Daktronics, Inc. — Form 10-Q Summary
Reporting period: Three months ended July 29, 2017, the first quarter of fiscal 2018, compared with the three months ended July 30, 2016. The request metadata identifies “2016 Q1,” but the filing covers fiscal 2018 Q1. Financial statements are unaudited and presented in thousands, except per-share data.
Business Context and Key Metrics
Daktronics designs, manufactures and sells electronic display systems through Commercial, Live Events, High School Park and Recreation, Transportation, and International business units. Results are affected by large project timing, sports-market seasonality, competitive pricing, foreign exchange, and construction-project execution.
| Metric | Q1 FY2018 | Q1 FY2017 | Change |
|---|---|---|---|
| Net sales | $172.7 million | $157.1 million | +9.9% |
| Gross profit | $44.6 million | $39.1 million | +14.3% |
| Gross margin | 25.8% | 24.9% | +90 basis points |
| Operating income | $11.7 million | $8.0 million | +46.9% |
| Operating margin | 6.8% | 5.1% | Improved |
| Net income | $8.4 million | $5.5 million | +52.2% |
| Diluted EPS | $0.19 | $0.13 | +$0.06 |
| Net margin | 4.9% | 3.5% | Improved |
Revenue, Segment Performance and Margins
| Segment | Q1 FY2018 Sales | Year-over-year change | Contribution margin |
|---|---|---|---|
| Commercial | $32.9 million | -9.4% | $3.6 million |
| Live Events | $77.6 million | +28.0% | $13.7 million |
| High School Park and Recreation | $28.5 million | +3.1% | $7.7 million |
| Transportation | $18.9 million | +32.4% | $5.9 million |
| International | $14.9 million | -19.0% | $(1.3) million |
Revenue growth was led by Live Events and Transportation. Commercial sales declined primarily because of lower billboard demand, while International sales declined because of lower order volume. Gross margin improved because of better-than-estimated performance on large projects and improved productivity. International remained loss-making at the contribution level because of lower volume against relatively fixed costs and higher warranty expense.
Orders totaled $153.1 million, down 12.6% year over year. Backlog was $184 million at July 29, 2017, versus $198 million a year earlier and $203 million at fiscal 2017 year-end. Management cautions that backlog varies with large-project timing, seasonality, delivery schedules, cancellations and estimated profitability.
Cash Flow, Liquidity and Capital Structure
- Operating cash flow was an outflow of $4.9 million, compared with $6.6 million of operating cash flow in the prior-year quarter. The decline primarily reflected higher accounts receivable, inventory, and costs in excess of billings.
- Investing cash flow was $3.0 million, including $4.1 million of capital expenditures, $7.6 million of marketable-security maturities or sales, and $0.6 million of equity investments.
- Financing cash flow was an outflow of $3.9 million, including $3.1 million of dividends and $1.0 million of principal payments. No shares were repurchased during the quarter.
- Cash and cash equivalents were $26.9 million at July 29, 2017, compared with $32.6 million at April 29, 2017. Marketable securities were $25.0 million, providing approximately $51.9 million of cash and marketable securities combined.
- Working capital was $137.2 million, compared with $127.1 million at fiscal 2017 year-end. Accounts receivable increased to $100.9 million from $78.8 million, inventories increased to $74.4 million from $66.5 million, and costs in excess of billings increased to $46.4 million from $36.4 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 $5.5 million and $3.4 million of bank guarantees were outstanding under the respective facilities. The company was in compliance with all covenants.
- Quarterly dividends were $0.07 per share, compared with $0.10 per share in the prior-year quarter. The board declared another $0.07 per share dividend on August 31, 2017.
Material Changes and Management Commentary
- Product design and development expense increased 28.5% to $9.0 million. Management expects increased spending on new or enhanced customer solutions during fiscal 2018.
- General and administrative expense increased 1.7% to $8.9 million, primarily due to personnel and information-technology costs. Selling expense declined 2.1% to $14.9 million.
- The effective tax rate decreased to 29.7% from 31.2%, primarily because of a higher expected research and development tax credit.
- The company projects fiscal 2018 capital expenditures of less than $20 million for manufacturing capacity, production equipment, quality and reliability initiatives, and information infrastructure.
- No formal revenue or earnings guidance is provided in the filing. Management believes available working capital and financing sources will meet foreseeable operating requirements, but notes that additional financing could be needed if growth exceeds expectations, profitability declines, or strategic investments are made.
Risks, Contingencies and Unusual Items
- A mechanical-device warranty issue affecting certain older out-of-home displays resulted in a $0.8 million increase to accrued warranty obligations during the quarter. Total accrued warranty obligations were $29.8 million at July 29, 2017, including $2.8 million estimated for the specific issue. Actual remediation costs could materially exceed the estimate.
- The company had $8.9 million of outstanding letters of credit and $21.6 million of surety bonds. Performance guarantees expose the company to potential reimbursement obligations if customers call on the guarantees.
- A contingent consideration liability related to the ADFLOW acquisition was $1.0 million at July 29, 2017. Its valuation depends on forecasted performance and other unobservable assumptions.
- Foreign currency forward contracts had a notional amount of approximately $9.6 million and were not designated as accounting hedges. Management estimates that a 10% change in foreign exchange rates would affect pre-tax income by approximately $0.5 million, subject to stated limitations.
- Risks include large-project timing and execution, backlog variability, competition and pricing pressure, dependence on two major digital-billboard customers, material availability and costs, economic conditions, government transportation spending, foreign exchange, seasonality, and warranty claims.
- Management reported no material expected loss from legal proceedings and concluded that disclosure controls and internal control over financial reporting were effective as of July 29, 2017.
Investor Verification Priorities
- Verify whether the quarter’s margin improvement is sustained after the favorable performance of large projects and whether International operations recover.
- Monitor conversion of the $184 million backlog into revenue and cash, including the effects of lower orders and project timing.
- Track accounts receivable, inventory, costs in excess of billings and operating cash flow, which turned negative despite higher earnings.
- Assess the ultimate cost and duration of the legacy display warranty program and changes in the $29.8 million warranty reserve.
- Confirm capital expenditures remain below the projected $20 million and evaluate dividend sustainability given working-capital requirements.
- Review covenant compliance, guarantee exposure, contingent acquisition consideration, foreign exchange effects and dependence on major digital-billboard customers.