the second quarter of fiscal 2013 as compared to net income of $772,000 in the same period of the prior year. The decrease in net income from the second quarter of fiscal 2012 to a net loss in the second quarter of fiscal 2013 is primarily the net result of increased net sales, decreased gross profit largely due to an increase in inventory reserves against inventory deemed obsolete and no longer useable, increased operating expenses, a 2013 goodwill impairment, and an income tax benefit in fiscal 2013 compared to income tax expense in fiscal 2012. A diluted loss per share of $(0.10) was reported in the second quarter of fiscal 2013 as compared to diluted earnings per share of $0.03 in the same period of fiscal 2012. The weighted average common shares outstanding for purposes of computing diluted loss per share in the second quarter of fiscal 2013 were 24,391,000 shares as compared to 24,341,000 shares in the same period last year when computing earnings per share.

SIX MONTHS ENDED DECEMBER 31, 2012 COMPARED TO SIX MONTHS ENDED DECEMBER 31, 2011 Lighting Segment (In thousands) Six Months Ended December 31 2012 2011 Net Sales $ 109,534 $ 102,697 Gross Profit $ 25,999 $ 23,548 Operating Income $ 6,990 $ 6,136 Page 25-------------------------------------------------------------------------------- Lighting Segment net sales of $109,534,000 in the first half of fiscal 2013 increased 6.7% from fiscal 2012 same period net sales of $102,697,000. The $6.8 million increase in Lighting Segment net sales is primarily the net result of a $4.1 million or 8.4% net increase in lighting sales to our niche markets (petroleum / convenience store market net sales were up 7%, net sales to the automotive market were up 97%, net sales to the Quick Service Restaurant Market were up 116%, and retail national net sales were down 45%), a $1.7 million or 27.8% increase in sales to the international markets, a $3.7 million or 272.6% increase in LED video screens (consisting largely of the sale of a large LED sports video screen), and a $2.7 million or 5.7% decrease in commissioned net sales to the commercial / industrial lighting market. Sales of lighting to the petroleum / convenience store market represented 30% of Lighting Segment net sales in the first half of both fiscal years 2013 and 2012. Lighting Segment net sales of lighting to this, the Company's largest niche market, were up 7% from last year to $32,768,000. The petroleum / convenience store market has been, and will continue to be, a very important niche market for the Company.

The Lighting Segment's net sales of light fixtures having solid-state LED technology totaled $36.9 million in the first half of fiscal 2013, representing a 9% increase from first half fiscal 2012 net sales of solid-state LED light fixtures of $33.8 million. The Lighting Segment's net sales related to LED video screens totaled $5.0 million in the first half of fiscal 2013, representing a 272% increase from first half fiscal 2012 net sales of $1.3 million.

Gross profit of $25,999,000 in the first half of fiscal 2013 increased $2.5 million or 10.4% from the same period of fiscal 2012, and increased from 22.7% to 23.4% as a percentage of Lighting Segment net sales (customer plus inter-segment net sales). The increase in amount of gross profit is due to the net effect of increased net sales at increased margins, increased overhead absorption, an increase in inventory reserves against inventory deemed obsolete and no longer useable ($0.5 million), increased benefits and compensation ($0.9 million), decreased warranty costs ($0.3 million), increased supplies ($0.2 million), decreased outside services ($0.2 million), decreased depreciation expense ($0.2 million), and increased customer relations expense ($0.6 million).

Selling and administrative expenses of $19,009,000 in the first half of fiscal 2013 increased $1.6 million or 9.2% from the same period of fiscal 2012 primarily as the net result of increased benefit and compensation expense ($0.7 million), increased sales commission expense ($1.0 million), increased research and development expense ($0.4 million), and decreased customer relations expense ($0.2 million).

The Lighting Segment first half fiscal 2013 operating income of $6,990,000 increased $0.9 million or 13.9% from operating income of $6,136,000 in the same period of fiscal 2012. This increase of $0.9 million was the net result of increased net sales, increased gross profit, and increased selling and administrative expenses.

Graphics Segment (In thousands) Six Months Ended December 31 2012 2011 Net Sales $ 21,277 $ 20,579 Gross Profit $ 3,061 $ 3,136 Operating (Loss) $ (1,495 ) $ (1,449 ) Graphics Segment net sales of $21,277,000 in the first half of fiscal 2013 increased 3.4% from fiscal 2012 same period net sales of $20,579,000. The $0.7 million increase in Graphics Segment net sales is primarily the net result of image conversion programs and sales to nine petroleum / convenience store customers ($0.5 million increase), two grocery retailers ($2.7 million increase), two national drug retailers ($1.0 million decrease), the net result of two quick-service restaurant chains ($1.4 million decrease), and changes in volume or completion of several other graphics programs. Sales of graphics products and services to the petroleum / convenience store market represented 41% and 33% of Graphics Segment net sales in the first half of fiscal years 2013 and 2012, respectively. Graphics Segment net sales of graphics to this, the Company's largest niche market, were up 28% from last year to $8,774,000. The petroleum / convenience store market has been, and will continue to be, a very important niche market for the Company. The Graphics Segment net sales of graphic identification products that contain solid-state LED light sources and LED lighting for signage totaled $0.5 million in the first half of fiscal 2013 as compared to $0.8 million in the same period of the prior year.

Image and brand programs, whether full conversions or enhancements, are important to the Company's strategic direction. Image programs include situations where our customers refurbish their retail sites around the country by replacing some or all of the lighting, graphic elements, menu board systems and possibly other items they may source from other suppliers. These image programs often take several quarters to complete and involve both our customers' corporate-owned sites as well as their franchisee-owned sites, the latter of which involve separate sales efforts by the Company with each franchisee. Some of these Image and Brand programs can be relatively large and are significant to the Company's operating results when comparing period-over-period results. The Company may not always be able to replace net sales immediately when a large image conversion program has concluded. Further, during periods where customers remain hesitant to initiate large image programs due to economic constraints, the period of time between such programs is lengthened. In the current economy, many of the Company's customers have held off on image programs, thereby providing limited opportunities to replace completed programs with new programs. Sales related to a customer's image or brand program are reported in either the Lighting Segment, Graphics Segment, or the All Other Category depending upon the product and/or service provided.

Page 26 -------------------------------------------------------------------------------- Gross profit of $3,061,000 in the first half of fiscal 2013 decreased slightly from the same period in fiscal 2012, and decreased from 15.0% to 13.6% as a percentage of Graphics Segment net sales (customer plus inter-segment net sales). The decrease in amount of gross profit is due to the net effect of increased net sales at decreased margins, increased overhead absorption, and increased benefits and compensation ($0.6 million).

Selling and administrative expenses of $4,556,000 in the first half of fiscal 2013 increased 5.3% from the same period of fiscal 2012 primarily as a result of increased benefits and compensation expense ($0.2 million). In the first half of fiscal 2012, the Graphics Segment recorded a goodwill impairment expense of $0.3 million with no comparable expense in fiscal 2013.

The Graphics Segment first half fiscal 2013 operating loss of $(1,495,000) is comparable to the operating loss of $(1,449,000) in the same period of fiscal 2012 and is the net result of increased sales at decreased margins.

Electronic Components Segment (In thousands) Six Months Ended December 31 2012 2011 Net Sales $ 10,713 $ 8,619 Gross Profit $ 3,237 $ 2,599 Operating Income (Loss) $ (773 ) $ 1,754 Electronic Components Segment net sales of $10,713,000 in the first half of fiscal 2013 increased 24.3% from fiscal 2012 same period net sales of $8,619,000. The $2.1 million increase in Electronic Components Segment net sales is primarily the result of a $0.1 million increase in sales to the telecommunications market, a $1.2 million increase in sales to the transportation market, a $0.2 million increase in sales to the medical market and a $0.5 million increase in sales to various other markets.

Gross profit of $3,237,000 in the first half of fiscal 2013 increased $0.6 million or 24.5% from the same period of fiscal 2012, and decreased from 14.2% to 13.3% as a percentage of Electronic Components Segment net sales (customer plus inter-segment net sales). The $0.6 million increase in amount of gross profit is due to the net effect of increased customer net sales, a lower gross profit margin percentage on increased inter-segment sales, and increased warranty expense ($0.3 million).

Selling and administrative expenses of $1,869,000 in the first half of fiscal 2013 increased $1.0 million from the same period of fiscal 2012 primarily as the result of increased employee compensation and benefits expense ($0.3 million), increased research and development expense related to lighting controls ($0.3 million). In the first half of fiscal 2013, the Electronic Component Segment recorded a goodwill impairment expense of $2.1 million with no comparable expense in fiscal 2012.

The Electronic Components Segment first half fiscal 2013 operating loss of $(773,000) decreased $2.5 million from operating income of $1,754,000 in the same period of fiscal 2012. The $2.5 million decrease from operating income in fiscal 2012 to a loss in fiscal 2013 was the net result of increased net sales, increased gross profit and decreased gross profit as a percentage of sales, increased selling and administrative expenses, primarily the fiscal 2013 goodwill impairment expense of $2.1 million.

All Other Category (In thousands) Six Months Ended December 31 2012 2011 Net Sales $ 4,277 $ 2,374 Gross Profit $ (294 ) $ 1,071 Operating (Loss) $ (1,431 ) $ (367 ) Page 27-------------------------------------------------------------------------------- All Other Category net sales of $4,277,000 in the first half of fiscal 2013 increased $1.9 million or 80.2% from fiscal 2012 net sales of $2,374,000. The $1.9 million increase in the All Other Category net sales is primarily the net result of net increased sales of menu board systems ($1.7 million), increased project management net sales ($1.0 million), and decreased net sales of specialty LED lighting ($0.5 million).

The gross loss of $(294,000) in the first half of fiscal 2013 is a $1.4 million decrease compared to the gross profit of $1,071,000 in the same period of fiscal 2012. The change in gross profit between the first half of fiscal 2013 and first half of fiscal 2012 is the result of increased net customer sales offset by an inventory reserve $1.2 million against inventory deemed technologically obsolete and no longer useable at our Canadian operation.

Selling and administrative expenses of $1,137,000 in the first half of fiscal 2013 decreased $0.3 million or 20.9% as compared to the same period of the prior year. The decrease in selling and administrative expense is primarily the result of lower research and development expense ($0.3 million).

The All Other Category first half fiscal 2013 operating loss of $(1,431,000) compares to an operating loss of $(367,000) in the same period of fiscal 2012. This $1.1 million increase in operating loss was the net result of increased net sales, an increase in obsolete inventory reserves, and decreased selling and administrative expenses.

Corporate and Eliminations (In thousands) Six Months Ended December 31 2012 2011 Gross Profit $ (250 ) $ 36 Operating Income (Loss) $ (2,973 ) $ (2,677 ) The negative gross profit (loss) relates to the intercompany profit in inventory elimination.

Selling and administrative expenses of $2,723,000 in the first half of fiscal 2013 were comparable to fiscal 2012 selling and administrative expenses of $2,713,000. The small change in expense is the net result of increased employee compensation and benefit expense ($0.8 million), decreased depreciation expense ($0.2 million) and a reduction of the contingent earn-out liability related to the Virticus acquisition ($0.7 million as further discussed in Note 12).

Consolidated Results The Company reported net interest expense of $2,000 in the first half of fiscal 2013 as compared to net interest expense of $77,000 in the same period of fiscal 2012. Commitment fees related to the unused portions of the Company's lines of credit and interest income on invested cash are included in both fiscal years.

Two factors that are contributing to the decrease in net interest expense from the first half of fiscal 2012 to the first half of fiscal 2013: 1) the mortgage associated with the LSI ADL facility in Columbus, Ohio was paid off in fiscal 2012 and 2) the reversal of the accrued interest expense related to the reduction of the contingent earn-out liability associated with the Virticus acquisition.

The $936,000 income tax expense in the first half of fiscal 2013 represents a consolidated effective tax rate greater than 100%. This is the net result of an income tax rate of 41.4% for the Company's U.S. operations, influenced by certain permanent book-tax differences that were significant relative to the amount of taxable income, by certain U.S. federal and Canadian income tax credits, by a benefit related to uncertain income tax positions, and most notably by a full valuation reserve on the Company's Canadian tax position.

Losses on the Company's Canadian operation were greater than the profits recognized on the Company's U.S operations thereby contributing to the effective tax rate in excess of 100%. The $1,224,000 income tax expense in the first half of fiscal 2012 represents a consolidated effective tax rate of 36.9%. This is the net result of an income tax rate of 35.0% for the Company's U.S. operations influenced by certain permanent book-tax differences that were significant relative to the amount of taxable income, by the goodwill impairment of $258,000 for which there was no tax effect, by certain U.S. federal and Canadian income tax credits, by a benefit related to uncertain income tax positions, and by a full valuation reserve on the Company's Canadian tax position.

The Company reported a net loss of $(620,000) in the first half of fiscal 2013 as compared to net income of $2,096,000 in the same period of the prior year. The decreased net income is primarily the net result of increased net sales, increased gross profit, increased operating expenses, increased goodwill impairment and decreased income tax expense. Diluted loss per share was $(0.03) in the first half of fiscal 2013 as compared to diluted earnings per share of $0.09 in the same period of fiscal 2012. The weighted average common shares outstanding for purposes of computing the diluted loss per share in the first half of fiscal 2013 was 24,382,000 shares as compared to 24,348,000 shares when computing earnings per share in the same period last year.

Page 28 --------------------------------------------------------------------------------Liquidity and Capital Resources The Company considers its level of cash on hand, borrowing capacity, current ratio and working capital levels to be its most important measures of short-term liquidity. For long-term liquidity indicators, the Company believes its ratio of long-term debt to equity and its historical levels of net cash flows from operating activities to be the most important measures.

At December 31, 2012, the Company had working capital of $78.6 million, compared to $83.7 million at June 30, 2012. The ratio of current assets to current liabilities was 4.36 to 1 as compared to a ratio of 4.65 to 1 at June 30, 2012. The $5.1 million decrease in working capital from June 30, 2012 to December 31, 2012 was primarily related to the net effect of decreased cash and cash equivalents ($0.8 million), decreased net accounts receivable ($7.6 million), and increased accrued expenses ($0.5 million), partially offset by increased net inventory ($1.8 million), increased refundable income taxes ($1.3 million), and increased other current assets ($0.6 million). The Company has a strategy of aggressively managing working capital, including reduction of the accounts receivable days sales outstanding (DSO) and reduction of inventory levels, without reducing service to its customers.

The Company generated $9.7 million of cash from operating activities in the first half of fiscal 2013 as compared to a generation of cash of $19.9 million in the same period of the prior year. This $10.2 million decrease in net cash flows from operating activities is primarily the net result of an increase rather a decrease in inventory (unfavorable change of $12.8 million), an increase rather a decrease in refundable income tax (unfavorable change of $2.4 million), a greater decrease in accounts receivable (favorable change of $3.2 million), and a smaller decrease in accrued expenses and other (favorable change of $1.7 million).

Net accounts receivable were $36.8 million and $44.4 million at December 31, 2012 and June 30, 2012, respectively. The decrease of $7.6 million in net receivables is primarily due to combined effects of a lower amount of net sales in the latter two months of the second quarter of fiscal 2013 as compared to the latter two months of the fourth quarter of fiscal 2012 and by a lower DSO. The DSO decreased to 54 days at December 31, 2012 from 55 days at June 30, 2012. The Company believes that its receivables are ultimately collectible or recoverable, net of certain reserves, and that aggregate allowances for doubtful accounts are adequate.

Net inventories at December 31, 2012 increased $1.8 million from June 30, 2012 levels. Based on a strategy of balancing inventory reductions with customer service and the timing of shipments, net inventory increases occuring in the first half of fiscal 2013 in the Electronic Component Segment of approximately $3.6 million and in the Graphics Segment of approximately $0.6 million partially offset net inventory decreases in the Lighting Segment of approximately $1.1 million and in the All Other Category of approximately $1.1 million. The drop in net inventory in the All Other Category was primarily the result of the establishment of obsolete inventory reserves against inventory deemed non-usable.

Cash generated from operations and borrowing capacity under two line of credit facilities are the Company's primary source of liquidity. The Company has an unsecured $30 million revolving line of credit with its U.S. bank group, with most of $30 million of the credit line available as of January 24, 2013 ($0.3 million of credit line is consumed by a standby letter of credit). This line of credit is a $30 million three year committed credit facility expiring in the third quarter of fiscal 2015. Additionally, the Company has a separate $5 million line of credit, renewable annually in the third fiscal quarter, for the working capital needs of its Canadian subsidiary, LSI Saco Technologies. As of January 24, 2013, all $5 million of this line of credit is available. The Company believes that $35 million total lines of credit plus cash flows from operating activities are adequate for the Company's fiscal 2013 operational and capital expenditure needs. The Company is in compliance with all of its loan covenants.

The Company used $3.1 million of cash related to investing activities in the first half of fiscal 2013 as compared to a use of $1.7 million in the same period of the prior year, resulting in an unfavorable change of $1.4 million. The primary change between years relates to an upgrade of the company's ERP software in fiscal 2013. Other than the upgrade to the Company's ERP software, capital spending in both periods is primarily for tooling and equipment. The Company expects fiscal 2013 capital expenditures to be approximately $10.0 million, exclusive of business acquisitions, if any.

The Company used $7.3 million of cash related to financing activities in the first half of fiscal 2013 as compared to a use of cash of $2.8 million in the same period of the prior year. The change between years is attributed to an increased dividend payment. In December 2012, the Board of Directors took action to accelerate the payment of the fiscal 2013 second quarter regular quarterly cash dividend and the board approved an additional cash dividend above and beyond the regular quarterly dividend.

Page 29 -------------------------------------------------------------------------------- The Company has, or could have, on its balance sheet financial instruments consisting primarily of cash and cash equivalents, short-term investments, 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 The Company has no financial instruments with off-balance sheet risk and has no off-balance sheet arrangements.

Cash Dividends In December 2012, the Board of Directors took action to accelerate the regular quarterly cash dividend of $0.06 per share (approximately $1,441,000) usually payable in February 2013, into December 2012. Accordingly, the cash dividend indicated annual rate for fiscal 2013 is $0.24 per share. An additional cash dividend of $0.12 per share was also paid in December 2012. The Company's cash dividend policy is that the indicated annual dividend rate will be set between 50% and 70% of the expected net income for the current fiscal year. Consideration will also be given by the Board to special year-end cash or stock dividends. The declaration and amount of any cash and stock dividends will be determined by the Company's Board of Directors, in its discretion, based upon its evaluation of earnings, cash flow, capital requirements and future business developments and opportunities, including acquisitions.

Critical Accounting Policies and Estimates The Company is required to make estimates and judgments in the preparation of its financial statements that affect the reported amounts of assets, liabilities, revenues and expenses, and related footnote disclosures. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. The Company continually reviews these estimates and their underlying assumptions to ensure they remain appropriate. The Company believes the items discussed below are among its most significant accounting policies because they utilize estimates about the effect of matters that are inherently uncertain and therefore are based on management's judgment. Significant changes in the estimates or assumptions related to any of the following critical accounting policies could possibly have a material impact on the financial statements.

Revenue Recognition Revenue is recognized when title to goods and risk of loss have passed to the customer, there is persuasive evidence of a purchase arrangement, delivery has occurred or services have been rendered, and collectibility is reasonably assured. Revenue is typically recognized at time of shipment. In certain arrangements with customers, as is the case with the sale of some of our solid-state LED video screens, revenue is recognized upon customer acceptance of the video screen at the job site. 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 four sources of revenue: revenue from product sales; revenue from installation of products; service revenue generated from providing integrated design, project and construction management, site engineering and site permitting; and revenue from shipping and handling.

Product revenue is recognized on product-only orders upon passing of title and risk of loss, generally at time of shipment. However, product revenue related to orders where the customer requires the Company to install the product is recognized when the product is installed. Other than normal product warranties or the possibility of installation or post-shipment service, support and maintenance of certain solid state LED video screens, billboards, or active digital signage, the Company has no post-shipment responsibilities.

Installation revenue is recognized when the products have been fully installed. The Company is not always responsible for installation of products it sells and has no post-installation responsibilities, other than normal warranties.

Service revenue from integrated design, project and construction management, and site permitting is recognized when all products have been installed at each individual retail site of the customer on a proportional performance basis.

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

Page 30 -------------------------------------------------------------------------------- The Company evaluates the appropriateness of revenue recognition in accordance with Accounting Standards Codification ("ASC") Subtopic 605-25, Revenue Recognition: Multiple-Element Arrangements, and ASC Subtopic 985-605, "Software: Revenue Recognition." Our solid-state LED video screens, billboards and active digital signage contain software elements which the Company has determined are incidental and excluded from the scope of ASC Subtopic 985-605.

Income Taxes The Company accounts for income taxes in accordance with ASC Topic 740, "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 and liabilities are reported on the Company's balance sheet. Significant management judgment is required in developing the Company's income tax provision, including the 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.

The Company operates in multiple taxing jurisdictions and is subject to audit in these jurisdictions. The Internal Revenue Service and other tax authorities routinely review the Company's tax returns. These audits can involve complex issues which may require an extended period of time to resolve. In management's opinion, adequate provision has been made for potential adjustments arising from these examinations.

The Company is recording estimated interest and penalties related to potential underpayment of income taxes as a component of tax expense in the Consolidated Statements of Operations. The reserve for uncertain tax positions is not expected to change significantly in the next twelve months.

Asset Impairment Carrying values of goodwill and other intangible assets with indefinite lives are reviewed at least annually for possible impairment in accordance with ASC Topic 350, "Intangibles - Goodwill and Other." The Company will first assess qualitative factors in order to determine if goodwill is impaired in accordance with ASU 2011 - 08, "Intangible - Goodwill and Other (Topic 350)." If through the qualitative assessment it is determined that it is more likely than not that goodwill is not impaired, no further testing is required. If it is determined more likely than not that goodwill is impaired, the Company's impairment testing continues with the estimation of the fair value of goodwill and indefinite-lived intangible assets using a combination of a market approach and an income (discounted cash flow) approach, at the reporting unit level, that requires significant management judgment with respect to revenue and expense growth rates, changes in working capital and the selection and use of an appropriate discount rate. The estimates of fair value of reporting units are based on the best information available as of the date of the assessment. The use of different assumptions would increase or decrease estimated discounted future operating cash flows and could increase or decrease an impairment charge. Company management uses its judgment in assessing whether assets may have become impaired between annual impairment tests. Indicators such as adverse business conditions, economic factors and technological change or competitive activities may signal that an asset has become impaired.

Carrying values for long-lived tangible assets and definite-lived intangible assets, excluding goodwill and indefinite-lived intangible assets, are reviewed for possible impairment as circumstances warrant as required by ASC Topic 360, "Property, Plant, and Equipment." Impairment reviews are conducted at the judgment of Company management when it believes that a change in circumstances in the business or external factors warrants a review. Circumstances such as the discontinuation of a product or product line, a sudden or consistent decline in the forecast for a product, changes in technology or in the way an asset is being used, a history of negative operating cash flow, or an adverse change in legal factors or in the business climate, among others, may trigger an impairment review. The Company's initial impairment review to determine if a potential impairment charge is required is based on an undiscounted cash flow analysis at the lowest level for which identifiable cash flows exist. The analysis requires judgment with respect to changes in technology, the continued success of product lines and future volume, revenue and expense growth rates, and discount rates.

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 collectibility 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. The amount ultimately not collected may differ from the reserve established, particularly in the case where percentages are applied against aging categories. In all cases, it is management's goal to carry a reserve against the Company's accounts receivable which is adequate based upon the information available at that time so that net accounts receivable is properly stated. The Company also establishes allowances, at the time revenue is recognized, for returns and allowances, discounts, pricing and other possible customer deductions. These allowances are based upon historical trends.

Page 31--------------------------------------------------------------------------------Warranty Reserves The Company maintains a warranty reserve which is reflective of its limited warranty policy. The warranty reserve covers the estimated future costs to repair or replace defective product or installation services, whether the product is returned or it is repaired in the field. The warranty reserve is first determined based upon known claims or issues, and then by the application of a specific percentage of sales to cover general claims. The percentage applied to sales to calculate general claims is based upon historical claims as a percentage of sales. Management addresses the adequacy of its warranty reserves on a quarterly basis to ensure the reserve is accurate based upon the most current information.

Inventory Reserves The Company maintains an inventory reserve for probable obsolescence of its 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. Significant judgment is used to establish obsolescence reserves and management adjusts these reserves as more information becomes available about the ultimate disposition of the inventory item. Management values inventory at lower of cost or market.

New Accounting Pronouncements In July 2012, the Financial Accounting Standards Board issued ASU 2012-02, "Intangibles - Goodwill and Other (Topic 350): Testing Long-Lived Intangible Assets for Impairment." This amended guidance is intended to simplify the test of indefinite-lived intangible assets for impairment by allowing companies to first assess qualitative factors to determine whether or not it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying value as the basis for determining whether it is necessary to perform the two-step impairment test. Current guidance requires companies to perform an annual indefinite-lived intangible asset impairment test. The amended guidance is effective for annual and interim tests performed for fiscal years beginning after September 15, 2012, or the Company's fiscal year 2014, with early adoption permissible. The Company will follow this guidance when it is adopted.

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