Daktronics, Inc. (DAKT) Q2 2023 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to Daktronics Fiscal Year 2023 Second Quarter Earnings Results Conference Call. As a reminder, this conference is being recorded today, Monday, December 12, and is available on the company's website at www.daktronics.com. We will have a question-and-answer session after the prepared remarks. [Operator Instructions] And I would now like to turn the conference over to Mr. Kevin McDermott, Daktronics Lead Independent Director. Please go ahead, Kevin.

Thank you, and good morning. My name is Kevin McDermott. I am the Lead Independent Director on the Daktronics Board and the Audit Committee Chair. I joined the Board in June 2015. Prior to my retirement in 2013, I was with the accounting firm at KPMG for 33 years. I served in various capacities at KP, the majority of which involved auditing the financial statements of publicly held companies. This morning, before passing the microphone to Reese and Sheila, I wanted to join you to acknowledge the concerns reflected in the stock price reaction to announcements made last week and to give you some background. Daktronics announced the going concern conclusion, the post fulfillment of the second quarter earnings release and call and a delay in the filing of the company's second quarter Form 10-Q. Daktronics was unable to provide further information at that time, because there were still related accounting and disclosure matters that had to be resolved. My presence today is also meant to underline to you that in addition to focusing on liquidity enhancement, your Board is prioritizing engagement with shareholders. Our goals today are to explain the substance of that going concern conclusion, share with you the exciting order pipeline, backlog and revenue update that might otherwise be overshadowed and give some specific detail on the plan and activity already underway to improve our liquidity situation and the cash flow generation from operations that has been hampered due to the necessary inventory buildup, given supply chain issues in order to serve this historic level of customer demand. Before Reece and Sheila take you through the earnings release and related commentary, I want to explain the going concern disclosure conclusion. Generally accepted accounting principles in the U.S. require a reporting company to consider at each annual and interim reporting date, whether there are conditions and events considered in the aggregate, that raise substantial doubt about the company's ability to continue as a going concern for the 12 month period from the issuance date of the financial statements. If such condition exists, management then must evaluate whether its plans sufficiently alleviate that substantial doubt. Management's assessment is then considered by the company's independent auditors. As discussed in this morning's release, and to a greater extent in the Form 10-Q Daktronics intends to file tomorrow. The company's order and backlog coming out of the pandemic has been very strong. However, Daktronics had to manage through significant pandemic induced supply chain issues. These supply line constraints led to the decision to increase inventory levels in order to improve the predictability in the production cycle, which has absorbed much of the company's customary levels of liquidity. In addition, global economic and geopolitical conditions have introduced increased risk to our cash flow forecasts and our ability to predict the radar backlog will convert to cash over the next 12 months. While Daktronics bank previously increased the company's borrower capacity from $35 million to $45 million,the incremental $10 million is subject to renewal every 90 days. Further, as plans for additional financing have not been finalized and are subject to market conditions that are not within Daktronics control, U.S. GAAP does not allow the company to consider such plans in its going concern evaluation. As a result, we unfortunately had to conclude the substantial doubt as defined under U.S. GAAP accounting framework did exist. I will now hand the call over to Reece and Sheila, but will be available during the Q&A session and we'll be happy to respond to questions at that time. Thank you. Now I'll turn the call over to Reece.

Thank you, Kevin. 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 impacts of global trade discussions and policies, the impact of governmental laws, regulations and orders, including those resulting from pandemics, disruptions to our business caused by geopolitical events, military actions, work stoppages, natural disasters or other international healthy emergencies, such as the COVID-19 pandemic, management of growth, timing and magnitude of future contracts, fluctuations of margins, availability of raw materials and components and shipping services, the introduction of new products and technology and other important factors. These identified important factors could cause actual results to differ materially from those disclosed in this call and the company's second quarter 2023 earnings release, and its most recent annual report on Form 10-K. We refer you to these documents. Our second quarter 2023 earnings release contains certain non GAAP financial measures and was furnished to the SEC on the Form 10 -- excuse me, 8-K this morning and is available on the Investors section at Daktronics' website at www.daktronics.com. I'll now turn the call over to Reece Kurtenbach for additional comments.

Thank you, Sheila. Thank you, Kevin, for your remarks. In the first half of fiscal 2023, we achieved sales increases even when our capacity was constrained due to significant unusual part shortages, a challenging labor environment, operating disruptions from COVID-19 related absences and the first quarter COVID-19 mandated shutdown of our Shanghai production facilities. I am proud of our teams’ ability to increase our sales output during the second quarter and through the first half of the year under these conditions. The unprecedented and persistent supply chain conditions caused lower gross profits through fulfillment, as well as higher cost for materials, labor and freightthat were not all able to be passed on to our customers. We made the strategic decision to keep delivery windows for our customers as close as possible to the originally committed date as supply chain and manufacturing constraints would allow. Even though this sometimes added additional cost to fulfill a project, to address supply chain volatility we aggressively secured inventory to fulfill orders for our customers, consuming cash while increasing predictability of our operations. We did all this because Daktronics has distinguished itself for 54 years for meeting our customer commitments on delivery dates, product quality and customer support. Our people displayed enormous strength, adaptability and resiliency over the past year and a half to maintain that reputation, securing supplies of critical components and responding to customers when demand came rushing back. So, through the first six months of fiscal 2023, cash was used for strategic growth in inventory stocking to add stability in our production, growth in accounts receivable due to continued growth in orders and sales and capital investments to increase manufacturing capacity. Today, our production and fulfillment operations continue to adapt and recover from the enduring implications of the pandemic. Supply chain disruptions have started to ease and we expect our inventory levels to peak in the current quarter Q3 of ‘23 and continue to decline to more normalized levels through production usage and reductions in purchases. Most important is how we are managing the cash implications of these supply -- strategic supply chain and production decisions. So I'd like to share more about that now. In our 54 year old history, we have not been faced with the perfect storm that dies last two years represent. Beginning with the immediate implications of the economy shutting down in the spring of 2022, followed by the sudden rebound in activity, while supply chains remain delayed, snarled and often just plain closed. These times have stressed our liquidity beyond levels that we have ever seen and our financial resources has not been sufficiently flexible. Our priority for today is to restore our balance sheet to appropriate levels of liquidity. Our entire organization is focused on four critical drivers of our liquidity enhancement plan. First is cash generation focus through proactively completing and fulfilling orders in our $463 million backlog. We will do this through productivity improvements from previous investments in factory, capacity and capital equipment and hiring only critical production and service personnel to increase output. We will focus on market -- operating margin improvement through pricing actions, product mix adjustments and prudent management of operating expenses. We will reengineer designs for supply chain resiliency and we will normalize inventory levels as supply chain challenges continue to ease. The second driver will be the aggressive management of working capital. Our third will be concentrating capital investments on maximizing asset returns, and the fourth will be to obtain additional sources of liquidity with the consent of our lead banking partner. To summarize where we are under the plan, we have already taken steps to move from a period of cash investment to cash generation to improve our liquidity and better position us for a profitable growth. We are pursuing avenues to strengthen our financing flexibility by adding liquidity and diversifying our funding sources. Additionally, since last year at this time, we have successfully increased prices and have focused on selling and fulfillment resources on the most profitable opportunities and have turned away price driven business. We have taken steps with a specific goal of improving profitability and cash flow over the coming quarters and beyond as our backlog in increasingly contains workbooked using current pricing methodologies. We are aware of the stress that the liquidity implications of the rapid re-expansion of our order book and backlog have placed on our employees, customers, communities and, of course, our investors. In the last few days, we have had employee town hall meetings and talked with hundreds of customers to reassure them and address any questions or concerns. Importantly,we have not seen order cancellations or retractions and are still booking new orders. I look forward to the opportunity this morning to engage with all of our investors who have taken the time to attend this call. I will now hand the call to Sheila to recap the financial results for the second quarter and first half.

Thanks, Reese. With that, I'll move on to our financial comments. Orders for the second quarter of fiscal 2023 increased 11.7% as compared to the second quarter of fiscal 2022 and increased by 2.2% on a year to date basis. Order increases for the year were driven by live events bookings for replacements and upgrades. These increases were offset by order volume declines in other areas, primarily as the market demand levels are normalizing after a record number of orders in fiscal 2022, driven up from pent up demand after the COVID-19 pandemic. In particular, orders have softened in international due to the weakening economic outlook related to geopolitical events and currency headwinds. Net sales for the second quarter of fiscal 2023 increased by 14% compared to the second quarter of fiscal 2022 and by 16.2% on a year to date basis. Sales growth was driven by fulfilling orders and backlog even while we experienced multiple material supply chain disruptions and labor shortages. As Reece conveyed, supply chain disruptions created an increase in lead times by extending the timing of converting orders to sales. This coupled with strong demand contributed to a larger than typical backlog and inventory levels. As a result of this relationship between the past order bookings and realization of sales, product order backlog remains at a historically high level of $463.1 million at the end of the quarter and was approximately $441 million as of the end of November. Gross profit as a percentage of net sales was 16.9% for the second quarter of fiscal 2023 as compared to 19.6% a year earlier and 16% for the six months ended October 29, 2022, as compared to 20.8% for the same fiscal six months a year earlier. This comparative decline in gross profit percentage was caused by inflation in materials, freight and personnel related costs that were not able to be passed on fully to customers. In addition, extraordinary supply chain disruptions created intermittent work stoppages and factory inefficiencies, adding additional costs to meet our customer commitments. However, to reflect the realities of these inflationary costs, prices were increased in late calendar 2021 and throughout 2022. These price changes are just beginning to be realized through sales and gross profit margins as we work through the prior backlog. We expect sales price increases to be realized and reflected through the remaining 2023 fiscal year. We are carefully managing our operating expense well. Operating expenses grew 13% to $61.5 million for the first half of 2023 as compared to $54.4 million for fiscal 2022, a slower rate than the rate of sales enabling some operating leverage. The $14 million of tax expense for the second quarter of fiscal 2023 was primarily a result of the valuation allowance against our net deferred tax assets and the reversal of fiscal 2023 tax benefits previously recognized to comply with the accounting regulations related to our going concern assessment. Of course, our balance sheet likewise reflected the change in business levels and strategies we pursued in managing supply chain and growing our capacity to meet customer commitments. For the first half of the year, we used $21.9 million in cash primarily to grow working capital, especially in inventory. Supply chain disruptions have started to ease and we expect their inventory levels to peak now in the third quarter and then to decline to more normalized levels through increased production and reductions in purchases. We have invested $16.2 million in capital expenditures during the first six months of fiscal 2023, primarily focused on expanding manufacturing capacity, automation and productivity. To fund working capital and capital asset additions, we have borrowed $26.4 million on our credit facility. As of October 31, 2022, we amended our credit facility to temporarily increase the commitment by $10 million to $45 million until January 31, 2023. As part of the liquidity enhancement program Reece detailed, the finance team is focused on accounts receivable collections, cash generation and accessing additional sources of liquidity. I'll turn it back over to Reece.

Thank you, Sheila. To our investors and stakeholders, I would say that management understands the concern and uncertainty generated by last week's required announcement. As both Sheila and I described earlier as a key component of our liquidity enhancement program, we are pursuing other additional sources of liquidity and are focusing on reducing inventory levels. Our goal is to be able to remove this qualifying language as soon as is practical. The world has seen a lot of change over the past two years and Daktronics has navigated this as the ongoing industry leader in quality, technology and reliability. Customers continue to choose Daktronics as demonstrated by our historically strong order volume and backlog. We appreciate our customers believed in the Daktronics brand and we thank all of you for your commitment to what our products represent. Even with our recent going concern challenges, we believe our strategy to emerge from this time of the pandemic healthy and profitable by stabilizing our fulfillment performance through increased purchasing and critical components and increasing production bubbles through selective equipment investments and production staffing has reinforced the reasons why customers choose Daktronics. We have delivered many of the orders quoted with previous pricing structures and our backlog now mainly consists of orders booked under new pricing methodologies. We see signs of supply chain stabilizing, which will allow reduced inventory levels in the coming months as our production levels continue to increase. We do not believe that the geopolitical situation is back to normal or however this would be defined. But we do believe that the levels of uncertainty and volatility will not be as great in the coming months and will continue to stabilize in the coming calendar year. While macroeconomic factors continue to make it difficult to forecast the future, over the coming years we currently see signs of the following. Our high school park and recreation business unit will continue to grow through adoption of video displays for sporting and educational use. This trend toward deploying what used to be professional grade technology in new markets grows the total addressable market. In addition, video displays also have a higher average selling price than the messaging and scoring equipment traditionally purchased in this segment. Commercial business unit, out of home advertising customers continue to buy after the pandemic related economic contraction. This is somewhat an effect of their natural replacement cycle. Our on premise business also remains strong as customers continued their purchase and use of digital messaging systems. We are also focused on increasing sales channels with audiovisual integrators for end use in government, military, healthcare and corporate applications. Transportation order levels continue to be strong worldwide as project planning and approval activities resume to more pre pandemic levels and our customers move forward in purchasing displays used for intelligent transportation systems and for mass transit venues. Infrastructure spending should continue to benefit this segment as digital signage is often used in these projects. Importantly, selling costs are lower in this sector as procurements over multi year periods are often handled through master agreements. In the international business unit, we naturally are seeing some softening in the European market due to macroeconomic factors, as well as the impact of the current strengthening of the dollar. We will watch developments closely and adjust resources and commitments accordingly. Our flagship business, the complex live events segment outlook remains strong due to large stadium renovations, continued replacement cycles and expansion of sales efforts beyond sports areas. Recent installations include college football displays at Clumpson and Tennessee and we previously announced recent wins of the new super system for the LA Clippers new arena. Having said that, as part of the gross profit improvement pillar of our liquidity enhancement plan, we are being very mindful about the profitability of this segment through pricing and contract terms. Thank you to our Daktronics team for increasing our capacity, adjusting to the uncertain and volatile supply chain conditions and continuing to serve our customers. We appreciate our suppliers and vendors for also helping us through these challenging times and thank you to our investors for your patience and support. These are unprecedented times that we are working through and our management teams and employees are focused on long term profitable growth and cash generation that we believe will create value for our shareholders now and into the future. With that, I would ask the operator to please open the line for any questions.

Thank you. [Operator Instructions] One moment for our first question please. Is from [B.J. Cook] (ph) with Singular Research. Please go ahead.

Can you guys hear me? Thanks for taking my questions.

Yes, no worries. We hear you fine.

Excellent. You had mentioned investing in manufacturing capacity upgrades. A lot of those projects finished, do you guys expect to execute on your order back -- order book faster going forward?If so, how much quicker do you guys trying to execute?

We have invested a lot in automation in our different factories and many of those projects have been completed and are being used. Equipment manufacturers are having their own supply chain challenges. So some of the equipment that we've ordered has not arrived yet and will be implemented in the coming months and maybe even early next fiscal year.

Okay. Thanks for that. Just one more quick one. Given the short term nature in the bump in the line of credit, are you guys expecting to realize cash from your elevated accounts receivable over the next month and a half or so or even since the end of the quarter?

Yes, maybe I'd say two things. Our banking facility has been very open and flexible with us. But of course, it's only guaranteed to the end of the quarter. And we believe as our business is continuing to be increasing, our production levels are increasing, we will convert more of our backlog more quickly into invoice orders.

Okay. Thanks. That's all I had. Appreciate it.

Thank you. [Operator Instructions] All right. Ladies and gentlemen, I'll turn it back to Mr. Reece for final remarks.

Thank you everybody for joining us on this morning's call. We are taking the going concern situation very serious and we are working hard to remove that qualifying language as soon as is possible and to update the group on those activities,we are planning to have our next conference call at the end of our Q3. Thank you, everyone, and have a good day. Bye-bye.

And with that, we thank you ladies and gentlemen. Today we conclude it with that and thank you for participating. You may now disconnect.