Item 2. Management’s Discussion and Analysis
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This section entitled "Management’s Discussion and Analysis of Financial Condition and Results of Operations" (“MD&A”) is intended to provide a reader of our financial statements with a narrative from the perspective of management on our financial condition, results of operations, liquidity, and certain other factors that may affect our future results. The MD&A provides a narrative analysis explaining the reasons for material changes in the Company’s (i) financial condition during the period from the most recent fiscal year-end, April 30, 2022, to and including July 30, 2022 and (ii) results of operations during the current fiscal period(s) as compared to the corresponding period(s) of the preceding fiscal year.
This Quarterly Report on Form 10-Q, including the MD&A, contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements reflect our current views with respect to future events and financial performance. The words "may," "would," "could," "should," "will," "expect," "estimate," "anticipate," "believe," "intend," "plan" and similar expressions are intended to identify forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Any and all forecasts and projections in this document are “forward looking statements” and are based on management’s current expectations or beliefs. From time to time, we may also provide oral and written forward-looking statements in other materials we release to the public, such as press releases, presentations to securities analysts or investors, or other communications by us. Any or all of our forward-looking statements in this report and in any public statements we make could be materially different from actual results. Accordingly, we wish to caution investors that any forward-looking statements made by or on behalf of us are subject to uncertainties and other factors that could cause actual results to differ materially from such statements.
We also wish to caution investors that other factors might in the future prove to be important in affecting our results of operations. New factors emerge from time to time; it is not possible for management to predict all of such factors, nor can it assess the impact of each such factor on the business or the extent to which any factor, or a combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
We undertake no obligation to update publicly or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Our MD&A should be read in conjunction with the Consolidated Financial Statements and related Notes included in Item 1 of Part 1 of this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the fiscal year ended April 30, 2022 (including the information presented therein under Risk Factors), as well other publicly available information about our Company.
OVERVIEW
We are engaged principally in the design, marketing, and manufacture of a wide range of integrated electronic display systems and related products which are sold in a variety of markets throughout the world and the rendering of related maintenance and professional services. We focus our sales and marketing efforts on markets, geographical regions and products. Our five business segments consist of four domestic business units and the International business unit. The four domestic business units consist of Commercial, Live Events, High School Park and Recreation, and Transportation, all of which include the geographic territories of the United States and Canada.
The following selected financial data should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended April 30, 2022 and the consolidated financial statements set forth in that Annual Report on Form 10-K, including the notes to consolidated financial statements included therein.
CURRENT CONDITIONS
Supply chain disruptions continue as a result of several factors, including the pandemic lockdowns, shipping container shortages, labor shortages, war and other conflicts, and changes in global demand. We are specifically impacted by the global shortage of semiconductors and related electronic components. Over the past months, our capacity was constrained due to significant and unusual part shortages, a challenging labor environment, and operating disruptions from COVID-19 related absences, and shutdown of our facilities in Shanghai, China due to a government mandated COVID-19 zero tolerance policy. Through this time, we also have experienced increased input costs for materials, commodities, personnel,
15
Table of Contents
freight, and tariffs. In addition, recent disputes by railroad workers regarding the terms of labor agreements have increased the likelihood of a potential strike or work stoppage by certain railroad workers. In response to these increased tensions, President Biden recently took an executive action to temporarily prevent approximately 115,000 U.S. railroad workers from going on strike for sixty days. It is uncertain at this time whether negotiations will be successful in preventing a strike or work stoppage by railroad workers. The International Longshore and Warehouse Union (ILWU) contract with the Pacific Maritime Association expired July 1st. While negotiations are in process, a strike or work slow-down mandate is possible. This would have a negative impact on the movement of material through west coast ports. We are monitoring these situations but it is difficult and uncertain to predict the level of impact this may have on our organization or our supply chain.
We have responded to input cost increases by increasing pricing through the last half of fiscal 2022 and implemented additional increases at the beginning of fiscal 2023. We also use pricing policies and opportunity evaluations across markets to manage price levels. We will continue to monitor our supply chains and our marketplaces and adapt our pricing methodologies as we see appropriate. We have also allocated resources to redesigns of certain products to provide the ability to source available components
Macroeconomic events including the possibility of sustained high inflation and tightening financials conditions, including the potential for higher interest rates, could increase the likelihood of deteriorating global economic conditions. We also expect impacts to the global economic conditions in reaction to the evolving war and geopolitical environment. Although we cannot predict the length or severity of these conditions, we expect continued disruptions in obtaining materials, commodities, labor, and freight availability and an increase in inflation. Due to longer planning horizons and volatility in supply chains, we plan to carry higher quantities of inventory and anticipate changes in the timing of payments from our customers as we work through different disruptions and fulfill our backlog, likely creating an increased consumption of cash. We are also planning additional cash use for capital spending to grow our manufacturing capacity.
All of these conditions have and will continue to cause volatility in our cash flow, pricing, order volumes, lead-times, competitiveness, revenue cycles, and production costs, and it is likely these conditions will continue to have negative impact in fiscal 2023.
For additional information, refer to the COVID-19 and raw material and component related risk factors disclosed in Item 1A of Part I in our Annual Report on Form 10-K for the fiscal year ended April 30, 2022.
RESULTS OF OPERATIONS
COMPARISON OF THE THREE MONTHS ENDED JULY 30, 2022 AND JULY 31, 2021
Product Order Backlog
Backlog represents the dollar value of orders for integrated electronic display systems and related products and services which are expected to be recognized in net sales in the future. Orders are contractually binding purchase commitments from customers. Orders are included in backlog when we are in receipt of an executed contract and any required deposits or security and have not yet been recognized into net sales. Certain orders for which we have received binding letters of intent or contracts will not be included in backlog until all required contractual documents and deposits are received. Orders and backlog are not measures defined by accounting principles generally accepted in the United States of America ("GAAP"), and our methodology for determining orders and backlog may vary from the methodology used by other companies in determining their orders and backlog amounts.
Order and backlog levels provide management and investors additional details surrounding the results of our business activities in the marketplace and highlight fluctuations caused by seasonality and our large project business. Management uses orders to evaluate market share and performance in the competitive environment. Management uses backlog information for capacity and resource planning. We believe order information is useful to investors because it provides an indication of our market share and future revenues.
Our product order backlog as of July 30, 2022 was $469.1 million as compared to $285.3 million as of July 31, 2021 and $471.6 million at April 30, 2022, which was the end of our fiscal 2022.
We expect to fulfill the backlog as of July 30, 2022 within the next 24 months. The timing of backlog may be impacted by project delays resulting from parts availability and other constraints stemming from the supply chain disruptions.
16
Table of Contents
Net Sales
The following table shows information regarding net sales for the three months ended July 30, 2022 and July 31, 2021:
Three Months Ended
(in thousands) July 30, 2022 July 31, 2021 Dollar Change Percent Change
Net Sales:
Commercial $ 40,118 $ 32,781 $ 7,337 22.4 %
Live Events 56,383 52,387 3,996 7.6
High School Park and Recreation 35,809 27,894 7,915 28.4
Transportation 19,540 12,558 6,982 55.6
International 20,070 19,112 958 5.0
$ 171,920 $ 144,732 $ 27,188 18.8 %
Orders:
Commercial $ 47,678 $ 38,329 $ 9,349 24.4 %
Live Events 51,753 49,686 2,067 4.2
High School Park and Recreation 37,579 45,711 (8,132) (17.8)
Transportation 15,704 21,345 (5,641) (26.4)
International 17,509 26,675 (9,166) (34.4)
$ 170,223 $ 181,746 $ (11,523) (6.3) %
For the fiscal 2023 first quarter, net sales were $171.9 million, an increase of $27.2 million from the prior year's first quarter. The year-over-year growth was driven by fulfilling orders in the backlog and continued strong orders. Material supply shortages and labor challenges are creating an increase in lead times and extending the timing of converting some orders to sales in the near-term. We expect supply chain conditions to persist through the fiscal year.
Order volume decreased in the first quarter of fiscal 2023 from the prior year's first quarter. Fiscal 2022 saw a record number of orders from pent up demand during the COVID-19 pandemic and orders for fiscal 2023 continue to be strong. Order bookings in the first quarter of fiscal 2023 were strong for shopping centers, casinos, and out of home advertising display systems in the Commercial business unit and in multiple sports venues in the Live Events unit. International markets have seen some softening in demand through the first quarter of fiscal 2023 due to the inflationary environment and geopolitical events.
Gross Profit and Contribution Margin
Three Months Ended
July 30, 2022 July 31, 2021
(in thousands) Amount As a Percent of Net Sales Amount As a Percent of Net Sales
Gross Profit:
Commercial $ 4,821 12.0 % $ 7,178 21.9 %
Live Events 3,786 6.7 8,582 16.4
High School Park and Recreation 9,977 27.9 9,509 34.1
Transportation 5,838 29.9 3,751 29.9
International 1,372 6.8 3,168 16.6
$ 25,794 15.0 % $ 32,188 22.2 %
The decline in gross profit percentage was primarily impacted by inflationary challenges in materials, freight, and personnel related costs. In addition, extraordinary supply chain disruptions, including the Shanghai factory closure, created intermittent work stoppages and factory inefficiencies, adding additional costs to meet customer commitments, especially
17
Table of Contents
in the Live Events business unit. We also recorded a $0.8 million provision for estimated losses on contracts in progress during the three months ended July 30, 2022 .
Total warranty costs as a percent of sales for the three months ended July 30, 2022 compared to the same period one year ago increased to 1.6 percent from 1.2 percent.
Three Months Ended
July 30, 2022 July 31, 2021
(in thousands) Amount As a Percent of Net Sales Dollar Change Percent Change Amount As a Percent of Net Sales
Contribution Margin:
Commercial $ 200 0.5 % $ (3,317) (94.3) % $ 3,517 10.7 %
Live Events 974 1.7 (5,354) (84.6) 6,328 12.1
High School Park and Recreation 6,581 18.4 (184) (2.7) 6,765 24.3
Transportation 4,943 25.3 2,089 73.2 2,854 22.7
International (1,337) (6.7) (2,266) (243.9) 929 4.9
$ 11,361 6.6 % $ (9,032) (44.3) % $ 20,393 14.1 %
Contribution margin is a non-GAAP measure and consists of gross profit less selling expenses. Selling expenses consist primarily of personnel related costs, travel and entertainment expenses, marketing related expenses (show rooms, product demonstration, depreciation and maintenance, conventions and trade show expenses), the cost of customer relationship management/marketing systems, bad debt expenses, third-party commissions, and other expenses.
Contribution margin was impacted by the previously discussed sales levels and impacts on gross profit, as well as a 22.3 percent increase in selling expenses in the first three months of fiscal 2023 compared to the prior year three-month period. We have adjusted our sales and marketing activities and staffing levels to achieve current and expected future sales levels. Our order volume is directly associated with our marketing and sales expenses.
The following table reconciles non-GAAP contribution margin to GAAP operating loss:
Three Months Ended
July 30, 2022 July 31, 2021
(in thousands) Amount As a Percent of Net Sales Dollar Change Percent Change Amount As a Percent of Net Sales
Contribution margin $ 11,361 6.6 % $ (9,032) (44.3) % $ 20,393 14.1 %
General and administrative 9,441 5.5 1,870 24.7 7,571 5.2
Product design and development 7,439 4.3 277 3.9 7,162 4.9
Operating (loss) income $ (5,519) (3.2) % $ (11,179) (197.5) % $ 5,660 3.9 %
General and administrative expenses in the first quarter of fiscal 2023 increased as compared to the same period one year ago primarily due to increases in personnel expense and approximately $1.0 million in professional fees related to shareholder engagement.
Product design and development expenses in the first quarter of fiscal 2023 increased slightly as compared to the same period one year ago primarily due to an increase in personnel related expenses partially offset by a decrease in consulting expenses.
Decreased contribution margin and increased spend in general and administrative and product development led to an operating loss for the first quarter of fiscal 2023 compared to the prior year first quarter.
18
Table of Contents
Other Income and Expenses
Three Months Ended
July 30, 2022 July 31, 2021
(in thousands) Amount As a Percent of Net Sales Dollar Change Percent Change Amount As a Percent of Net Sales
Interest (expense) income, net $ (60) — % $ (197) (143.8) % $ 137 0.1 %
Other expense, net $ (747) (0.4) % $ 121 (13.9) % $ (868) (0.6) %
Interest (expense) income, net: The change in interest income and expense, net for the first quarter of fiscal 2023 compared to the same period one year ago was primarily due to utilizing our line of credit during the 2023 first quarter for our strategic investments in inventory.
Other (expense) income, net: The change in other income and expense, net for the first quarter of fiscal 2023 as compared to the same period one year ago was primarily due to losses recorded for equity method affiliates and foreign currency volatility.
Income Taxes
We have recorded an effective tax rate of 15.8 percent for the first quarter of fiscal 2023 as compared to 25.2 percent for the first quarter of fiscal 2022. The decrease in tax rate is primarily driven by an increase in estimated tax credits and other permanent tax items less valuation allowances as a percentage of estimated pre-tax earnings for fiscal 2023 compared to the estimated value of tax credits and other permanent items less valuation allowances as a percentage of the estimated pre-tax earnings in the first quarter of fiscal 2022.
LIQUIDITY AND CAPITAL RESOURCES
Three Months Ended
(in thousands) July 30,
2022 July 31,
2021 Dollar Change
Net cash (used in) provided by:
Operating activities $ (22,815) $ (1,019) $ (21,796)
Investing activities (10,372) (1,852) (8,520)
Financing activities 24,128 (200) 24,328
Effect of exchange rate changes on cash 80 (132) 212
Net decrease in cash, cash equivalents and restricted cash $ (8,979) $ (3,203) $ (5,776)
Cash decreased by $9.0 million for the first three months of fiscal 2023 compared to a decrease of $3.2 million in the first three months of fiscal 2022. The decrease in the first quarter of fiscal 2023 is primarily due to the use of cash for investments in inventory required to support the conversion of increased backlog and strong orders into sales and as a strategy during this time of supply chain disruptions. The decrease in cash was also due to investing in capital assets for increased capacity and automation and loans to affiliates. We utilized our line of credit to support these uses of cash.
Net cash used in operating activities: Net cash used in operating activities was $22.8 million for the first three months of fiscal 2023 compared to net cash used in operating activities of $1.0 million in the first three months of fiscal 2022. The $21.8 million difference between net cash used in operating activities in the first quarter of fiscal 2023 compared to net cash used in operating activities in the first quarter of fiscal 2022 was primarily the result of changes in net operating assets and liabilities and the result of having a net loss in the first quarter of 2023 compared to net income in the first quarter of 2022.
19
Table of Contents
The changes in net operating assets and liabilities consisted of the following:
Three Months Ended
July 30,
2022 July 31,
2021
(Increase) decrease:
Accounts receivable $ (12,495) $ (10,412)
Long-term receivables 688 309
Inventories (23,237) (10,256)
Contract assets (3,690) (5,434)
Prepaid expenses and other current assets 3,342 (2,390)
Income tax receivables (1,725) 98
Investment in affiliates and other assets (900) 91
Increase (decrease):
Accounts payable 7,212 17,352
Contract liabilities 6,975 3,134
Accrued expenses (409) (1,392)
Warranty obligations (110) (478)
Long-term warranty obligations 643 (100)
Income taxes payable (6) (130)
Long-term marketing obligations and other payables 969 147
$ (22,743) $ (9,461)
Net cash used in investing activities: Net cash used in investing activities totaled $10.4 million in the first three months of fiscal 2023 compared to net cash used in investing activities of $1.9 million in the first three months of fiscal 2022. Purchases of property and equipment totaled $10.7 million in the first three months of fiscal 2023 compared to $1.3 million in the first three months of fiscal 2022. Purchases of and loans to affiliates accounted for by the equity investment method totaled $1.1 million in the first three months of fiscal 2023 as compared to $0.7 m illion in the first three months of fiscal 2022.
Net cash provided by (used in) financing activities: Net cash provided by financing activities was $24.1 million for the three months ended July 30, 2022 due to draws on our line of credit compared to a payment of $0.2 million in the same period one year ago primarily due to payments for shares repurchased.
Other Liquidity and Capital Resources Discussion: The timing and amounts of working capital changes, dividend payments, stock repurchases, capital spending, profitability, and investments in affiliates impact our liquidity. Our cash needs are funded through a combination of cash flow from operations and borrowings under bank credit agreements.
We believe the audiovisual industry fundamentals will drive long-term growth for our business; however, for the near-term outlook, we expect our customers may continue to have disruptions and may continue to reduce or increase their spend on audiovisual systems and related services as they work through the economic and business implications of COVID-19, supply chain challenges, and emerging war and geopolitical situations. Ongoing supply chain disruptions and inflationary challenges in materials, freight and personnel related costs also impact our profitability and cash flows. We have increased pricing when we are able in an effort to offset the increase in input costs. In addition, we are planning additional capital spending to grow our manufacturing capacity. We anticipate needing to utilize a portion of our line of credit through fiscal 2023 for these conditions and investments.
Working capital was $118.5 million and $103.9 million as of July 30, 2022 and April 30, 2022, respectively. The changes in working capital, particularly changes in inventory, accounts payable, accounts receivable, contract assets and liabilities, and the sports market and construction seasonality, can have a significant impact on the amount of net cash provided by operating activities largely due to the timing of payments and receipts. On multimillion-dollar orders, the time between order acceptance and project completion may extend up to or exceed 12 months depending on the amount of custom work and a customer’s delivery needs. We often receive down payments or progress payments on these orders. We expect to use
20
Table of Contents
cash in operations as our business returns and exceeds pre-pandemic levels and due to longer planning horizons and volatility in supply chains. While these conditions continue, we plan to carry higher quantities of inventory and anticipate changes in the timing of payments from our customers as we work through different disruptions and fulfill our backlog.
We had $24.1 million advanced on our line of credit as of July 30, 2022. On August 16, 2022, we entered into an agreement to temporarily expand the line of credit by $10 million through October 31, 2022. In addition, certain financial covenants were modified. Our line of credit expires in April 2025.
The credit agreement and amendments require us to be in compliance with certain financial ratios, including a covenant to maintain the ratio of interest-bearing debt to earnings before income taxes, depreciation, and amortization of less than 6.0 for the quarter ending October 29, 2022 and beginning with the fiscal quarter ending January 28, 2023 to be less than 2.5. A minimum fixed charge coverage ratio must be met of at least 2 to 1 at the end of any quarter during fiscal year 2023 and a ratio of at least 1.25 to 1 for the year end of fiscal 2023. As of July 30, 2022, we were not in compliance with these covenants, and our bank provided waivers for the first quarter of fiscal 2023 for such covenants. Based on future projections, we expect to be in compliance with these covenants through the next year; however, with the uncertainty and volatility in the supply chain and the sensitivity of the covenants, we cannot be certain. If we violate a covenant and cannot obtain a waiver from the bank, we may need to seek additional debt or equity financing.
We had $7.8 million of retainage on long-term contracts included in receivables and contract assets as of July 30, 2022, which has an impact on our liquidity. We expect to collect these amounts within one year.
We are sometimes required to obtain bank guarantees or other financial instruments for display installations and utilize a global bank to provide such instruments. If we are unable to complete the installation work, our customer would draw on the banking arrangement, and the bank would subrogate its loss to Daktronics' restricted cash accounts. As of July 30, 2022, we had $0.6 million of such instruments outstanding.
We are sometimes required to obtain performance bonds for display installations, and we have a bonding line available through a surety company for an aggregate of $150.0 million in bonded work outstanding. If we were unable to complete the installation work, and our customer would call upon the bond for payment, the surety company would subrogate its loss to Daktronics. As of July 30, 2022, we had $82.5 million of bonded work outstanding against this line.
Our business growth and profitability improvement strategies depend on investments in capital expenditures and strategic investments. We are projecting total capital expenditures to be approximately $30 million for fiscal 2023. Projected capital expenditures include purchasing manufacturing equipment for new or enhanced product production and expanded capacity, increasing automation of processes, investments in quality and reliability equipment, demonstration and showroom assets, and continued information infrastructure investments.
We also evaluate and may make strategic investments in new technologies or in our affiliates or acquire companies aligned with our business strategy. We committed to invest an additional $2.0 million over the next year in our current affiliates.
We may repurchase shares of our common stock from time to time in open market purchases, private transactions or other transactions. The timing, volume and nature of share repurchases will be at the sole discretion of management, will be dependent on market conditions, applicable securities laws and other factors, and may be suspended or discontinued at any time. The Board of Directors suspended share repurchases during fiscal 2020 as part of our cash conservation measures through the pandemic. The share repurchase program was reinstated on December 2, 2021. During the three months ended July 30, 2022, we repurchased no shares of common stock.
Significant Accounting Policies and Estimates
We describe our significant accounting policies in "Note 1. Nature of Business and Summary of Significant Accounting Policies" of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended April 30, 2022. We discuss our critical accounting estimates in "Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the fiscal year ended April 30, 2022. There have been no material changes in our significant accounting policies or critical accounting estimates since the end of fiscal 2022.
21
Table of Contents
New Accounting Pronouncements
For a summary of recently issued accounting pronouncements and the effects of those pronouncements on our financial results, refer to "Note 1. Basis of Presentation" of the Notes to the Condensed Consolidated Financial Statements included elsewhere in this Report.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to certain interest rate, foreign currency, and commodity risks as disclosed in our Annual Report on Form 10-K for the fiscal year ended April 30, 2022. There have been no material changes in our exposure to these risks during the first three months of fiscal 2023.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.