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Daktronics, Inc. (NASDAQ:DAKT)

F3Q10 Earnings Call

February 23, 2010 11:00 AM EST

Executives

Bill Retterath – CFO

Jim Morgan – CEO

Operator

Good day, ladies and gentlemen, and welcome to the Daktronics third quarter fiscal year 2010 earnings results conference call. As a reminder this conference is being recorded Tuesday, February 23rd, 2010 and is available on the company’s website at www.daktronics.com.

I would now like to turn the conference over to Mr. Bill Retterath, Chief Financial Officer for Daktronics, for some introductory remarks; please go ahead, sir.

Bill Retterath

Thank you. Good morning, we appreciate your participation on our third quarter conference call. As usual we will start out with some comments about the quarter and the future and we will open it up for a limited time for some Q&A.

I would like to first offer our disclosure cautioning investors and participants in addition to the statements of historical facts, this call and in our quarter-end news release contains forward-looking statements reflecting our expectations and belief concerning future events, which could materially affect our performance in the future.

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 orders, and other risks as noted in our SEC filings, which may cause actual results differ materially.

Forward-looking statements are made in the context of information available to us as of the date of this call. We undertake no obligation to update or revise such statements to reflect new circumstances or unanticipated events as they occur.

With that, I will turn it over to Jim Morgan, our Chief Executive Officer, for some comments on the quarter.

Jim Morgan

Thanks Bill, and thanks everyone for being with us this morning. This quarter was somewhat of the perfect storm for Daktronics. Q3 is typically our lightest quarter anyway. We went into the quarter with a smaller backlog and the orders didn’t come along during the quarter for us to achieve the sales level we would have hoped to achieve.

We announced about a month ago there were no large baseball projects happening this year. In the past years, we have had anywhere from $10 million to $30 million of worth of large baseball projects at this time of the year. And this is the most notable gap, but orders were slower pretty much across the board with some orders been delayed and off those some booked near the end of the quarter and others are still out there to be booked. For example, in live events, we had equipment out in our rental program that was planned to be purchased during the quarter for more than a $1 million and this got pushed out now to this quarter.

Also we had a nice project with the University of Louisville that we have booked that’s got caught up an extended contract negotiations. In our commercial market, we had a multimillion dollar Times Square contract get pushed out as well as a multimillion dollar national account order. So neither of these commercial projects are booked yet today, but we still expect to book them. I wanted to emphasize this point just to point out that we don’t see this level as indicative of the future, but we do see greater uncertainty and greater time involved in closing orders. Our plants worked reduced hours through the quarter; it was just a slow quarter for us. And if there is a small positive here, it is that we did build backlog. While orders were not great, they did outpace sales by about $13 million.

To give a little sense of what we are seeing in our various businesses, the biggest downturn in the past two quarters has been in our live events business, the reasons we have as mentioned above. It is noteworthy that even the orders are down significantly, we believe we have maintained our win rate in the marketplace. So for us, the top line in live events is more a factor of the total market’s activity.

Our high school sport business has actually been relatively flat compared to last year, which in this environment is very positive. We are also seeing more interest in video displays in this market, but it remains to be seen as to how many of these deals actually materialize this year. There is certainly enough interest that could drive some growth year-over-year in this market. Also, our Vortek hoist business which we grouped into our schools and theatres business unit; and that is on solid ground under the experience of some growth this year. And again, it’s a relatively small part of our overall business.

Our commercial business have been relatively flat for the first half of the year, and for the third quarter was down. But we see it as holding its own with some signs of improvement. Our billboard business is seeing rather a steady activities from the Tier 2 and 3 companies and we are getting some indications if there could be a slow uptick ahead, but time will tell. We believe that will help position us as things pickup again. There are signs that the advertising world is slowly starting to get back on track.

Our national accounts orders were less than expected as our main customers placed fewer orders. It’s hard to predict when national accounts business will pickup the pace again as well. It does appear we have lost one competitor in that part of our business, but it remains a very competitive environment. Our transportation business has been holding its own through the downturn. As mentioned in the news release, we have been awarded a very nice contract with the New Jersey Turnpike Authority that is for up to $25 million over a three to five-year project. We also have indications that a competitor that recently entered the US market with some unusually low prices maybe exiting the market.

Our international business is always the lumpiest of all. International today has much stronger activity than we had a year-ago, but especially in Asia, the price competition is extremely tight. We had a number of orders for third-party advertising displays internationally with a $1 million order for Beirut and another $1 million order for Albania this quarter. So it is interesting to see where the business comes from.

We have some exciting new products that we are just in the process of launching. These all offer improved functionality at a reduced price point and thereby enhancing both our competitive position and our margin position. Our new DVX video displays which we are just ramping up to adopt a more comprehensive product platform strategy which offers increased commonality across multiple models and which in turn reduces our manufacturing cost while at the same time offering more robust product performance.

Our new and improved 4000 series digital billboard we will start shipping in May. It offers improved power efficiency, improved diagnostics and improved environmental robustness at a reduced cost. We will also start shipping our redesigned Vanguard over the roadway walking display in our transportation business. And this is a redesign focused heavily on improved manufacturability, again thereby reducing our cost, while at the same time offer improved performance.

Going forward, we have to adjust our cost to be profitable on a lower run rate even as we continue to work to increase orders and revenue. We are being more aggressive on reducing our cost structure going forward and expect the cost reduction efforts will continue as a process. The two keys going forward will be how things develop in the digital billboard business and how things develop in the large sports business. We will be giving a lot of attention to both of these markets as we move forward.

This is obviously a very difficult time for our employees as we are used to be in profitable. Our employees continue to work hard to serve our customers, but we have to adjust to this new reality. I want to thank all of our employees for their ongoing efforts. It’s much harder dealing with the downturn that it is with the growth, and again thank you for all of your efforts.

With that, I will turn it over to Bill, for some additional comments on the financials.

Bill Retterath

Thanks, Jim. I will start with a few comments on gross profit, which was noticeably worse than expected for the quarter. The biggest impact to gross profit was due to the lower level of sales. In the short-term, our manufacturing costs are generally fixed, and when sales come in so much less than expected, a significant impact on gross profit percent. This accounted for somewhere between four and five margin points. Margins were also negatively impacted by higher than expected inventory write-downs and higher customer maintenance costs. Inventory was about a point and maintenance contracts had another other point to the margin decline.

During the third quarter, our domestic manufacturing costs did decrease by a $1 million sequentially from the last quarter. Much of those came from the shorter work time and reductions we have made by closing down the plants for a limited periods of time as Jim mentioned earlier. We are continuing to work on cost reductions in manufacturing to adjust to the sales level.

We continue to be down on warranty costs quarter-over-quarter which is another good sign. There are a little bit higher than expected, but we are still down significantly, almost $3 million as compared to the third quarter one year ago with part of that obviously being due to decline in sales, but still long-term trending fairly well in that regard.

We mentioned in the press release the backend loading of the revenue stream in the fourth quarter, which adds a little more detail and that it turns out that based on timing of orders, customer expectations in the DVX video display introduction timing, some shipments and their related revenues therefore are backend loaded and delayed in the March and April, so manufacturing is actually dealing with a bulge during late March and throughout April. This is just an added challenge for the quarter, but we expect to see one-time sales on a sequential basis when things go as planned. Backlog maybe an indicator as how much is possible at a top end. We still have a significant amount of backlog that extends beyond the quarter. However – and so we remain dependent on our current order bookings to achieve what we are setting our sights on internally.

With the expectation on rising sales, our expectation is that gross profit rises accordingly, but it continues to be challenged by the competitive environment and cost of excess capacity. To be more specific on gross margin expectation, it’s difficult at this point given the level of sales and the competitive issues. On operating expenses we mentioned last quarter the benefits costs were unusually low and expected to rise which they did negatively impacting operating expense. This is also the first quarter in six quarters that operating expenses have not actually declined on a sequential basis. Currently, plans as Jim mentioned are reduce our operating cost structure further. These efforts will occur during the fourth quarter and then into first quarter, and so we expect to see operating expenses to continue to decline.

On the issue of goodwill impairment which was noted in the release, most of the impairment relates to goodwill associated with our hoist acquisition from a number of years ago and due to the purchase of the sales and service platform in Europe. We have a relatively small amount of goodwill left, less than $3 million, given a non-cash charge and how the computations are done, it’s not an area that we have much control over. Both of these acquisitions, as it turns out, have lived up to the internal expectations, and the impairment doesn’t reflect adversely on how those acquisitions have performed, but the methods of computation caused this takes a hit. The impairment was estimated, during the fourth quarter, we will complete the evaluation process. And we don’t expect it to change, but it is an estimate at this point.

The gain on insurance proceeds relates to the fire that we had late in October in our circuit board manufacturing operation, which should be up and operating there again by the middle of the fourth quarter as fire did not cause any interruptions in our customer deliveries or revenue. And we have reached as a result of the fire, we moved the operations into the building which we are contractually obligated to purchase going back and believe into the fiscal year 2007, and we will be selling the old building.

The effective tax rate for the quarter was approximately 40%. On a year-to-date business, it looks unusual, which is primarily due to the mix between foreign and domestic taxable income and adjustments we made as a results of our actual fiscal year 2009 tax return filings. Our overall domestic rate is getting hurt by the loss of the R&D tax credit, the goodwill impairment and other issues that result from having a domestic operating loss. So overall there is lots of moving parts tax, especially the mix between foreign and domestic and how that turns on. So it’s difficult to forecast a rate for the fourth quarter, especially when consolidated results are closer to breakeven.

With that, I will turn it over to the operator, and open up for any questions if there maybe.

Question-and-Answer Session

Operator

Thank you. Today’s question-and-answer session will be conducted electronically. (Operator Instructions). And at this time, we have no questions, so I will now turn the call back over to management for any additional or closing remarks.

Jim Morgan

All right, well, thank you everyone for being with us. Apparently we explained things very clearly, we have no questions. And Bill and I are going to get back to work here.

Operator

This does conclude today’s conference. Thank you for your participation.

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