Earnings Call Transcript - DAKT Q1 2024

Operator, Operator

Good day, ladies and gentlemen, and welcome to the Daktronics Fiscal Year 2024 First Quarter Earnings Results Conference Call. As a reminder, this conference is being recorded today, Wednesday, September 6, and is available on the company’s website at www.daktronics.com. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. I would now like to turn the conference over to Ms. Sheila Anderson, Chief Financial Officer for Daktronics, for some introductory remarks. Please go ahead, Sheila.

Sheila Anderson, CFO

Thank you, Liz. Good morning, everyone. Thank you for participating in our First 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. These forward-looking statements reflect the company’s expectations or beliefs concerning future events. All forward-looking statements involve risks and uncertainties, which could cause actual results to differ materially from our expectations. Such risks include, but are not limited to, changes in economic and market conditions, management of growth, timing and magnitude of future contracts and orders, fluctuations in margins, the introduction of new products and technologies, availability of raw materials, components and shipping services and other important factors. These identified factors could cause actual results to differ materially from those discussed on this call in our company’s first-quarter 2024 earnings release and its most recent annual report on Form 10-K. Our first-quarter 2024 earnings release contains certain non-GAAP financial measures and was furnished to the Securities and Exchange Commission on Form 8-K this morning. These documents are available on the Investors section at Daktronics website at www.daktronics.com. I’ll turn the call over to our CEO, Reece Kurtenbach.

Reece Kurtenbach, CEO

Good morning. Thanks, Sheila. I’d like to thank all of you for joining us today. Our record sales and operating income for the quarter are a result of strong execution across all our business areas. We continue to benefit from our past decisive and deliberate actions to improve our customers’ experience while increasing our profitability and working capital levels. Our performance is also a testimony to the resiliency and strength of our teams within Daktronics as well as our strategy of diversified markets and innovation across technology platforms. Our teams strategically utilized our capacity to complete the manufacturing and installation for the start of fall football season for our High School Park and Recreation and Live Events customers. Numerous high schools and colleges turned on Daktronics displays this football season. Several professional sports stadiums also trusted Daktronics' value and have new installations, including the Green Bay Packers, the Denver Broncos, and the New England Patriots. With our sales performance, we also were able to bring lead times back down towards pre-pandemic levels and generate profits. For additional details on the financial results for the quarter, I’ll turn it over to Sheila.

Sheila Anderson, CFO

Thank you, Reece. As Reece mentioned, we had a record start for orders and operating income in the quarter. We had sales of $232.5 million for the first quarter of fiscal 2024. This was an increase of 35.3% compared to $171.9 million for the first quarter of fiscal 2023. Sales growth was driven by fulfilling orders and backlog, especially in the Live Events and High School Park and Recreation business areas, as Reece mentioned. The increase is attributable to a stable operating environment, increased manufacturing capacity, and realization of price increases. What a difference a year makes, as in comparison during the first quarter of fiscal 2023 we experienced multiple material supply chain disruptions, labor shortages, and a pandemic-related shutdown in our facilities in Shanghai, China for a significant portion of that quarter. Gross profit as a percentage of net sales increased to 30.6% for the first quarter of fiscal 2024 as compared to 15% in the first quarter of fiscal 2023. The increase in gross profit percentage is attributable to the record sales volume over our cost structure, strategic pricing actions, and fewer supply chain and operational disruptions during this quarter as compared to last year at the same time. Operating expenses for the first quarter were $30.9 million compared to $31.3 million for the first quarter of fiscal 2024. As a percentage of sales, operating expenses for the quarter over the prior year quarter declined 13.3% from 18.2%. Operating income was $40.2 million or 17.3% of sales during the first quarter of fiscal 2024 as compared to last year’s loss of $5.5 million. Tax expense for the first quarter was $8.9 million with an effective income tax rate of 31.7%. Absent any major tax changes, we expect our full-year effective rate to be in the mid-20s before the noncash, nontax impact with fair value accounting of our convertible debt. Our balance sheet reflects the changes in business levels and strategies we pursued in managing our supply chain and growing our capacity to meet customers’ commitments, all while managing our liquidity. At the end of fiscal 2024 first quarter, our working capital ratio was 1.9:1. Inventory levels dropped slightly since the end of the year and are expected to approach more normalized levels. The supply chain disruptions continue to ease, and order backlog is fulfilled. Cash, restricted cash, and marketable securities totaled $54.9 million, and we have a face value of debt of $40 million outstanding. There were no drawdowns on our line of credit. As a reminder, we closed on our financing in May 2023 as a result of the comprehensive review of financing alternatives, led by the Board’s strategy and financing review committee. This new debt structure provides us the financial resources to serve our customers and build long-term value for our shareholders. The interest expense created by this debt also includes the debt issuance cost of the convertible debt. The convertible debt is recorded at fair value, and we recorded a $7.3 million noncash charge because of the change in the fair value, and that fair value was primarily caused by the increase in our stock price and decline in market interest rates. Going forward, we will remeasure the fair value of this convertible note until maturity or conversion, which will create this noncash charge below operating income each quarter. During the first quarter of fiscal 2024, we generated $19.3 million of cash from operations and used $4.5 million for purchases of property and equipment. We continue to focus on optimizing our working capital for investments and for investments into working capital assets. Our plans are to spend approximately $19 million for capital assets, primarily in manufacturing and technology areas. We also plan investments in digitization to improve customer and employee experiences, and we’ll continue to invest in our affiliates through this year. Over the long term, we expect to grow revenues and profitably. Our backlog at the end of the first quarter of fiscal 2024 was at $324 million, which provides a nice base of business to fulfill in the coming quarters. And the reduction of backlog reflects the stabilization of our supply chain and our ability to return to more customer-anticipated lead times. I’ll now turn it back over to you, Reece for more comments.

Reece Kurtenbach, CEO

Thanks, Sheila. As we look ahead, we expect growth in the global use of audiovisual communication systems in both traditional and new applications. Industry research predicts the LED market will achieve an estimated 20% compounded annual growth rate over the coming years, depending on the specific end market and geography. We are poised to capitalize on this growth by continuing to do things we do well, including how we engage in a full range of activities to serve our customers by providing high-quality standard display products as well as custom-designed integrated systems, both with ongoing services and support. We manufacture a complete line of products from small scoreboards and electronic displays to large multimillion-dollar video display systems and the related control and sound systems. We developed capabilities to design, manufacture, install, and service complete integrated systems, and we are recognized as a technical leader in these areas. We generate new leads and serve repeat customers based on our performance, reputation, and marketing efforts. As we look ahead to the remainder of the current fiscal year, our attention remains focused on our multiyear journey to capture the market’s expected growth and broaden our leading market position by offering best-in-class technologies and services to both our traditional customers as well as new and adjacent markets. We have applied the experience of the preceding two fiscal years to closely monitor the ever-evolving geopolitical and global economic environment and, as necessary, quickly adjust our resources and market approaches so that we can maintain profitability and cash generation throughout various cycles. As we evaluate our business areas, we continue to expect the following over the long term with some natural volatility in size and timing of orders across fiscal periods. We expect our High School Park and Recreation business unit to grow through adoption of video displays for sporting and educational use. These customers are deploying more Daktronics professional-grade technology and sophisticated content increasing the total addressable market. In the Commercial area, we are focused on increasing sales channels with audiovisual integrators for end use in government, military, health care, and corporate applications, which will create growth in this business area. In addition, customers depending on out-of-home advertising or self-promotion use our products and services as an effective medium for both indoor and outdoor applications. We expect existing and new customers to purchase displays to install in new locations as well as replacement displays for existing locations to capitalize on the effectiveness of digital technologies. Transportation demand is strong 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, and we are qualified to do business in all U.S. states. In the International business unit, we continue to experience a softer market due to macroeconomic and geopolitical factors. We expect to see these factors continue to impact sales in the coming year. We are watching developments closely and can adjust resources and commitments accordingly. Over the longer term, we expect similar growth trends in the Commercial and Transportation areas outside the U.S. We also expect continued interest in sports venue projects, and these will be a focus in our marketing efforts. The Live Events segment outlook remains strong due to large stadium renovations, continued replacement cycles, and expansion of sales efforts beyond sports effort areas. We are the acknowledged market leader in this segment, which allows us to be strategic in our pricing and contract terms while being very mindful about the profitability of this business. In FY ‘24, we will make investments in high-return projects and technologies to support long-term profitability. Our experience in engineering, process design, service design, and product development capabilities and investments made in affiliated companies are very important factors in continuing to develop, produce, and offer the most up-to-date digital displays and control system solutions desired by the market. We will continue to invest in our development efforts and our affiliated companies to release differentiated product platforms, software offerings, and support services. We will also advance critical architecture and design in new competitive narrow pixel pitch and micro LED technologies, sustainable technologies, software architecture, and other related areas. We also plan to grow our operational efficiency by focusing on the retention of our highest performing team members and capitalization on automation capabilities added over the last years. We will invest in digital transformation project automation that will support improved customer and employee experiences and lower costs to operate. We believe the stage is set for a strong fiscal 2024 and look forward to continued growth of sales and expansion of operating income. With that, I would ask the operator to please open the line for questions.

Operator, Operator

Our first question comes from BJ Cook with Singular Research.

BJ Cook, Analyst

Hello, can you guys hear me?

Reece Kurtenbach, CEO

Yes, we can.

BJ Cook, Analyst

Awesome. Thanks. Thanks for taking the call. Nice quarter. It looks like gross margins turned out really great from a historical perspective. Can we attribute that to continued improved pricing actions on your backlog? And it seems like inflation is set to be here in the short term. Are new orders going to reflect a more historically lower gross margin? I guess, in other words, is your higher gross margin sustainable?

Reece Kurtenbach, CEO

Yes, we are very pleased with the gross profit margin in the last quarter. We believe much of this is due to our current pricing structure and the smoothness of operations, as the supply chain has become more predictable this year compared to last year. While there are still inflationary pressures, they do not seem as severe or dynamic. The stabilization of the supply chain contributes to this predictability. As we finish the surge of work that arose after the pandemic, I expect a return to a more competitive environment. We are very aware of the inflationary pressures and the current dynamics in the marketplace. Therefore, we are carefully evaluating each opportunity in every market to understand the competitive nature of that business.

BJ Cook, Analyst

Got it. Awesome. Similarly, operating margin was fantastic, too. I know just one quarter that we’re looking at and some of that was due to the gross margin. But it seemed like you supported a notably higher amount of revenue with similar operating expenses compared to first quarter last year. So I guess a similar question, is this reflective of your operational improvements filtering through the P&L? Again, is this sustainable cost structure going forward?

Reece Kurtenbach, CEO

Yes. We believe our ability to ship that much product stems from significant investments we made in automation equipment over the past 18 months. The teams managing these systems have had ample time to enhance their understanding of operations. Additionally, we have greatly increased our staffing levels and established a more stable workforce that is well-versed in the products and our expectations for them. We have a clear understanding of what we can deliver. The management team will focus on maintaining a stable backlog and ensuring all fulfillment areas operate at a high level in the upcoming quarters.

BJ Cook, Analyst

I have a couple of questions regarding the debt structure. Can you pay the mortgage without incurring a prepayment penalty? If that is the case, is that your long-term intention? I assume this is contingent on ensuring working capital and capital expenditures are secure?

Sheila Anderson, CFO

We are able, BJ, to repay that mortgage at any time. And as the management team and our Board reviews the outlook, we’ll be evaluating the use of that cash and working to put it to use for different opportunities to invest it back in the company or, like you mentioned, we could prepay.

BJ Cook, Analyst

So can you remind us what would trigger the conversion of the debt? It looks like the stock has been over the conversion price for a while, but it hasn’t converted yet. Do you have force conversion rates? I think so. Could you remind us about that situation?

Sheila Anderson, CFO

We do have a term of force conversion, but that doesn’t come into effect until 18 months from May of 2023. And then it’s that certain tranches we can force conversion. And the stock price that’s also been over 150% of that $6.31 conversion price.

BJ Cook, Analyst

Just one last quick question, although it might be too early for guidance. Can you share your outlook for the rest of the fiscal year? I've noticed a slight decrease in orders compared to last year, and the press release mentioned that the main concern was the Commercial segment. Is there anything you can provide on that?

Reece Kurtenbach, CEO

We don’t typically give guidance, so that is, we’re still on that track. And in the Commercial business area, the out-of-home business tends to be the most sensitive to economic factors. As you might recall, in the last 9 months, are we going to have a recession? Are we going to have a soft landing? It seems like the press or the pool of experts out there are getting more optimistic that this might be a soft landing, which would bode well for that business segment typically.

Sheila Anderson, CFO

I would like to point out that there is some variability in our larger project business within the Commercial market, specifically in what we refer to as the spectacular business area. This can lead to fluctuations when comparing one quarter to another, resulting in variations in the level of orders.

BJ Cook, Analyst

Yes. Okay, it seems like involved. That’s fine. All right. That’s it for me. Thanks, guys. I appreciate your time.

Sheila Anderson, CFO

Thank you.

Reece Kurtenbach, CEO

Thanks, BJ.

Operator, Operator

I’m showing no further questions in queue at this time. I’d like to turn the call back to Reece Kurtenbach for closing remarks.

Reece Kurtenbach, CEO

Well, I appreciate everybody attending today’s conference call and the questions and any other feedback we will receive. We will host the next conference call when our second quarter results are released and I look forward to talking to you all again then. Thanks, everyone. Have a great day.

Operator, Operator

This concludes today’s conference call. Thank you for participating. You may now disconnect.