Daktronics, Inc. — Form 10-Q Summary
Reporting period: Three months ended July 28, 2018, representing the first quarter of fiscal 2019. The request metadata identifies “2017 Q1,” but the filing covers fiscal 2019 Q1 and compares it with the three months ended July 29, 2017.
Business Context
Daktronics designs, manufactures, and sells electronic scoreboards, programmable display systems, large-screen video displays, transportation signs, and related services. Reportable segments are Commercial, Live Events, High School Park and Recreation, Transportation, and International.
Revenue and profitability are affected by seasonality, weather, timing of large custom projects, customer delivery schedules, competitive pricing, foreign currency movements, and raw-material costs.
Key Financial Metrics
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Net sales | $154.2 million | $172.7 million | Down 10.7% |
| Gross profit | $38.2 million | $44.6 million | Down 14.3% |
| Gross margin | 24.8% | 25.8% | Down 100 basis points |
| Operating income | $4.0 million | $11.7 million | Down 65.6% |
| Operating margin | 2.6% | 6.8% | Down approximately 420 basis points |
| Net income | $4.6 million | $8.4 million | Down 45.7% |
| Diluted EPS | $0.10 | $0.19 | Down $0.09 |
| Operating cash flow | $(10.3) million | $(4.9) million | Greater use of cash |
Net income benefited from a 13.1% effective tax rate benefit in Q1 FY2019, compared with a 29.7% tax expense rate in the prior-year quarter. The benefit primarily reflected the lower federal corporate tax rate under the Tax Cuts and Jobs Act and projected tax credits.
Cash, cash equivalents, and restricted cash totaled $15.9 million at July 28, 2018, compared with $27.1 million at July 29, 2017. Marketable securities totaled $27.4 million, providing additional liquidity. Working capital was $132.9 million.
The company had no advances outstanding under its $35.0 million U.S. revolving credit facility or its $20.0 million international facility. Approximately $11.5 million of letters of credit and $1.2 million of bank guarantees were outstanding under the facilities. The company was in compliance with all loan covenants.
Material Changes Versus the Prior Comparable Period
- Sales declined primarily because Q1 FY2018 included more than $23 million of Live Events revenue from four large projects; comparable projects were not recognized in Q1 FY2019.
- Live Events sales fell 36.3% to $49.5 million, while International sales increased 94.3% to $28.9 million. Commercial, High School Park and Recreation, and Transportation sales also declined.
- Orders increased 4.3% overall to $159.6 million. Commercial, High School Park and Recreation, Transportation, and International orders increased, while Live Events orders declined.
- Gross margin declined because of lower sales volumes over relatively fixed infrastructure costs and unfavorable sales mix, partly offset by lower warranty expense.
- Contribution margin declined 26.4% to $21.9 million. International contribution margin improved from a loss of $1.3 million to positive $1.6 million, but margins declined in the other four segments.
- Operating expenses increased modestly overall: general and administrative expense declined 4.5%, while product design and development expense increased 2.7%.
- Operating cash flow worsened as accounts receivable, inventories, and contract assets increased. Contract assets rose 33.3% from fiscal year-end to $41.3 million, and current contract liabilities rose 28.6% to $50.6 million.
- The company acquired AJT Systems, Inc. on June 21, 2018, using approximately $2.3 million of cash. AJT develops real-time graphics rendering and video server systems for broadcast television.
- The company adopted ASC 606 revenue recognition guidance using the modified retrospective method. Management stated that adoption did not materially change the timing or amount of revenue recognized and did not require a retained earnings adjustment.
Backlog, Outlook, Risks, and Unusual Items
Remaining performance obligations were $223.8 million at July 28, 2018, of which approximately $190.2 million was expected to be recognized within 12 months. Product order backlog was approximately $177 million, compared with $184 million a year earlier and $171 million at fiscal year-end. The filing cautions that backlog may be affected by cancellations, deferrals, scope changes, foreign exchange, project timing, and varying profitability.
Management projected fiscal 2019 capital expenditures of less than $20 million, primarily for manufacturing equipment, capacity, quality and reliability investments, and information infrastructure. Management expected product design and development spending to remain at a similar level to fiscal 2018 for the remainder of fiscal 2019. No specific revenue or earnings guidance was provided.
- Tariffs, trade actions, sanctions, and related international responses may increase the cost of aluminum, electrical components, and other materials or affect international sales.
- The company relies on certain single-source suppliers, creating potential supply, delay, and cost risks.
- Foreign currency exposure is material: 21.1% of Q1 FY2019 sales were denominated in currencies other than the U.S. dollar. Management estimated that a 10% change in foreign exchange rates could affect pretax income by approximately $1.0 million.
- A previously disclosed mechanical device failure warranty issue generated $0.6 million of warranty expense in Q1 FY2019, with $1.3 million remaining accrued for probable future claims. The ultimate cost could materially exceed the current estimate.
- Outstanding performance guarantees included $12.7 million of letters of credit and $14.8 million of surety bonds.
- A customer was withholding $2.2 million of payment over alleged performance deficiencies. Management believes collection is probable and considers the loss assessment remote.
- The company had $10.3 million of operating cash outflow despite reporting net income, reflecting working-capital requirements and project timing.
Investor Verification Items
- Verify whether the decline in Live Events revenue is temporary project timing or indicates sustained weakness in large-venue demand.
- Track conversion of the $223.8 million remaining performance obligation balance into revenue and cash flow.
- Monitor gross-margin recovery, especially the impact of tariffs, component costs, sales mix, and fixed manufacturing infrastructure.
- Assess operating cash flow, receivables, inventories, contract assets, and contract liabilities as large projects progress.
- Review the AJT acquisition’s contribution, contingent consideration liability, and integration costs.
- Monitor the mechanical device warranty issue and whether discretionary remediation costs or failure rates exceed the $1.3 million remaining accrual.
- Confirm continued compliance with credit-facility covenants and the availability of borrowing capacity through the November 2019 maturities.
- Consider the sustainability of the $0.07-per-share dividend given negative operating cash flow and planned capital expenditures.