Daktronics CEO Says Company Endured Perfect Storm Last Two Years, But Business Skies Seem To Now Be Clearing
December 12, 2022 by Dave Haynes
The CEO of Daktronics says a “perfect storm” of COVID-era lockdowns and shuttered economies, followed rapidly by huge supply chain issues, has forced the LED manufacturer to rethink operations and find ways to improve cash flow.
The South Dakota company is one of the most well-established manufacturers in LED displays and one of few not directly tied to China. It delayed its SEC-required financial reporting by several days, from last week, citing worries about the company’s viability.
That reporting was filed today, and while the company is seeing solid growth in sales, it has a “historically high” product order backlog to clear and operated at a loss for the most recent quarter, owing heavily to a $13.0 million “non-cash deferred tax asset valuation adjustment.” The filing lays out belt-tightening measures and plans to seek additional financial backing.
The SEC filing says Daktronics had:
- Net sales of $187.4 million, a 14.0 percent and 9.0 percent increase from the second quarter of fiscal 2022 and the first quarter of fiscal 2023, respectively;
- Orders of $182.8 million, a 11.7 percent increase from the second quarter of fiscal 2022;
- Product order backlog remains at historically high levels of $463.1 million;
- Operating income of $1.5 million and net loss in large part due to a non-cash deferred tax asset valuation adjustment.
CEO Reece Kurtenbach says in the filing:
“Our business continues to adapt and recover from the enduring implications of the pandemic. Supply chain disruptions have started to ease and we expect our inventory levels to peak in the third quarter and begin to decline to more normalized levels as order backlog is fulfilled and we reduce purchases. Our teams are focused on improving our cash flow and enhancing our liquidity, which includes:
- Cash generation focus through proactively completing and fulfilling orders in our $463.1 million backlog, through:
- Productivity improvements from previous investments in factory capacity expansion and capital equipment and hiring only critical production and service personnel to increase output
- Operating margin improvement through pricing actions, product mix adjustments, and prudent management of operating expenses
- Re-engineering designs for supply chain resiliency
- ‘Normalizing’ inventory levels as supply chain challenges continue to ease
- Aggressive management of working capital
- Concentrating capital investments on maximizing asset returns
- Obtaining additional sources of liquidity, with the consent of our lead banking partner.
“In our 54 year history, we have not been faced with the perfect storm that the last two years represent beginning with the immediate implications of the economy shutting down in the spring of 2020, followed by the sudden rebound in activity while supply chains were delayed, snarled and often closed. These times have stressed our liquidity beyond levels that we have ever seen, and our financial resources have not been sufficiently flexible. Our immediate priority is to restore our balance sheet to historical levels of liquidity. We are pursuing avenues to strengthen our financing flexibility by adding liquidity and diversifying our funding sources. Additionally, since last year at this time, we have successfully increased prices and have focused our selling and fulfillment resources on the most profitable opportunities and turning away price-driven business. We have taken steps with the specific goal of improving profitability and cash flow over the coming quarters and beyond as our backlog increasingly contains orders booked using current pricing methodologies.
He added: “We continue to improve the stability and consistency in our operations to provide increased production and output during these dynamic times of volatile supply chain and tight labor market conditions. These actions include carefully matching our production schedules, inventory, and labor to demand fulfillment. Our completed and planned capital investments will also increase our capacity as we enhance our automation capabilities. As supply chains continue to ease, we are further conserving cash by reducing inventory purchases and lowering inventory levels. We are prudently managing operating costs. We will continue to actively monitor market and supply conditions, adjusting pricing and operations accordingly.”
This last bit details the accounting side of that tax valuation thing, but you may need a finance background to understand it (I don’t).
The $14.0 million tax expense for the second quarter of fiscal 2023 was primarily a result of a $13.0 million valuation allowance against our net deferred tax assets and the reversal of tax benefits recognized in the first fiscal quarter as a result of our going concern assessment.
In light of the substantial doubt in our ability to continue as a going concern and our related evaluation of the income tax implications of reaching this conclusion, we expect to conclude that the Company’s disclosure controls and procedures and internal control over financial reporting were not effective as a result of material weaknesses. Our going concern policy did not contemplate evaluating the income tax implications of reaching a substantial doubt going concern conclusion. In addition, the material weaknesses relate to the untimely internal communication to support the functioning of internal controls and the resulting accounting for income taxes. The Company continues to evaluate its disclosure controls and procedures and internal controls over financial reporting, and its ultimate conclusions on these topics may differ from what the Company currently anticipates.
It appears, based on descriptions of current sales and production, that the perfect storm described by Kurtenbach is clearing and things don’t look as dark as the going concern statements suggest.
Net sales for the second quarter of fiscal 2023 increased by 14.0 percent as compared to the second quarter of fiscal 2022 and by 16.2 percent on a year to date basis. Sales growth was driven by fulfilling orders in backlog even while we experienced multiple material supply chain disruptions and labor shortages. Supply chain disruptions are creating an increase in lead times by extending the timing of converting orders to sales. This coupled with strong demand has contributed to a larger than typical backlog and inventory levels.
Gross profit as a percentage of net sales was 16.9 percent for the second quarter of fiscal 2023 as compared to 19.6 percent a year earlier and 16.0 percent for the six months ended October 29, 2022 as compared to 20.8 percent for the same fiscal six months. This comparative decline in gross profit percentage was caused by inflation in materials, freight, and personnel related costs. In addition, extraordinary supply chain disruptions created intermittent work stoppages and factory inefficiencies, adding additional costs to meet customer commitments. These conditions are beginning to abate. Prices were increased in late calendar 2022 and throughout 2023; these price changes are just beginning to be realized through sales as we work through backlog without price changes. We expect sales price changes to be realized through the remaining 2023 fiscal year.
Operating expenses increased 8.2 percent to $30.2 million in the second quarter of fiscal 2023 as compared to $27.9 million for the second quarter of fiscal 2022, and increased 13.0 percent to $61.5 million for the six months ended October 29, 2022 as compared to $54.4 million for the first six months of fiscal 2022. The year to date increases were primarily due to personnel related expenses, convention and travel related expenses, and approximately $1.0 million for professional fees related to shareholder engagement.
Operating margin for the second quarter of fiscal 2023 was a positive 0.8 percent, compared to a positive 2.7 percent for the second quarter of fiscal 2022 and a negative 1.1 percent for the six months ended October 29, 2022 as compared to positive 3.2 percent for the first six months of fiscal 2022.