Daktronics, Inc. (DAKT) Q2 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Daktronics Fiscal Year 2019 Second Quarter Earnings Results Conference Call. As a reminder, this conference is being recorded today, Wednesday, November 21, 2018 and is available on the Company's website at www.daktronics.com. At this time, all participants are in a listen-only mode. Later we'll conduct a question-and-answer session and instructions will follow at that time. [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, Rusty. 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 economic conditions, changes in the competitive and market landscape, including impact of global trade discussions and policies, management of growth, timing and magnitude of future contracts, fluctuations in margins, the introduction of new products and technologies and other important factors as noted in detail in our 10-K and 10-Q SEC filing. With that, let me highlight some of the financials for the quarter. Orders for the second quarter of fiscal 2019 were $151 million as compared to last year's second quarter of $142 million. Most of the order fluctuation this quarter is attributable to the variability of timing in large projects and account-based business. Transportation's increase in orders was due to continued intelligent transportation system investments by city and the State Department of Transportation. High School Park and Recreation increased due to higher demand for larger video systems. Commercial increased for orders on the on-premise and spectacular niches with other form of orders similar in comparison to last year. Internationally, we won a multi-million dollar project in the Middle East in the transportation segment with the rest of the segments down compared to last year's same quarter. Live events orders were similar in comparison to last year. As a reminder, we derived a significant portion of our orders and sales from large dollar based projects primarily for colleges and professional sports facilities, entertainment venues, transportation market application and from spectacular niche and account-based business in the out-of-home niche. The timing and amount of these contracts can cause material fluctuations in our orders, sales and earnings. Awards of large contracts and their timing and amount are difficult to predict, may not be repeatable and are outside of our control. Our business also fluctuates seasonally, based on the sports markets and construction cycle and is dependent on the various schedules based on our customers' needs. Sales for the second quarter of fiscal 2019 were $173 million as compared to $169 million last year. Net sales increase in Commercial, High School Park and Recreation, Transportation and International business units and decrease in Live Events business unit quarter-over-quarter. We expected the sales in Live Events business unit for the second quarter and for the first half of the year to be lower as compared to 2018, as we completed a number of arenas, professional sports and colleges and university venues in 2018 with no similar sized projects this year during the same time frame. Commercial, especially in spectacular and on-premise, transportation and international sales increased mostly related to the variability of timing in large projects. High School Park and Recreation sales increased as a result of more activity and larger sized orders and the timing of customer demands. Other financial comparables include gross profit as a percentage of net sales at 24.8% for the second quarter as compared to 25.2% last year during the same quarter. Warranty expenses declined year-over-year, unfortunately this improvement was offset by high commodity costs, higher commodity costs due to the current global trade environment, which made our overall profitability to decline year-over-year. Total warranty as a percent of sales decreased to 2.5% as compared to 3.9% quarter-over-quarter. Operating expenses for the second quarter of 2019 was $33.7 million compared to $33.2 million for the second quarter of fiscal '18. The increase in total operating expenses of $0.5 million was primarily attributable to the increase in selling expenses, which is mostly due to personnel-related costs. General and administrative expenses and product design and development expenses in total remained relatively flat quarter-over-quarter. Operating income as a percentage of sales was 5.2% for the second quarter of fiscal 2019 as compared to 5.6% for the second quarter of fiscal 2018. For the quarter, our overall effective tax expense was 5.8% compared to expense of 24.6% last year. This decrease in effective tax rate is due to tax credits proportionate to pre-tax book income as compared to the same period, prior year period and a decrease in the federal statutory rates from 35% to 21% pursuant to the U.S. Tax Cuts and Job Acts. In the first quarter of fiscal 2019, we recorded a benefit and in the second quarter we recorded a tax expense, which resulted in a zero tax expense for a year-to-date basis as our estimated effective tax rate is based on our estimate of the permanent research and development tax credits we receive, offsetting the estimated tax expense for the year. As we have previously discussed, our effective tax rate can fluctuate depending on changes in tax legislation and the actual geographic mix of taxable income. Our cash and marketable securities position was $67.3 million at the end of the quarter. We reported a positive free cash flow of $12.9 million for the second quarter of fiscal 2019 as compared to $3.6 million for the same period last year. The fluctuation in free cash flow is the result of timing differences in operating assets and liabilities corresponding with the seasonality of our business, offset by a decrease in net income this quarter as compared and with the $12.1 million used for investments in capital acquisitions, and acquisitions as well. We expect capital expenditures to be less than $20 million for fiscal 2019. Our product backlog is $150 million going into the third quarter. Much of this backlog is projected to be realized over the coming few quarters. We expect sales for the third quarter of fiscal 2019 to be slightly lower as compared to last year's third quarter. Of course, sales could change pending project bookings and customer schedule changes. I'll now turn the call over to Reece Kurtenbach, our Chairman, President and CEO for a few comments.

Thank you, Sheila. Good morning everyone. We had a good second quarter. As Sheila highlighted our orders and sales for the quarter were up as compared to last year during the same time and our pipeline of projects remains strong in our various business segments. Overall, our outlook for the second half of fiscal 2019 remains similar to our past discussions. We predict ongoing global market growth and continue to provide a competitive and diverse solution offering to meet customers' needs. Both factors support our goal of long-term profitable growth. Some specific highlights of our outlook by business units include, we expect sustained demand and growth for larger sized orders due to the adoption of video in sporting applications in the High School Park and Recreation market. During the second quarter, we continue to quote and win higher-dollar video projects. In our international business unit, we believe the market's increased adoption of digital systems as well as our focus on increasing market share in our segments sports, out-of-home, spectacular and transportation, will continue our growth outside of the U.S. and Canada. The transportation business in the U.S. and Canada has growth opportunities due to continued investment in the U.S. transportation systems, the stability in federal funding and increasing advertising and on premise promotional application needs in mass transit facilities. In our commercial business unit we see opportunities for growth mainly driven by digital opportunities in the spectacular segment both new and replacement systems for our account based business -- businesses, expansion of solutions for indoor applications and continued replacement and new investment activity in the out-of-home segment. We expect live events sales in the short term to be down as this business is primarily lumpy and can be highly competitive in the larger contract space. Over the long term replacement cycles and new product uses support a similar sized business. In all our markets, we have a natural replacement cycle and strive to serve our customers with their needs today as well as in the future. Our range of solutions and global capabilities makes us the industry's most experienced digital display provider to support them over the long term. We are focused on developing and bringing innovative solutions to our customers in all segments. For example, the expected use of narrow pixel pitch technology by customers in our markets is predicted to grow and we continue to release newer generations of this product line to serve this demand. We also have differentiated our product offering, allowing customers to have choices for their particular situation. We invest in new technologies to enhance our service and control system offerings and regularly release new offerings. While we are optimistic about our long-term growth in the digital display industry, various geopolitical, economic and competitive factors influence order growth. Daktronics competes on a world stage and we are impacted by the uncertainties in today's trade and business environments, both in the sourcing of components to produce our products and in shipping these finished products globally. As we know today's global trade environment is very dynamic. We continue to monitor the situation and evaluate ways to minimize these impacts through vendor negotiations, alternative sources and potential price adjustments. Our teams are focused on the continued development of industry leading solutions and global sales channels to support long-term profitable growth. With that, I would ask the operator to please open the line for questions.

[Operator Instructions] Our first question comes from the line of Greg Pendy from Sidoti. Your line is open.

Hey guys. Thanks for taking my questions. I guess just a couple. First, can you just kind of share with us on the higher commodity costs, I mean, were a lot of these just raw input costs or was it also a mix of, I guess, higher costs related to sourcing components?

There were input costs related to aluminum and some of the electronic components. There's been a high demand in the world for both of those and some of the tariff impacts have caused some of the supply to-- supply and demand factors to be at worse right now. So that's the areas we've seen some higher costs.

And could you just share with us, I guess, what are you seeing in terms of right now maybe on a go-forward basis on the electronic component side? Is that starting to ease up do you think or is it going to stay sort of a headwind for some time now?

It's difficult to predict. The next clear milestone is after the first of the year when this list three could potentially be increased, and we think there's a lot of decisions being made right now trying to anticipate what that could be. It will be easier as we get into 2019 and maybe not as much dynamic change and we can understand what the steady state may be.

Got it. Got it. And then just switching gears, maybe just one other thing, just -- you mentioned earlier on the call the investments we've seen you guys ramp up in narrow pixel pitch technology now that we're in sort of further generations. Is that something that was sort of cycle year-over-year that will kind of stay at these levels or is that something you think those investments will continue to ramp higher?

We've increased our product development expense or investment considerably in 2018 and held that flat within 2019 and I would expect that we wouldn't see it increase in 2020. But I would find it unlikely we will significantly decrease it either.

There are no further questions at this time. You may continue now, Reece.

Well, thank you. I appreciate everybody joining the call today. For those of you in the U.S., I hope you have a great Thanksgiving holiday and for everybody I hope your holiday season and new year go well and we will talk to you in a quarter. Thank you.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day. You may all disconnect.