Daktronics, Inc. (DAKT) Q2 2018 Earnings Report, Transcript and Summary

Good day ladies and gentlemen and welcome to the Daktronics fiscal year 2018 third quarter earnings results conference call. As a reminder, this conference call is being recorded today, Tuesday, November 21, 2017 and is available on the company's website at www.daktronics.com. [Operator Instructions]. I would now like to turn the conference over to Ms. Sheila Anderson, Chief Financial Officer for Daktronics, for some introductory remarks. Please go ahead, Sheila.

Thank you Candace. Good morning everyone. Thank you for participating in our second quarter earnings conference call. I would like to review our disclosure cautioning investors and participants that in addition to statements of historical facts, we will be discussing forward-looking statements reflecting our expectations and plans about our future financial performance and future business opportunities. All forward-looking statements involve risks and uncertainties, which may be out of our control and may cause actual results to differ materially. Such risks include changes in the economic condition, changes in the competitive and market landscape, management of growth, timing and magnitude of future contracts, fluctuations of margins, the introduction of new products and technology and other important factors, as noted and detailed in our 10-K and 10-Q SEC filings. With that, let me highlight some of the financials. Orders for the second quarter of fiscal 2018 were $142 million as compared to last year's second quarter of $117 million. Most of this order fluctuation is attributable to the volatility in our large project and account-based business, in live events, international and commercial business units. As a reminder, both orders and net sales fluctuate due to the impact of our large project and account based business. Large projects include multi-million dollar orders of display systems for professional sports facilities, colleges and universities and spectacular projects. Account based orders can also be multi-million dollar in size for national or global customers, mostly in our out-of-home advertising space. Our business also fluctuates seasonally based on the sports markets and construction cycles and is dependent on various schedules based on our customer's needs. Orders, also for the quarter, were impacted by a softer demand in the commercial on-premise displays. For the year, orders are up slightly by 1.1%. Sales for the second quarter of fiscal 2018 were relatively flat at $169 million as compared to $170 million last year for the second quarter. Sales increased in live events, high school park and recreation and transportation business units and decreased in the commercial and international business units, quarter-over-quarter. Live events contributed to the sales increase as the number of projects for professional sports and colleges and universities was up as compared to last year. Continued market demand and delivery timings also contributed to sales increases in the transportation and high school park and recreation business unit. Commercial business unit sales declined compared to last year due to the softer demand in the on-premise display business, a reduction of shipments and orders in the spectacular niche, which was partially offset by an increase in our billboard niche due to the timing of deliveries. International business unit sales followed the decline in orders Gross profit was 25.2% during the second quarter of fiscal 2018 as compared to 26.1% during the second quarter of fiscal 2017 and remains flat on a year-to-date basis. Gross margin percentages for the quarter were negatively impacted by the additional warranty expenses mentioned in the release offset by a positive one-time $1.2 million gain from the sale of our non-digital operating business and also due to the improved productivity in sales mix. Total warranty as a percent of sales was 3.9% during the second quarter of fiscal 2018 as compared to 2.7% last year during the same period. Operating expenses increased $1.5 million or around 4.8% during the second quarter of fiscal 2018 as compared to the same period last year due to a large degree from the increase in product development expenses. Product development expense increased by $1.8 million for additional resources focused on speeding up the development of display and control solutions to the market. Selling expense decreased quarter-over-quarter, mostly due to lower bad debt expense and commission expenses. And general and administrative expenses remained relatively flat quarter-over-quarter. Our overall effective tax rate was 24.6% as compared to the expense of 30.1% last year. The primary factors impacting our effective tax rate is due to an increase in expected research and development tax credits because of the increased velocity of product development this year as well as utilizing a portion of our foreign valuation allowance against net operating losses. We forecast the forward-looking effective annual rate to be approximately 30%. As we have previously discussed, our effective tax rate can fluctuate depending on changes to the tax legislation and on the geographic mix of taxable income. Our cash and marketable securities position was at $61.5 million at the end of the quarter. We reported a positive free cash flow of $3.6 million as compared to a positive free cash flow of $10.5 million for the same period in fiscal 2017. Capital expenses for the first six months of the year were $7.7 million as compared to $4.6 million last year. Primary uses of capital include manufacturing equipment, research and development, testing equipment and facilities, demonstration equipment for new products and information technology infrastructure. We expect capital expenditures to be less than $25 million for the fiscal year. We made no repurchases of stock during the first six months of the year. Looking ahead, our third quarter is historically a lighter quarter for sales and profits due to the seasonality of our business of sports, outdoor construction and the impact of two major holidays in the U.S. We are starting fiscal 2018's third quarter with a higher backlog than last year and an active order pipeline. Based on current estimates of production deliveries for the quarter, we estimate third quarter sales to be at a level higher than last year's third quarter. However, sales could change pending project bookings and customer's schedule changes. I will now turn the call over to Reece Kurtenbach, our Chairman, President and CEO, for a commentary on our business.

Thank you Sheila. Good morning everyone. We had a positive financial performance for the first half of fiscal 2018 reflected in increases in sales, operating income and net income. Order bookings came similarly to last year at $342 million overall for Daktronics. Looking deeper into the business units, order bookings on a year-to-date basis were up in live events business unit where continued demand for upgrading or new installations throughout professional sports including the NFL, NHL and MLB. We continue to see demand in the marketplace from facilities using our solutions to enhance the fan experience or the entertainment factor using increasing higher resolution display products. We are seeing this both in upgrades or refurbishment for existing facilities as well as planning for new venues. High school park and recreation orders remained flat for the first six months year-over-year. This market continues to trend toward more sophisticated video systems which have higher average selling prices in addition to continued need outside of the sports venues to communicate with students, parents and visitors. Once again, these trends exist when refurbishing existing systems as well as in new locations. Commercial business unit orders decreased this year as compared to the same timeframe last year. The major factors contributing to this difference were the competitive environment in the on-premise niche, fewer national account based on-premise opportunities and volatility of large custom projects in the spectacular niche. Digital billboard orders were up slightly year-over-year. While it was a slower start for orders, the marketplace continues to adopt digital technology for on-premise and third-party advertising applications and we see this continuing in the future. The pipeline of opportunity is active in the spectacular area of our business as well. We have seen strong activity for replacing or refurbishing existing systems as well as the placement of systems in new locations across our commercial segments. Orders in our international business unit are lagging year-over-year, primarily due to the irregular nature of large projects. This inherent variability affects timing of both orders and sales and sales was also impacted in this period. Transportation business unit orders have decreased on a comparative six months year-over-year basis while we believe this decline is due to the general volatility of timing and not an identification of changes in overall market activity or our market share. Opportunities continue to surface due to stabilization of transportation funding and increased customer demand for mass transit systems and advertising application. The higher sales level for the year improved gross margins through gains in manufacturing productivity. We also saw improvement in gross margins on large projects and selected price increases in certain markets. In addition, profitability improved by selling our non-digital business. Unfortunately, these increases were offset by higher warranty expenses which made our overall gross profit relatively flat year-over-year. The increase in warranty cost is not the result of a new issue but is based on our decision to preserve market leadership by more quickly addressing certain field issues to keep our customer relationship strong. During fiscal 2017, we made progress on increasing product development velocity and expect to continue this throughout fiscal 2018 and likely into fiscal 2019. While these efforts will increase development expenses as a percent of sales in the near-term, we believe this investment is necessary to drive forward new solutions to meet customer needs and to expand our global market share. Rollouts of products including display and control solutions are expected throughout the coming year. We expect continued success in growing our business over the long-term for the following reasons. We remain confident in the expanding global digital marketplace through adoption of digital systems across the sectors we serve. These products have a known end-of-life that will drive continued business to replace or refurbish the installed base. We continue to enhance and develop product lines and comprehensive solutions for our broad market base as well as specific customer needs. This allows for success in markets during natural ups and downs of each segment. In addition to our comprehensive product lines we are committed to earning customers for life, driving continued investments in quality, reliability and other performance enhancements to meet our customer's needs today and over the long-term. And finally, active support from initial project planning through intended use of a system leads to satisfied customers and repeat business aligned with the natural replacement cycle. While optimistic about our long-term future, various geopolitical, economic and competitive factors may impact order growth. Our business will continue to be lumpy. While these areas can impact a specific fiscal period, we continue to pursue long-term profitable growth. While the path may not always be smooth, we believe the growing market and our industry-leading solutions position us to generate long-term profitable growth. With that, I would ask the operator to please open up the line for any questions.

[Operator Instructions]. And our first question comes from Morris Ajzenman of Griffin Securities. Your line is now open.

Hi guys.

Hi Morris.

Good morning.

The live events had some good traction here recently and we understand in the past that it can be lumpy, but have we potentially entered a period here, based on what you see going forward, that this becomes a little more sustainable?

I believe our live events marketplace, as far as topline, has been sustained over the past three years or possibly more. And I think that continues to be a strong marketplace for Daktronics. It continues to be highly competitive and it's a different set of customers season-by-season even though the marketplace is the same, leagues or types of venues. So I would predict more that we continue to see good performance by Daktronics in this marketplace and we believe that our reputation in this area remains strong and we have a good chance at continuing our previous performance.

All right. Switching gears, warranty expense. You have highlighted over the past handful of years and then you have shown some improvement. What happened this quarter where it bumped up 120 basis points year-over-year to 3.9%? And how long before you think you can really get that under control towards a much lower level?

We are dealing with not a new issue, but an issue we have talked about maybe more than a year in the past and we made a conscious decision this quarter to address certain field issues in certain areas more aggressively. That's really to retain customer satisfaction and we have reserved, we believe appropriately, for that and we will see that as a continued expense in future quarters.

Last question and I will get back in queue. What's happening with the softer demand as far as on-premise displays? What's causing that to have some sort of a weakness here?

Yes. That's a good question, Morris. We see that that business continues to adopt the technology, but for some reason there wasn't as much activity in the first half of this year. We continue to see optimism from that marketplace. We use a reseller market as well as some direct sales to national accounts and we believe that will be an ongoing positive business for us in the future.

Thank you.

Thank you. And that concludes our question-and-answer session for today. I would like turn the conference back over to Reece Kurtenbach for any further remarks.

I appreciate everybody for signing in today. And I hope you have a great holiday season and we will talk again in a few months. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.