Daktronics Inc /Sd/ Q4 FY2020 Earnings Call

Good day, ladies and gentlemen, and welcome to Daktronics Fiscal Year 2020 Fourth Quarter Earnings Results Conference Call. As a reminder, this conference is being recorded today, Wednesday, June 10th, 2020 and is available on the company's website at www.daktronics.com. After the speakers' presentation, there will be a question-and-answer session.

Thank you, operator. Good morning everyone. Thank you for joining our fiscal year and fourth quarter earnings conference call. I want to remind investors and participants that in addition to discussing historical facts, we will also be addressing forward-looking statements about our expectations and plans for our future financial performance and business opportunities. All forward-looking statements carry risks and uncertainties that may affect actual outcomes. These risks include changes in economic conditions, market dynamics, government regulations, and disruptions caused by geopolitical events, natural disasters, or health emergencies like the COVID-19 pandemic. Other factors include our management of growth, timing of future orders, margin fluctuations, and the launch of new products, which are detailed in our SEC filings. Now, let me highlight some financial results, starting with the fourth quarter compared to the fourth quarter of fiscal 2019. Orders decreased by 9.4%, largely due to a decline in advertising spend associated with our commercial and international business units affected by the COVID-19 outbreak. Sales declined by 1.3% because of variations in order timing and conversions to sales. Midway through the fourth quarter, we experienced customer shipment delays and were unable to access some project sites due to global stay-at-home orders. Gross profit as a percentage of net sales was 22.7%, up from 19.1% in last year’s fourth quarter, positively influenced by lower warranty expenses, which decreased to 1.6% of sales from 2.2% in fiscal Q4 2019. We also faced one-time charges that did not recur in fiscal 2020. During this quarter, our cost of goods sold expenses reflected our decision to furlough employees due to lower demand. For example, our service support areas saw decreased demand because of global stay-at-home restrictions. Our manufacturing facilities in Minnesota and Ireland closed for two weeks during peak quarantine. Some other factories operated on reduced schedules to align capacity with customer demand. Fourth quarter operating expenses for fiscal 2020 were $32.1 million, down from $34.7 million, primarily due to decreased travel resulting from COVID-19 responses, canceled sales events, fewer on-site demonstrations, and lower payroll expenses due to reduced work weeks in some areas. For income taxes, the effective rate in the fourth quarter of fiscal 2020 was influenced by permanent tax credits for research and development, relative to a small book loss. The effective tax rate in fiscal 2019's fourth quarter was notably different because of a one-time event. Fiscal 2020 was a 53-week year, while fiscal 2019 was 52 weeks, with the additional week falling in last year’s first quarter. Sales orders and operating expenses were affected by these variances. For the full fiscal year, orders rose by 2% compared to last year, marking our second-highest order volume in history, primarily due to our new product offerings and strong demand throughout the fiscal year. This change in orders demonstrates our ability to meet diverse market needs and secure orders of varying types and sizes. Orders in Live Events increased, largely driven by the demand for upgrades or new solutions for arenas and professional sports stadiums, with specific orders for teams like the Texas Rangers and Cincinnati Reds. Transportation orders also rose as interest in intelligent transportation systems grew, supported by investments from state transportation departments and private-public partnerships. We secured a $16.5 million order from a repeat customer in this sector, which will be delivered over the coming years. The increase in High School and Recreation orders was influenced by fluctuations in order timing. We are witnessing strong market demand and growth in projects for larger video systems, with opportunities for customers to generate revenue through advertising or providing educational content using our displays. Commercial orders fell mainly due to fewer large orders in our Spectacular niche and a stagnant market in the out-of-home sector at year-end, affected by COVID-19's impact on customer cash flow. International orders also decreased, mainly due to timing delays caused by the pandemic across sports and out-of-home customers, similar to our domestic business units. We operate across a variety of customer segments and geographies outside the U.S. and Canada, including transportation, government, sports, and commercial. On a year-to-date basis, sales have increased in all business units except international, reflecting the same reasons as noted for order changes. Gross profit margin year-to-date was 22.8%, similar to last year's 22.9%. Total warranty expenses as a percentage of sales fell to 1.9% in fiscal 2020 from 2.3% in fiscal 2019. Year-to-date operating expenses rose by 2.8%, mainly due to higher selling and product development costs, which in turn were driven by personnel-related expenses and increased marketing efforts. Product design and development expenses increased due to higher personnel costs and investments in our solution portfolio. For the fiscal year 2020, our operating loss was just below break-even, leading to a zero percent annual operating loss as a percentage of sales, compared to 0.8% loss in fiscal 2019. The effective income tax rate for fiscal 2020 was affected by permanent tax credits, reduced by a valuation allowance proportional to a small pretax book loss, resulting in an unusual effective rate. The effective rate for fiscal 2019 was 80.6%, impacted by a discrete one-time effect of $3.3 million. Our effective tax rate may vary with changes in tax laws and the geographic distribution of taxable income and credits. Our cash and marketable securities at the fiscal year's end stood at $41.6 million, with $10.8 million generated from operations. We borrowed $15 million to bolster our liquidity amid COVID-related uncertainty. We invested $29.8 million in capital, new production capabilities, information systems, and equity investments, including a $10 million investment in microLED technology. Additionally, we spent $37.8 million on product development last year. Looking ahead to fiscal 2021, the uncertainties caused by COVID-19 will continue to impact the economy and our customers' buying behaviors. We have proactive measures in place to control expenses and manage cash conservatively to address potential near-term order and revenue downturns. Steps taken include reduced use of outside contractors, temporary cutbacks on benefits, executive and Board salary reductions, restricted travel, offering voluntary exit and retirement options, and implementing a workforce reduction in May 2020. We have also cut back on capital expenditure allocations for fiscal 2021. As we communicated in our April press release about COVID-19, our Board has suspended dividends and share repurchase programs for the foreseeable future to conserve cash during these unprecedented times. We will continue to closely monitor this evolving situation and respond accordingly.

Thank you, Sheila. Good morning everyone. As we entered into fiscal 2020, we focused on order growth, market development, deployment of newly designed solutions, development of advanced manufacturing techniques, and managing capacity and spending. We achieved these goals. Our investments in technology yielded additional control system features and broadened our display lineup, contributing to increased orders. As Sheila said, we were able to achieve the second highest level of order value in our company's history. Winning projects and delivering on our commitments to customers is also a testament to our continued leadership in the marketplace. Customers choose Daktronics for new and leading technologies, our broad range of solutions, the reliability of our products, and our commitment to serve them over the lifetime of their system. Like many other companies, the uncertainty of the impacts of the COVID-19 global pandemic has impacted our business. COVID-19 has created disruptions since its initial outbreak first affecting our China operations. Our goals throughout have been to keep our people and stakeholders safe while operating our business. To this end, beginning in February, we created COVID-19 response teams to manage our global and localized response activities. Using the guidance from the U.S. Centers for Disease Control and Prevention, the World Health Organization, and other applicable regulatory agencies, we enhanced or implemented robust health, safety, and cleaning protocols across our organization. Employees are working from home where possible and we have limited or eliminated travel for the time being. As this virus has spread across the globe, it has generated appropriate responses by governments and regulatory agencies to keep people safe, but these responses have also disrupted our customers' businesses in various ways, as well as impacting how work is done. Because of this, our manufacturing and service teams have adjusted capacity, often including furloughing employees. For example, our China, Ireland, and Minnesota production facilities all temporarily suspended production for a few weeks this spring. We have, however, continuously shipped product during this crisis, as the timing of these closures was staggered, and some facilities have not interrupted operations at all. Currently, all production facilities are operational. Our sales teams have continued to engage our customers, mostly virtually across our diverse markets and geographies, with some customers continuing to place orders, while others are choosing to delay purchases. Our supply chain team has remained alert to potential short supply situations and shipping disruptions, and if necessary, we are utilizing alternative sources and shipping methods. To date, we have not seen a large disruption due to deliveries of components or other materials. The COVID-19 situation has created an unprecedented and challenging time. We continue to believe the underlying fundamentals of digital displays will drive long-term growth in our businesses, but the near-term outlook is some contraction in different areas and greater volatility overall. Moving into fiscal 2021, we have taken actions to position ourselves for a strong recovery when the crisis is over, continuing some investments in market and product development, but with a greater focus on reacting to the new realities of this uncertain environment. The length and depth of the global economic recovery will shape how our customers will invest in digital solutions in the future. We continue to win business in all areas and we'll monitor and adjust our capacity to these needs, balancing our cost structure and timing of deliveries to our customers. To highlight our outlook by area, our Live Events business, which is lumpy, primarily consists of larger contracts and can be highly competitive. Our customers in this area have been impacted by a lack of revenue due to event cancellations. However, planning is in process to bring back both professional and college sports activities. Some projects are being planned, but we also know constrained budgets and potential for fall sports will impact this business unit. In addition to sports, we continue to focus on college campus sales outside of the sports areas for other network digital solutions. We are still seeing demand in our High School Park and Recreation market due to the continued adoption of video in sporting applications. However, there are questions as to the sustainability as we anticipate some constraint in school budgets and uncertainty regarding when events will begin. We have launched a streaming application to help schools broadcast and monetize school events in this time of COVID and beyond. In our commercial business unit, we expect order volumes to be impacted by both new and replacement systems for account-based businesses, expansion of solutions for indoor applications for retail, and growth in military applications, a new market niche for us. Continued replacement and new investment activity in the out-of-home segment is expected; however, we anticipate this activity will be lower until late calendar year 2020. The Spectacular segment will be difficult to predict, as it includes multimillion-dollar projects that are discretionary choices by customers, which can cause ups and downs in timing and trends. Internationally, with our establishment of localized sales and service channels outside the U.S. and Canada, our focus is on increasing market share and growing new business areas. Our current outlook based on known opportunities suggests some contraction in the beginning part of this fiscal year with continued improvement over time. The Transportation business in the U.S. and Canada remains strong due to continued investment in U.S. transportation systems and stability in federal funding. However, the impacts to tax funds and other revenues because of responses to the COVID-19 crisis caused uncertainty about the magnitude and timing of these projects. For example, we had been seeing an increasing demand in advertising and on-premise promotional applications for mass transit facilities like airports. But due to drastic reductions in travelers, there will be some pullback in these investments. 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. We continue to enhance our indoor narrow pixel pitch offerings and see a receptive market for these products across our business units. We continue to foster and build out indirect sales channels for existing and new markets. Our range of solutions and global capabilities make us the industry's most experienced digital display provider. And to support our customers over the long term, we are focused on developing and releasing innovative solutions and services tailored to different applications in each segment. We enter fiscal 2021 with a strong product backlog of $212 million. We are focused on reacting to the current economic environment and prioritizing key initiatives that will make us stronger and better able to compete as this crisis dissipates. The market's increasing adoption and use of digital solutions, along with our new technology releases, cause us to remain positive on the long-term growth in the industry and the overall future of our business. With that, I would ask the operator to please open the line for questions.

Certainly. Our first question comes from line of Greg Pendy from Sidoti. Your question, please.

Hey, guys. Thanks for taking my questions. First of all, congratulations on getting the warranty expenses down for the year. I know there's a lot out of your control, but you definitely delivered on what you can control. I just wanted to get a sense, I guess on a go-forward basis, I know there was an uptick and some failures a few years back, but where are we in that? And are you comfortable that we can start thinking that the warranty expenses will be in sort of that 1.5% to 2% range on a go-forward basis?

We believe we're through that other issue and we have not seen a significant issue like that raise its head. And so yes, I believe that's a fair estimate.

Great, that's helpful. Thanks. And then second question. Thanks for the color on the supply chain. Can you just maybe talk to us a little bit about what you're seeing on the costs of both components and maybe things like aluminum and how we should be thinking about the costs outside of just the disruptions and the availability of product?

Yes, that's a great question. The volatility in so many of these markets is not a continued increase in price pressure and isn't a bargaining position where things are lowering in cost, but it can fluctuate greatly based on various factors in brief periods of time. We do negotiate longer-term contracts for many of our commodities, which gives us stability there and we have very deep vendor relations. So, I believe we have stability in our supply chain, but predicting some of that volatility and pricing is pretty difficult.

Okay, great. And then just one final one, just in light of paring back on the dividends and share repurchases, but then going for the investment on the microLED side, can you kind of elaborate maybe on why that's significant from an investment standpoint, perhaps from a strategic standpoint, as we kind of look out to the future?

I believe as we've said in our continued communication that this narrow pixel pitch, which is roughly seen as products at a 2.5 millimeter pitch and less, is critical for our ongoing viability. As we get to 1 millimeter and below, we believe microLED is a good technology for that. And this investment sets us up for that ongoing into the future. We believe it's critical for our sustainability.

Great. All right. Well, congratulations on the quarter. I appreciate the follow-up on the questions. Thanks.

Appreciate it. Thanks, Greg.

Thank you. This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Reece Kurtenbach for any further remarks.

Thank you. We appreciate everybody's attendance in today's call. We know this is a challenging time and we're committed to the long-term viability of Daktronics and working through this in a way that makes us stronger as we come out. So, we hope you have a great summer and we'll talk to you again in the fall. Thank you.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.