Q3 2023 Daktronics Inc Earnings Call
Reece A. Kurtenbach; Chairman, President & CEO; Daktronics, Inc.
Sheila Mae Anderson; CFO & Treasurer; Daktronics, Inc.
Good day, ladies and gentlemen, and welcome to the Daktronics Fiscal Year 2023 Third Quarter Earnings Conference Call. As a reminder, this conference is being recorded today, Wednesday, March 8, and is available on the company's website at www.daktronics.com. (Operator Instructions) 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 Mae Anderson
Thank you, Michelle. Good morning, everyone. Thank you for participating in our third quarter earnings conference call. I would like to review our disclosures 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. All forward-looking statements involve risks and uncertainties, which may be out of our control and may cause actual results to differ materially. Such risks include, but not limited to, our ability to obtain additional financing on terms favorable to us or at all, changes in economic conditions, changes in the competitive and market landscape, including impacts of global trade discussions and policies; the impacts of governmental laws, regulations and orders, including those resulting from pandemics, disruptions to our business caused by geopolitical events, military actions, work stoppages, natural disasters or international health emergencies such as the COVID-19 pandemic.
Any future goodwill impairment charges, management of growth, timing and magnitude of future contracts, fluctuations of margins, availability of raw materials, components and shipping services, the introduction of new products and technologies and other important factors. These identified important factors could cause actual results to differ materially from those disclosed in this call in the company's third quarter 2023 earnings release and its most annual report on Form 10-K.
We refer you to these documents. Our third quarter 2023 earnings release contain certain non-GAAP financial measures and was furnished to the SEC Securities and Exchange Commission on a Form 8-K this morning and is available on the Investors section at the Daktronics website at www.daktronics.com. I'll turn the call over to our CEO, Reece Kurtenbach.
Reece A. Kurtenbach
Thanks, Sheila. Good morning. Thank you for joining us today. Our past actions to carefully match our production schedules, inventory and labor to demand fulfillment were successful, as measured by the increase in sales and generation of operating income for the third quarter.
The pandemic recovery period was unprecedented. The last 24 months were marked by historically high demand while experiencing persistent instability of supply chains, a tight labor market and inflationary conditions. We are seeing supply chain conditions easing, which supports a more stable production schedule. We have also increased production capacity to match market demand which was achieved despite labor shortages and long cycle times for the technology and fixed assets necessary to increase output on an ROI positive basis.
Operating margin improvement was achieved because of a more stable environment, pricing actions that we took in light of supply chain conditions and inflationary pressures, product mix adjustments and prudent management of operating expenses. Quoting activity and sales opportunities remain active, resulting in an order volume of $148 million for the quarter. Fiscal year '22's levels were partially attributed to pent-up demand. As a comparison, orders for the fiscal 2020 third quarter. The last quarter prior to the onset of the pandemic were $135 million.
During the past quarter, our team focused on our liquidity enhancement program and working capital improvements as evidenced by the lowering of inventory levels and their attention to billings and collections of accounts receivable and deposits. I appreciate the efforts of our teams across the company have made to come together to solve these challenges and to serve our customers. I will now turn it over to Sheila for some more details on the financial results.
Sheila Mae Anderson
Thank you, Reece. As Reece mentioned, we experienced higher stability in our fulfillment areas in the third quarter after experiencing a challenging first half of the year. Operating income was $7.1 million or 3.8% of sales or using adjusted operating income, we generated $11.7 million or 6.3% of adjusted operating margin during the third quarter of fiscal 2023. Net sales for the third quarter of fiscal 2023 increased by 32.5% to $185 million compared to $140 million for the third quarter of fiscal 2022.
The $463 million of backlog coming into the quarter, coupled with easing in the supply chain, supported production stability and the third quarter's record level of net sales. Orders for the third quarter of fiscal 2023 decreased 30.9% as compared to the third quarter of fiscal 2022. As Reece noted, order volume levels declined after a record number of orders in fiscal 2022, driven from pent-up demand coming out of the pandemic shutdown and because of timing differences in bookings of large projects.
This high demand coupled with supply chain challenges led to historically high backlog, creating much longer lead times, which impacted order levels. At the same time, we utilize this opportunity to be selective in addressing demand. And so we prioritize our focus on winning only the most profitable opportunities. In addition, our International business unit orders were lower due to the softening market caused by exchange rates and geopolitical conditions in various regions.
As a result of the relationship between past order bookings and the realization of sales, product order backlog remains historically high at $429 million at the end of the third quarter. Gross profit as a percentage of net sales was 22.6% for the third quarter of fiscal 2023 as compared to 16% a year earlier. The increase in gross profit for the third quarter of fiscal 2023 was primarily due to strategic changes in our prices beginning in late calendar year 2022 and throughout fiscal year 2023 and because of fewer disruptions during the third quarter of fiscal 2023.
The year-to-date comparative decline in gross profit for the 9 months 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. Operating expenses increased 22.9% to $34.6 million in the third quarter of fiscal 2023 as compared to $28 million for the third quarter of fiscal 2022.
We performed our annual goodwill impairment test and concluded that the carrying value of the International and Live Events reporting units exceeded their respective fair values. Consequently, we recorded a $4.6 million noncash goodwill impairment charge, which attributed to the increase in operating expenses. The increase was also due to legal fees, accounting and auditing services and other personnel-related expenses. The $1.6 million tax expense for the third quarter of fiscal 2023 reflected a tax rate of 30.5%. Fiscal year 2023 year-to-date tax expense levels represent a deferred tax valuation charge relating to the growing concern condition in the second quarter.
Our balance sheet reflects the change in business levels and strategies we pursued in managing our supply chain and growing our capacity to meet customer commitments. This past year, supply chain disruptions created an increase in lead times by extending the timing of converting orders to sales. This coupled with stronger -- strong demand contributed to a larger than typical inventory level.
At the end of 2023 third quarter, our working capital ratio was 1.6:1. Inventory levels have dropped slightly since the end of the second quarter, yet are still elevated from the prior year-end. Supply chain disruptions has started to ease, and we expect inventory levels to begin to decline to a more normalized levels as order backlog is fulfilled and we reduced purchases. During Q3, we have increased our focus on cash management as a key pillar of our liquidity enhancement plan.
We have taken steps to move from a period of cash investment to cash generation, improving our liquidity and better positioning us for profitable growth. Our teams are focused on lowering inventory through increased production and reductions in purchases. We are collecting more deposits and progress payments ensuring timely billings and collecting accounts receivable on invoiced terms. We are completing capacity additions in our factory and reducing capital spend for fiscal 2024. We are maintaining our strategic pricing initiatives to improve profitability.
For the third quarter, we generated $12.4 million from operations. And for the 9 months of the fiscal year, we have used $9.5 million in cash, primarily to grow working capital, especially inventory. Supply chain disruptions have started to ease. And as mentioned, we expect our inventory levels to decline to more normalized levels over the coming quarters. We have invested $21.8 million in capital expenditures through the first 9 months of fiscal 2023, primarily focused on expanding manufacturing capacity, automation and productivity.
To fund working capital and capital asset additions, we have borrowed $23.6 million in our credit facility as of January 28, 2023, and we amended our credit facility to extend the temporary $10 million increase and the commitment to $45 million until May 1, 2023, when the amount of the credit facility will revert to $35 million. This portion of the facility matures on April 29, 2025. Our Board's independent strategy and financing review committee retained financial advisers to explore additional ways to improve our long-term liquidity profile. This group and management is reviewing structure and financing options. While there can be no assurance that this process will result in any transaction or alternative outcome, indications from the market have been positive. I'll turn it back to you, Reece.
Reece A. Kurtenbach
Thank you, Sheila. As we emerge from the uncertainty of the pandemic and its response, we expect greater stability in our production and overall business. We began FY '23 Q4 with a $429.1 million backlog, and we'll enter FY '24 with a backlog that is unusually large for Daktronics, which will provide consistent use of our factory capacities. We are still focused on reducing backlog to improve lead times, which we believe will have a positive demand generation effects in most of our business areas.
In addition, we continue to selectively and carefully price projects and manage costs in all areas. Supply chains have been stabilizing which will allow us to reduce our component inventory levels in the coming months as our production levels continue to increase and we're able to purchase less safety stock. Our capacity to fulfill manufacturing and services work is dependent on plant automation and people.
We have invested heavily in both areas over the past 24 months as many of our automation projects complete and are close to our desired staffing levels in most areas. We expect to complete the remaining factory automation projects by the end of fiscal year '24 Q1. These were delayed due to equipment lead times and are focused on increasing staffing levels at certain factories and in our technical services areas.
We believe these investments will carry us through expected demand growth through FY '24 and possibly into FY '25. The world has seen a lot of change over the past 2 years and Daktronics has navigated this as a recognized industry leader in quality, technology and reliability. Now in our 55th year of operation, customers continue to choose Daktronics as demonstrated by our strong order volume and backlog. We do not believe that the geopolitical situation is back to normal but we do believe that the levels of uncertainty and volatility will not be as great in the coming months and will continue to stabilize in the coming calendar year.
While macroeconomic factors continue to make it difficult to forecast the future, over the coming years, we currently see signs of the following: Our High School Park and Recreation business will continue to grow through the adoption of video displays for sporting and educational use. This trend toward deploying what began as professional-grade technology in new markets, grows the total addressable market while continuing to distinguish Daktronics as a technology leader. In addition, video displays also have a higher average selling price than the messaging and scoring equipment traditionally purchased in this segment. Commercial business unit out-of-home advertising customers continue to buy after the pandemic-related economic contractions. This is somewhat an effect of their natural replacement cycle.
Our on-premise business also remains strong as customers continued their purchase and use of digital messaging systems. Our spectaculars area, we are also focused on increasing sales channels with audiovisual integrators for use in government, military, health care and corporate applications. Our transportation demand continues to be strong as project planning and approval activities resumed to more prepandemic 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. In the International business unit, we naturally are seeing some softening in the European market due to macroeconomic factors, and we expect to see this to impact sales in the coming year. We are watching developments closely and can adjust resources and commitments accordingly.
Over the longer term, outside the U.S., we continue to focus on and winning projects in transportation type orders, which are characterized by recurring contracts overtime. Out of home orders which rely on building customer relationship with providers in different regions and support venue projects in many areas. The Live Events segment outlook remained strong due to large stadium renovations continued replacement cycles and expansion of sales efforts beyond sports areas. We are a knowledge market leader in this segment, which allows us to be strategic in our pricing and contract terms while being very mindful about the profitability.
Overall, we believe we have adjusted our strategies to the market conditions, which enabled Daktronics emergence from this period, healthy, profitable and continuing to grow. I again want to thank our Daktronics team for increasing our capacity adjusting to the uncertain and volatile supply chain conditions and serving our customers. We appreciate our suppliers and vendors for also helping us through these challenging times. And thank you to our investors for your patience and support as we work through and emerge from these unprecedented times stronger and better positioned to meet the future.
Our management teams and employees are focused on long-term profitable growth and cash generation that we believe will create value for our shareholders now and into the future. With that, I would ask the operator to please open the line for questions.
(Operator Instructions). I am showing no questions at this time. And I would like to turn the conference back over to Reece Kurtenbach for any closing remarks.
Reece A. Kurtenbach
Well, I'd like to thank everybody for attending today's conference call. We will see you in a few months as we have our next call to announce our year-end results, and I wish you all a happy spring.
This concludes today's conference call. Thank you for participating. You may now disconnect.