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Daktronics (NASDAQ:DAKT)

Q2 2013 Earnings Call

November 20, 2012 11:00 am ET

Executives

Sheila Mae Anderson - Chief Financial Officer and Treasurer

James B. Morgan - Chief Executive Officer, President and Director

Analysts

Stephen Altebrando - Sidoti & Company, LLC

James Ricchiuti - Needham & Company, LLC, Research Division

Robert Hoffman

Rebecca Simmons

Operator

Good day, ladies and gentlemen, and welcome to the Daktronics Second Quarter Fiscal Year 2013 Earnings Results Conference Call. As a reminder, this conference is being recorded today, Tuesday, November 20, 2012, 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, Ms. Anderson.

Sheila Mae Anderson

Thank you, Tyrone. Good morning, everyone. Thank you for participating in our second quarter earnings conference call. I would like to review our disclosure cautioning investors and participants that in addition to statements of historical facts, this call and our quarterly news release contain forward-looking statements reflecting our expectations and beliefs concerning future events which could materially affect our performance. We caution you that these and similar statements involve risks and uncertainties, including changes in economic and market conditions, management of growth, timing and magnitude of future contracts, fluctuations of margins, the introduction of new products and technology and other risks, as noted in our SEC filings, which may cause actual results to differ materially. Detailed risk information is included in our SEC filings. Forward-looking statements are made in the context of the information we know as of today. We undertake no obligation to update or revise such statements to reflect new circumstances or unanticipated events as they occur.

At this time, I would like to introduce Jim Morgan, our President and CEO, who will provide highlights for the quarter.

James B. Morgan

Thanks, Sheila. Good morning, everyone, and thank you for joining us this morning. This was a great second quarter for us, and it follows a very good first quarter. With the record quarter for orders that we had in the first quarter and the resulting backlog we had going into the second quarter, we were well positioned to have a great quarter. We just had to execute and deliver, and we did.

Our performance this quarter is a testament to the progress we have made and continue to make in improving our product designs to make them easier to manufacture and install and improving our manufacturing processes by utilizing lean principles to meet the demand of shipping our quality products on time, and in improving our project management and installation processes to allow us to complete the installation and commissioning as cost-effectively as possible on a timely basis. I'd like to thank all of our employees and our business partners for the good execution during the quarter to serve our customers and meet the critical fall sports deadlines.

The only downside for the quarter was that orders were a bit light for us. Orders for the quarter were $110 million. We typically expect the second quarter orders to be less than the first quarter orders due to the seasonality of our business, but this was a little lighter that we would have liked. However, we do have a number of large orders that we have either booked or been given approval or award of since the end of the quarter. We alluded to some of these in the press release. These orders total over $30 million and range from -- in size from $3 million to $9 million. They are all expected to book soon, although contract negotiations on large orders can sometimes take a while.

Our product development continues to be a key to our future success. Just to add a few comments to the comments in our press release, as we noted in the press release, we are just beginning the shipment of our new 4200 Series Digital Billboard Product. Our 4200 Series product offers enhanced features such as improved image quality, improved diagnostics and reliability and greater energy efficiency, which in turn lowers the cost of ownership for our customer and, of course, makes the ROI better for them as well.

We also recently began shipping our latest fuel price digit products offering an enhanced font, along with improved overall reliability. And this product is part of a new digit platform strategy that will increase commonality and complements our manufacturing processes across all of our digit products that are used both in our commercial and our sports applications. And this commonality brings a manufacturing cost reduction while offering improved performance at the same time.

Our Transportation business will begin shipping full-color Vanguard displays in the next few months. This will be the first of a complete product family offering full-color solutions for everything from lean control displays to larger roadside message displays. This application is a part of a new phase of intelligent transportation systems, which is often referred to as ITS. And this new application is called Active Traffic Management, and this includes realtime lane control and variable speed limit signs, among other things, to have a more realtime control of the traffic. This trend to full color is in response to both this new application for the product in Active Traffic Management as well as the cost-effectiveness of full-color LED technology. And historically, the product in -- for this transportation market has been monochrome amber, so this trend to full color we see as a growth driver for this market going forward.

Our primary focus in our video products area is the business development -- I'm sorry, is the development of our next generation of outdoor service mount LED product, which will offer a wider variety of pixel pitches and improve the manufacturability of the product to achieve improved performance at a reduced cost. And we've been manufacturing outdoor display DVX [ph] surface mount LEDs for a number of years. For example, the Sony display in Times Square is one of the more high-profile displays using this technology, and it's been installed for a couple years. There were many other installations as well in both sports and commercial sites. Our new design is the next generation of that technology and will offer a wider array of pixel spacings, along with improvements in the manufacturability of the displays and enhanced reliability. We anticipate the first shipment of this product later in this fiscal year.

Looking ahead, historically, due to the seasonal nature of our business, our second quarter tends to be our strongest quarter financially, and our third quarter tends to be our weakest quarter financially. Therefore, we expect sales and gross profit margins for the rest of the year to be less than the first half of the year. We are committed to our 3-year strategic goal to significantly improve the operating margin. We were pleased with the operating margin for the quarter, which is greater than 11% and year-to-date is just under 10%. However, to achieve our strategic goal of double-digit operating margins for the year, we will have to have greater operating margins in our strongest quarter of the year -- quarters of the year. Nonetheless, the first half of the year was a good step in that direction, and we are very pleased with the results.

We continue to work to improve the gross profit on contracts for all our standard products through initiatives in product design manufacturing and project management, and that along with the continued emphasis on controlling operating expenses to achieve our goal of sustainable double-digit operating margins.

And with that, I will turn it over to Sheila for some more color on the numbers.

Sheila Mae Anderson

Thank you, Jim. As Jim noted, our financial performance for the second quarter was strong. Sales were up 10% over last year's same quarter due to the strong $164 million backlog we came into this quarter with. In our Transportation business unit, we continued deliveries on the New Jersey Turnpike procurement project and began productions on the Los Angeles Airport project that we've previously announced. Live Events sales included the completion of a display system for the Tampa Bay Lightning, the completion of the new Barclays Center arena in New York and a number of university sports facilities. Sales in Schools and Theatres increased over last year's same quarter due to the continued strong interest in high school scoreboard country [ph], increased video displays for high schools and some relaxation of school budgets. International sales were up due to a strong order booking in the first quarter, which we converted to sales in the second quarter. Sales included third-party advertising applications both in South America and the Middle East, and also included the completion of our second soccer stadium project in Brazil. Commercial is down in sales compared to a year ago due to the video contracts [indiscernible] being higher last year as compared to this year.

Looking forward to the third quarter, we expect sales to be down from the second quarter. We began the third quarter with $127 million in backlog, and we expect sales to be in the range of last year's quarter 3 of about $123 million. Due to the inherent seasonality of the business and the holidays this coming quarter, the third quarter is historically a lighter quarter for sales and profitability. As Jim mentioned, we are optimistic about booking some large orders in quarter 3. However, we don't expect to convert many of these to sales until quarter 4 or until next fiscal year.

Gross profit percentage increased to 28% for the quarter or 5 percentage points better than last year's same quarter and 1 point higher than our quarter 1 results. This uptick is due to the higher production levels to deliver our quarter 1 orders, which created a higher utilization of both our manufacturing and services infrastructure. We also had a higher profitability and sales mix, which included a larger portion of smaller orders, which generally have higher margins for us. We had an improved execution on our on-site projects compared to prior quarters, and gross profit was also impacted by the effects of other cost reduction initiatives.

Gross profit levels for the next few quarters will be lower than our first half of the year and similar to slightly higher compared to last year's third quarter. The decrease from the first half of the year is primarily due to the lower revenues, which in turn are due to the normal seasonality of our business, sales mix for the third quarter, as we'll have some more production on the larger orders at these lower margins, and lower utilization of our fixed-cost infrastructure.

Operating expenses were relatively flat compared to the first quarter and compared to last year's same quarter. We are planning to hold operating expenses flat for the remainder of the year, as previously discussed. Operating income for the quarter was 11%. This level and the increase in operating income dollars over the same year last year are due to our increased sales volumes, higher gross profits and flat operating expenses. We do not expect our second half operating income to be at the levels of the first half. Operating income will more closely match last year's third quarter due to the seasonality of the business and the resulting lower sales, as previously discussed.

Our effective tax rate for the quarter was 33%. We had a onetime deduction relating to a foreign tax strategy, which saved us about 2 percentage point on taxes. Our effective tax rate can vary due to the mix of pretax income in the various countries where we have established entities. For the full year, we are forecasting our effective tax rate to be back in that 35% to 36% range.

We generated $17 million of cash from operations this past quarter. Looking ahead, we estimate total capital expenditures for the year will be about some $14 million. That capital expenditures are primarily for production equipment for the new product lines and replacements or enhancements of our information systems infrastructure.

With that, we will ask the operator to open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We have a question from Steve Altebrando of Sidoti & Company.

Stephen Altebrando - Sidoti & Company, LLC

Do you see a comparison year-over-year?

James B. Morgan

Steve, can you repeat that, we weren't -- come again? We missed the first part of your question.

Stephen Altebrando - Sidoti & Company, LLC

Okay. I was just asking about the baseball pipeline for Q4.

James B. Morgan

There's a couple of possibilities out there yet. Not a lot at this time.

Stephen Altebrando - Sidoti & Company, LLC

Okay. I guess, if you can you remind me, I think there was not much last year as well. I think it is somewhere, I believe, south of $10 million. Is that accurate?

James B. Morgan

Last year was also light. I don't -- Sheila, do you have the numbers handy?

Sheila Mae Anderson

Baseball for last year was under -- just under $10 million for the year.

Stephen Altebrando - Sidoti & Company, LLC

Okay. And then in terms of the LAX project, I know that's like a big one -- a big contributor for just our Transportation. Is there much remaining on that project in terms of revenue recognition?

Sheila Mae Anderson

Actually, there is. We got started with about $2 million at that project. We'll see most of that revenue coming in Q3, Q4 and just a little bit trailing into next fiscal year.

Operator

Our next question is from Jim Ricchiuti of Needham & Company.

James Ricchiuti - Needham & Company, LLC, Research Division

I just wanted to go over the gross margin outlook for the current quarter. It sounds like you're expecting flat to up slightly gross margins versus a year ago. Is that correct?

Sheila Mae Anderson

That's correct.

James Ricchiuti - Needham & Company, LLC, Research Division

Just in light of the improvement that you've seen so far in the first half of the year, and I can understand certainly the margins coming down given that sequential decline in revenues from Q3 to Q2, it's still a little surprising that your margins wouldn't be up somewhat. It seems like you're making more improvements in gross margins than what you're guiding to.

Sheila Mae Anderson

We do. We are making improvements, like you mentioned. However, in the pipeline, we are working on some of the larger projects in the third quarter, which are weighting down that gross profit percentage.

James B. Morgan

I would say, to add to that, Jim, I think we -- the utilization factor is not a minor thing. The Remograph [ph] also much has a pretty -- has a significant effect.

James Ricchiuti - Needham & Company, LLC, Research Division

Okay. okay. And then even as we look out to Q4, it sounds like you're building some backlog. It looks like most of these large orders that you've alluded to, you will see some revenues from that in -- beginning in Q3 -- Q4, I should say. So can you give us any sense as to, Jim, how you're viewing Q4 versus Q4 last year without giving specific guidance? Just in general, do you feel like you're -- you've got better visibility into Q4 than perhaps you had last year at this time?

James B. Morgan

I would say the visibility is probably about the same in terms of seeing out that far. Obviously, the Q4 will depend on what orders we booked in Q3. There -- certainly, our pipeline, there's a number of opportunities, nice opportunities in the pipeline in addition to those we've alluded to in the discussion here. So it's all about booking orders here in the third quarter, Jim, is really what it comes down to, and so that will determine how Q4 goes.

James Ricchiuti - Needham & Company, LLC, Research Division

Okay. And can you expand at all on just the activity you're seeing in the international markets? It looks like you had another fairly decent quarter from a booking standpoint. It looks like you're roughly a little below Q1 levels. Is this coming from a number of different markets and countries? Can you maybe expand on that?

James B. Morgan

Sure. We -- well, first, we mentioned that the large architectural lighting order that we looked over in China, we've done several of those over the announcements [ph]. It's good to see that -- those opportunities continuing. We've had -- as Sheila mentioned, we did our -- finished our second soccer stadium in Brazil, which is -- actually, we just really established our entity in Brazil here in the last quarter, so it's good to see some activity there. There's certainly opportunity down there for some more on the sports side, and there's also opportunity in Brazil in the third-party advertising side of the business. In Europe, one of -- the biggest long-term opportunity, really, is third-party advertising. We did have some nice wins in the quarter in that area. We had a nice win for [indiscernible], one of a spectacular third-party display in the U.K. that was an order of $1 million order. We had a nice win with one of the major European third-party companies with some high resolution displays, which is kind of a pilot project for them. So that was -- hopefully will bear more fruit down the road. So there's money in that, and third-party advertising is certainly the bigger, long-term opportunity on the European side.

James Ricchiuti - Needham & Company, LLC, Research Division

Jim, how do you view the pipeline looking out in the second half in International? It seems like it's still pretty healthy, or would you expect the -- potentially the order flow to fall off from what looks like a pretty, pretty good first half.

James B. Morgan

The pipeline, Jim, is still strong, and you certainly read about what's going on in European economy and you wonder how it might affect things. But I guess at this point, the things we're seeing -- I guess we're not seeing a direct effect of that. And [indiscernible]. So I think overall that there's a -- they're feeling the effects of the economy not being real robust right now, but -- well, things are -- our pipeline in International still is healthy.

Operator

Our next question is from Robert Hoffman of Princeton OPportunity.

Robert Hoffman

Kind of 2 difficult questions. Those of us on the East Coast are still -- kind of have Hurricane Sandy on our minds, and I'm in, obviously, in New Jersey. And I was just wondering whether an event like this has increased any awareness for more transportation signs. Do you have -- if you've got any uptick in interests, or do you think that something like this will affect the demand for more transportation signage? And then I have a follow-up.

James B. Morgan

I guess at this point, we don't have any correlation there. Certainly, one of the things that the transportation displays can be used for is emergency situations for evacuation, and that's our thing. Clearly, there's an opportunity to use displays for that. So whether that, longer term, is something that invites us into -- this entity has decided to deploy more of these displays, that certainly is a possibility.

Robert Hoffman

And then on a follow-on completely in terms just on seasonality. As you -- I'm not quite sure I'm familiar enough with your business as to why the second quarter is so much stronger than the third. I can imagine it has to do with the Christmas holiday and things like that. But as your business mix continues to go international, do you see maybe even the out-years that the seasonality may be muted? Is there anything different about the seasonality of some of your international markets that might help smooth out the quarters a bit, which obviously would then help, perhaps on the gross margin side?

James B. Morgan

Well, sure. Well, first of all, in terms of our current business, the -- our sports business is significant for us, and so the -- and the fall sports season happens to be quite a big deadline driver for installation. So that drives a lot of the seasonality of our business and, as you mentioned, the holidays in third quarters is an additional contributing factor. But it's more of the booked -- when the order's booked and when the customer needs the delivery. Your point, will expanding international business offer some business that's not in sync with that seasonality? I think that's definitely the case, and we're doing business in the Southern Hemisphere, which should be 180 degrees out of sync. So that could help. And to that point, we've had some real good success down in Australia, as an example. So that's -- long term, I think it will provide us with an offset to the seasonality to some degree, but the U.S. sports market is still -- it's a big market for us, and we expect it to continue to be.

Operator

Our next question is from Rebecca Simmons of DePrince.

Rebecca Simmons

So I know billboards right now are seasonally weak. But I wanted to see if maybe you could give an update on Del Mar and Clear Channel replacement cycle for billboards and maybe how we should think of timing and opportunity coming from that?

James B. Morgan

Yes. Well, our perspective of that right now is that what we're generally getting from our major customers there is that they don't see their spending -- that the replacement spending will be additive to the new product spending, that it will be -- replacements will be in lieu of some new product. Well now, that's our current understanding, and I guess time will tell if that changes, but that's our view of it at this point. And with that in mind, we're currently viewing that, that will remain more or less steady as far as the visibility we have on it.

Operator

[Operator Instructions] We have a follow-up from Steve Altebrando of Sidoti & Company.

Stephen Altebrando - Sidoti & Company, LLC

I just wanted to follow up on that last question. Is there a difference in profitability or your margin profile? Obviously, the replacements could be a little bit of a different solution versus a new board.

James B. Morgan

Sheila?

Sheila Mae Anderson

Clearly, there is some sort of a large difference in profitability. We are seeing this market is highly competitive, and we're working on that 4200 Series, like we mentioned, will help with the profitability. As far as our replacement cycle, it's about the same, same gross margin.

Stephen Altebrando - Sidoti & Company, LLC

Okay. Do you -- I guess what I was getting at, do you have -- I guess, how developed are you right now in terms of developing a solution that is instead of a total new board but kind of changing the LED displays, so it's kind of a little bit of a different scenario? I just want to see how bent you are in terms of developing a solution for that.

James B. Morgan

Yes. So we have a solution for that, and many of the replacements that we've done -- and we haven't done a real large number, but we've done some. And a number of those have just been just the modular replacement as opposed to replacing the whole display. So we do have a solution, and it's more of a kit-type solution that we can ship to the site, and then the customer can just, in effect, upgrade the existing display with new modules.

Stephen Altebrando - Sidoti & Company, LLC

Okay. And then just, Jim, do you have the billboard revenue number for the quarter in terms of revenue recognized around here?

Sheila Mae Anderson

Yes, we had about $14 million of revenue for the quarter.

Stephen Altebrando - Sidoti & Company, LLC

Okay. And then last one, I think for the year, you guys had hoped to keep operating costs flat, and you mentioned it in the script. Is that implying -- is it we're right to imply that we could see operating costs actually decline in the second half year-over-year? Just you're -- right now, you're up just slightly, an impressive number considering how much revenues up but...

Sheila Mae Anderson

It might be a slight -- yes, it will be flat to just a slight decline.

Operator

Our next question is from Robert Hoffman of Princeton OPportunity.

Robert Hoffman

Balance sheet, obviously, it's very strong. You have a great cash generation. You do have a dividend, and I'm assuming that will grow over time with profitability. Do you have any other plans on what you might want to do with the balance sheet? Are there acquisition candidates that might be out there? Are there foreign plants that you might need to -- if you're delivering a whole lot to Asia-Pacific region, might you put something rare? If you could just expand a little bit about where you see the balance sheet in the years from now.

James B. Morgan

Well, just in terms of maybe just talk about this -- the question about acquisition first. Certainly, we're not an acquisition-driven -- we don't have an acquisition-driven strategy. However, that opportunistic, and so we will continue to be opportunistic. And acquisitions, our history there is most of the acquisitions we've done have been relatively small. We've been, I'd say, fairly conservative, but we are also looking for opportunities that might be complementary to what we're doing. You mentioned, do we have any need to invest in plants overseas. It might be we're just -- really, though, we actually have a small factory in Shanghai, and we have been investing in that. It's our own factory, and we have a nice little operation over there. In that factory, we have the capability to build this first set-up to focus on architectural lighting, which tends to be a more -- the market tends to be more centered over there, and it tends to be a little more of a labor-intensive type of a process to build. We have now added a module -- video module capability to that plant over there as well. So we have invested in that, but that was just through organic development. It was not an acquisition. So and I guess that's the extent of how we've looked at the build of cash. And the dividend, of course, historically is what we have done.

Robert Hoffman

Great. And just one final. Is the dropping in price of LEDs in general, the market price of LEDs, is that meaningful to you guys as a cost of goods? Or is it such a small component on all of the labor intensity or the systems intensity of your products that you see it but it's not meaningful?

James B. Morgan

In our video products, the LED pricing is a significant part of the cost of the build materials. And so certainly, reduction of LED price there is significant. In some of our products, like our scoreboards, maybe it wouldn't be quite as big a part of the build material cost. But it's very significant, and it's part of what has allowed the overall price points in the industry to come down, which in turn expands the market because of that. And yes, we can offer a cost-effective product to our customers.

Robert Hoffman

Considering -- do you ever get into a situation where a competitor has different pricing on their LEDs, like they -- either you bought in advance and you're paying x and they didn't buy in advance and they're paying x minus something? Or is it a dynamic market that nobody buys ahead of an order and then you're basically going out and buying at the market?

James B. Morgan

I think the difference in pricing that our competitors would have more to do with who they're sourcing from as opposed to what we're buying. We certainly -- we're a very large purchaser of LEDs, and we expect that for the level of quality of LEDs that we're purchasing, that we're purchasing as well as anybody. But there are other suppliers of LEDs, many suppliers in China, and so certainly, we see a Chinese product across the world showing up. And so that -- it's the sourcing of LED is, I think, is the big issue there, a big difference.

Robert Hoffman

And you differentiate on quality, so they don't get a better price, but who knows how long the LED will last or the quality. Is that the inference there?

James B. Morgan

Yes, there's a wide range of suppliers, and their background or history and that sort of thing.

Operator

There are no further questions at this time. I'd like to turn the call over to management for any closing remarks.

James B. Morgan

Well, thank you, everyone, for your -- for being with us this morning. Thank you for the questions, and have a good day.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Have a wonderful day.

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