DAKTRONICS INC quarterly report, Q2 FY2018

Daktronics, Inc. Form 10-Q Summary

Reporting period: Quarter and six months ended October 27, 2018, representing fiscal 2019 second quarter and first six months. The request metadata identifies “2017 Q2,” but the filing itself is for October 27, 2018, with comparisons to October 28, 2017.

Business Context

Daktronics designs, manufactures, and sells electronic scoreboards, programmable display systems, and large-screen video displays for commercial, live events, schools and recreation, transportation, and international markets. Results are affected by large custom projects, sports-market seasonality, outdoor construction timing, competitive bidding, commodity costs, foreign currency, and warranty activity.

The company adopted ASC 606 revenue recognition in the first quarter of fiscal 2019 using the modified retrospective method. Management reported no material change to the timing or amount of revenue recognized.

Key Financial Metrics

Metric	Three months ended October 27, 2018	Three months ended October 28, 2017	Six months ended October 27, 2018	Six months ended October 28, 2017
Net sales	$172.7 million	$169.3 million	$326.9 million	$342.0 million
Gross profit	$42.8 million	$42.6 million	$81.0 million	$87.3 million
Gross margin	24.8%	25.2%	24.8%	25.5%
Operating income	$9.0 million	$9.4 million	$13.1 million	$21.2 million
Net income	$8.6 million	$7.1 million	$13.2 million	$15.6 million
Diluted EPS	$0.19	$0.16	$0.29	$0.35

Second-quarter revenue increased 2.0%, while six-month revenue decreased 4.4%. Second-quarter net income increased 20.7%, primarily reflecting lower income taxes, while six-month net income decreased 15.3%. The second-quarter effective tax rate was 5.8% versus 24.6% in the prior year; the six-month rate was 0.0% versus 27.5%.

Operating margin was approximately 5.2% for the quarter and 4.0% for the six-month period, compared with approximately 5.6% and 6.2%, respectively, in the prior-year periods. Selling expense was $16.1 million in the quarter and $32.5 million year to date. General and administrative expense was $8.6 million in the quarter and $17.1 million year to date. Product design and development expense was $9.0 million in the quarter and $18.3 million year to date.

Liquidity, Cash Flow, and Capital Structure

Cash, cash equivalents, and restricted cash totaled $35.6 million at October 27, 2018, compared with $29.8 million at April 28, 2018.
Marketable securities totaled $31.7 million, producing cash and investments of approximately $67.3 million.
Working capital was $137.1 million, compared with $132.8 million at fiscal year-end.
Operating cash flow was $22.6 million, compared with $9.3 million in the prior-year six-month period.
Investing cash flow was an outflow of $9.9 million, including $9.8 million of capital expenditures, $2.3 million for the AJT Systems acquisition, and net marketable-security purchases.
Financing cash flow was an outflow of $6.9 million, including $6.3 million of dividends and $0.4 million of principal payments.
No borrowings were outstanding under the company’s U.S. or international revolving facilities. Available facilities totaled up to $55.0 million, subject to terms and covenants.
The company was in compliance with all applicable bank covenants. Capital expenditures were projected to be less than $20.0 million for fiscal 2019.

Material Changes Versus the Prior Comparable Period

Segment revenue: Second-quarter Commercial revenue increased 34.0%, while Live Events declined 19.7%. High School Park and Recreation, Transportation, and International increased 6.5%, 9.7%, and 8.6%, respectively.
Six-month revenue: Commercial increased 14.0% and International increased 44.9%; Live Events declined 28.5%, while Transportation was essentially flat and High School Park and Recreation increased 2.7%.
Large-project timing: Live Events revenue was lower because the prior-year quarter included more than $12 million from four projects; the prior-year six-month period included more than $28 million from five projects, including three projects above $5 million.
Orders: Six-month orders increased 5.3% overall to $311.0 million, led by Transportation, Commercial, and High School Park and Recreation, but Live Events orders decreased 21.2% and International orders decreased 10.3%.
Backlog: Product order backlog was approximately $150 million at October 27, 2018, down from $155 million a year earlier and $177 million at the end of the first fiscal quarter.
Margins: Gross margin declined because of higher commodity costs, competitive bidding, unfavorable mix, component-related manufacturing costs, and the absence of a prior-year supplier reimbursement and $1.2 million gain on the sale of non-digital assets. Lower warranty expense partly offset these effects.
Warranty: Warranty expense related to a previously disclosed mechanical device issue was $1.3 million in the first six months, compared with $3.4 million in the prior-year period. The remaining accrual for that issue was $1.3 million, but ultimate costs could be materially higher.
Acquisition: Daktronics acquired AJT Systems on June 21, 2018, primarily with cash. The acquisition was not material enough to require pro forma disclosures.

Guidance, Outlook, Risks, and Unusual Items

Management expects product design and development spending for the remainder of fiscal 2019 to remain at a level similar to fiscal 2018.
Management expects capital expenditures below $20.0 million for fiscal 2019 and believes available working capital will satisfy foreseeable operating requirements.
Management expects to continue paying dividends, but dividend amounts remain subject to regular review and board approval.
Tariffs, sanctions, and related international trade responses are creating volatility in aluminum, electrical components, and other input costs. The company is evaluating vendor negotiations, alternative sources, and possible price adjustments.
Revenue, backlog, margins, and cash flows may fluctuate materially because of project timing, cancellations, customer deferrals, seasonality, weather, and changes in estimated costs to complete contracts.
The company had $11.9 million of outstanding letters of credit and $5.2 million of surety bonds. It also had $8.3 million of purchase commitments and $9.0 million of future minimum operating lease payments.
A customer was withholding $2.2 million, alleging nonperformance. Management believes it performed according to the written specifications and expects collection, but acknowledges that circumstances could change.
The company recorded a $1.0 million favorable adjustment to contingent consideration related to a prior acquisition, increasing operating income.
A shareholder rights plan was adopted after quarter-end on November 16, 2018, with one Right distributed per common share and an initial exercise price of $25 per Right, subject to adjustment.

Important Facts for Investors to Verify

Whether Live Events bookings and backlog recover after the decline in large projects and the reported order cancellation.
Whether tariff, commodity, component, and competitive-bidding pressures continue to reduce gross margins.
The ultimate cost of the disclosed mechanical-device warranty issue and other warranty obligations, which totaled $28.7 million at October 27, 2018.
The collectability and timing of the $2.2 million customer receivable under dispute and the related subcontractor property-damage claim.
The assumptions supporting the $201.955 million of remaining performance obligations, including the $167.857 million expected to be recognized within 12 months; management notes that cancellations, deferrals, and scope adjustments may occur.
The impact of the AJT Systems acquisition, future contingent consideration, and the company’s annual goodwill impairment analysis.
The company’s ability to maintain dividends and fund capital expenditures while managing seasonal working-capital requirements.
The effect of the November 2018 shareholder rights plan and any related subsequent disclosures.