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Daktronics, Inc. (NASDAQ:DAKT)

Q4 2014 Earnings Conference Call

May 28, 2014, 11:00 AM ET

Executives

Sheila Anderson - Chief Financial Officer

Reece Kurtenbach - President and Chief Executive Officer

Analysts

Jim Ricchiuti - Needham & Company

Morris Ajzenman - Griffin Securities

Steve Altebrando - Sidoti & Company

Operator

Good day, ladies and gentlemen, and welcome to the Daktronics Fiscal Year 2014 Fourth Quarter and Fiscal Year Earnings Conference Call. As a reminder, this conference is being recorded today, Wednesday, May 28, 2014, and is available on the company's website at www.daktronics.com.

Now I'd like to turn the call over to Sheila Anderson, Chief Financial Officer. Ms. Anderson, you may begin.

Sheila Anderson

Thank you, Kevin. Good morning, everyone. Thank you for participating in our fourth quarter and year-end conference call.

I would like to review our disclosure 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 changes in economic condition, changes in the competitive and market landscape, management of growth, timing and magnitude of future contracts, fluctuations of margins, the introduction of new products and technology and other important factors as noted in details in our 10-K and 10-Q SEC filings.

At this time, I would like to introduce Reece Kurtenbach, our President and CEO, for a few comments.

Reece Kurtenbach

Thank you, Sheila. Good morning, everyone. We had a positive fourth quarter with quarter-over-quarter increases in both orders and revenues. We shipped a lot of products and were still able to grow our backlog. This should set us up nicely as we enter FY 2015. And we are projecting modest growth in our next fiscal year. I should mention that we operate on a 52, 53-week fiscal year and our fiscal year 2015 is a 53-week year. The first quarter will be 14-week period with the remaining quarters at 13 weeks each. Please keep this in mind if you do your analysis and comparisons.

While we were pleased with our performance in FY 2014, we are still striving to increase gross profit and operating income through continued focus on process improvements across the entire value stream. As we have mentioned before, our business that's cyclical with the summer months tending to be our busiest, large projects in our various business segments can also have a significant impact as these tend to be more competitive and can have significant general contracting, which tends to be of lower margins. Many of our customers that invest in these systems have purchased this type of product before from either Daktronics or from one of our competitors.

We're successful in winning business when our customers have a positive experience with our people and our products in individual interactions which accumulate over time. This has created a positive brand for Daktronics and the marketplace. I would like to thank the entire Daktronics team for their hard work over the years, which has driven much of our success in FY 2014 and puts us in a favorable position as we enter FY 2015.

We continue to see strong activity in our different market segments in North America as well as our other regions of the world. The strongest segments are our large sports venues, third-party advertising and spectaculars. In our large sports business, new stadium construction is down from five years ago, but the equipment in many existing facilities is nearing or exceeding 10 years of age, which is a typical point when our customers choose to upgrade their systems. This replacement trend also exists in our billboard business with orders for new locations as well as increasingly refurbishment or replacement of existing digital displays.

While these were the strongest segments, we continue to have a positive outlook for our transportation, on-premise and schools and theaters businesses. Overall our markets are still very dynamic and competitive, and we believe we will need to keep the strong focus on both product development and process improvement to be successful over the long term.

In product development, we will continue our strategy for the creation of product platforms for both display and control systems. We subscribed to the lean principles of continuous improvement for our production and business processes. We believe it is important to prioritize our activities on the highest value areas through knowledge and understanding of our markets and careful planning between our teams. This has allowed us to produce a record amount of display area than in any other fiscal year in essentially the same factory spaces five years ago. We believe we are positioned well as we enter our fiscal year 2015 and have a positive outlook.

With that, I will ask Sheila to give more detail on our fiscal performance.

Sheila Anderson

Thank you, Reece. Sales increased by 9% from last year's fourth quarter to $136 million. This sales level is the highest fourth quarter revenue in the company's history. Live event sales were the primary reason for the increase in the quarter, as we produced and began installations on the NFL stadium orders we mentioned in the press release. Commercial sales were up due to increased digital billboard and on-premise advertising orders, offset by a decrease in commercial large video application sales realized as compared to the same period last year.

International sales increased primarily due to large video projects and transportation and schools and theaters sales decreased as compared to the same quarter last year. Transportation sales reduction is a result primarily of the large Los Angeles airport project we had last year at the same time, which generated $7 million of revenue in fiscal quarter four of 2013. Schools and theaters sales declined as some large video display projects continued to move out or be delayed further into calendar year 2014. The sales results have been concentrated on smaller projects as compared to last year. And therefore, there is a lower average sales price per order realized during the quarter.

We continue to see interest from our customers in large video system projects in the marketplace and live events international and commercial business units. In the commercial market, we predict modest growth in digital billboard, national accounts and on-premise advertising business. Transportation and schools and theaters demand appears to be flat for both business units for the coming year. And for the first quarter, we predict sales will be up modestly due to the increase in the beginning backlog. And also, as Reece mentioned, fiscal 2015 is a 53-week year of which that extra week is in our first quarter.

While our second half of the fiscal year has historically been lower in sales and profitability than the first half of the year because of the sports and construction seasonality, we were able to increase operating margin in the second half of the fiscal year 2014 by over $7 million as compared to last year. Gross profit was 24.8% in the fourth quarter as compared to 22.6% in the fourth quarter of last year. This increase is primarily due to our increased manufacturing utilization, our decrease in warranty as a percent of sales, which were both offset by the sales mix, which included a greater percentage of large video projects. And as Reece mentioned, those large video projects typically have lower margins than standard video displays and scoring systems due to the competitive environment as well as the amount of the installation and other contracted work for these types of projects.

We continue to focus on lowering warranty issues by investing in quality initiatives, including manufacturing process improvements, supply chain management and robust product design efforts. For the year, gross profit remained relatively flat at 25.7% as compared to 25.8% in fiscal 2013. For the first quarter of 2015, we anticipate gross profit to be slightly higher than the fourth quarter.

Operating expenses were 19.8% of sales during the quarter compared to 21% of sales in the fourth quarter of fiscal 2013. In dollars, operating expenses increased for personnel related cost and due to increases in travel. For the year, operating expenses decreased to 19.1% of sales compared to 19.9% of sales in the prior year. For fiscal '15, we predict an increase in operating expense dollars to support business growth, but continue to work to hold these expenses flat or down as a percentage of total sales for the year.

We continue to work internally on all fronts to improve operating profitability. Company initiatives include continued focus on reducing warranty expenses by investing in supplier quality programs, investment in quality and reliability equipment and manufacturing process control techniques. Our product development teams continue to focus on robust product designs, while lowering overall cost of the product. In addition, we continue to work on operational efficiencies throughout all areas of our business to reduce cost and improve services to our customers.

The 2014 fiscal fourth quarter earnings per share was negatively impacted by $0.05 per share due to the recognition of a $2.3 million valuation allowance against our deferred tax assets from a prior equity investment. The effective tax rate prior to this charge was 34.2%. We estimate our effective tax rate to be 35% to 36% for fiscal 2015, however this rate can fluctuate depending on which tax efficient sales are realized around the world and can fluctuate for changes in tax legislation.

Our free cash flow was $22.9 million compared to $44.5 million last year. This is caused by timing differences, as we working on a lot of large contracts at the end of the fourth quarter. These projects are under progress billing and the timing of the projects cause our net receivables and cost and process in excess of billings to increase, which consume some cash. We think that will turn around in the first quarter.

In addition, we're carrying a higher level of inventory needed for the production of the large video system orders and other backlog and also due to a number of standard order projects not being delivered in the fourth quarter, because winter weather conditions pushed out some installations. And therefore, our deliveries of the equipment pushed out later to the spring.

Our capital expenditure estimate of $25 million for fiscal 2015 is higher than we typically average during a fiscal year. We'll be completing the Redwood Falls expansion, as previously discussed, and other infrastructure improvements for approximately $4 million of that $25 million. The remaining capital expenditures will be used to add new module production line capabilities for new or enhanced product offerings we're introducing in fiscal 2015. We'll also expend capital for quality and reliability equipment to be used in our design and manufacturing processes, which align with our continued quality strategic initiative to lower warranty cost. And we'll updating other machinery and equipment to enhance the efficiencies.

We also currently plan to invest in our IT infrastructure hardware and software at higher rates than prior years. Finally, we invest in demonstration equipment for our sales initiatives. And over time, we expect future years expenses to reach on to historical averages.

Reece, will turn it back to you for further comments.

Reece Kurtenbach

Thank you, Sheila. Looking forward, we're seeing increased activity in our major segments at sports, commercial and transportation business worldwide and we're optimistic on our future business.

Some comments about specific segments. In our commercial business, we have seen orders in billboard and on-premise continue to perform well as digital displays are increasingly accepted in the industry and even expected in certain markets. We also have a strong pipeline in the large projects of our commercial business and see this area continue to grow as we move into the next fiscal year. Overall, we're expecting modest year-over-year growth in the commercial market for FY 2015.

In live events, we continue to see ongoing interests on venues at all levels to increase the size and capability of their display systems. The ongoing trend is to install larger systems capable of high-definition video as well as dynamic digital advertising. The larger systems are for the major league stadiums and arenas in the US, but this drives interest in video through all other areas of sports and entertainment, both in the US and international. Our largest growth in FY 2014 was in our live events business and we believe this business will sustain in FY 2015, remaining relatively flat in year-over-year comparisons.

The trends in commercial and live events drive our high school business, as these customer purchase systems to place outside of their schools as well as in their sports venues. The cry for larger systems, as seen in this market, is well. And while both orders and revenue were down in FY 2014, we believe this is due to the timing of large video systems and not of our current trend. We see modest year-over-year growth in our schools and theaters market in FY 2015.

Our transportation business is still strong and we see the core business continue to grow, even though year-over-year comparison is down due to project cycles and the LAX project that was installed in FY 2013, as mentioned earlier by Sheila. We're expecting modest growth in this business for FY 2015.

Our international business builds on all the areas listed above in geographic regions where we have much lower market share. This raises our expectations of this business to be our highest percent growth in FY 2015. International business is mainly on large sports products, large commercial video projects and third-party advertising. However, we see some business in all of our core markets. In general, we believe there is room for growth in our international business.

Overall, we're optimistic about the future. We continue to focus on our internal goals of improving operating margin and increasing revenue. And we believe we have a plan in place to be successful. We're the world leader in many of our markets. We have great products and great people and we continue to make progress in reducing costs through eliminating waste and this work is still ongoing. We feel we are positioned well to continue to achieve some topline growth and we'll maintain our focus on cost reduction and bottomline performance as we go forward.

With that, I would ask the operator to open up the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from Jim Ricchiuti of Needham & Company.

Jim Ricchiuti - Needham & Company

You've talked about modest growth in a number of areas of the business in fiscal '15. And as I look back over the last two years, your growth on average this topline growth has been around 6% or so. Is that kind of in the ballpark of modest in terms of the way you're characterizing the business outlook or do you see a little stronger growth just by virtue of the fact that you also have an extra week in the fiscal year and maybe live events see a stronger pipeline?

Reece Kurtenbach

I think you're on track, Jim, that that's in the range of modest growth. But you would need to add on to it for an extra week's worth of production in business in our next fiscal year.

Jim Ricchiuti - Needham & Company

You may have given it and I may have missed it, but can you talk a little bit about the billboard business in terms of revenues and bookings in the quarter?

Sheila Anderson

Sure, I have the revenue announced for the quarter. For fiscal '14 quarter four, there was $13 million of revenue. For the full year, it was $47 million.

Jim Ricchiuti - Needham & Company

On the booking side, how were the bookings on billboards, in the quarter?

Sheila Anderson

Booking side for the quarter, we achieved $12 million of bookings.

Jim Ricchiuti - Needham & Company

And just going forward on the billboard market in general, any sense as to how much of the business that you're seeing now is replacement and should we assume there is going to be a bit of a mix shift in fiscal '15 more toward replacement?

Reece Kurtenbach

I would say still most of the business is in new displays, even though it's increasingly time to replace existing displays. How much of additional investment the billboard companies are going to make on an annual basis is still uncertain as to how if the replacement business would be additive to the new displays or if they [inaudible] both over their planned capital expenditures.

Operator

And our next question comes from Morris Ajzenman.

Morris Ajzenman - Griffin Securities

On the gross margins, clearly it improved year-over-year, though 24.8%, longer term I presume that that would still be well below what you guys are targeting. The question is, I mean, to understand in this quarter live events was a bigger part of business and i.e., to the mix of business, the margins related to that business is lower than overall company margins. But how should we expect this to evolve over the next year or two? Again you focused on reducing costs, there's always the competitive landscape out there. You touched on this in the past. And in the past, you talked about a three-year target [inaudible] returns. But where do you believe we can still grow gross margins even on a fourth quarter basis a couple of years out? What sort of level do you think we can attain even with the competitive landscape remaining as it is today?

Sheila Anderson

One of the areas we talked about is the warranty and quality and reliability of our products. Warranty for the quarter was 3.7%, which is lower than last year's fourth quarter. Last year's fourth quarter, you'll remember we had a supplier component issue that was 5.6%. Warranty for the year is still at 3.1% compared to 3.4% in 2013. That continues to be one of our focus areas we feel we can drop a percentage or so out of that if we continue to design and build robust products.

Morris Ajzenman - Griffin Securities

So we should add 100 basis points to 200 basis points to a gross margin level by warranty expense declines?

Sheila Anderson

Correct. Warranty expense is one of the targeted areas for that gross margin improvement as well as our operating margin improvement.

Morris Ajzenman - Griffin Securities

Now if I recall, in the previous quarter, warranty expense was under 2%. Is that correct? I'm just curious if that's correct, what happened on the third to the fourth quarter that it jumped up even though it was down year-over-year.

Sheila Anderson

It depends on product mix for warranty set aside for the different projects. That has some impact. And we had a couple of little warranty issues that we reserved for this quarter as well.

Morris Ajzenman - Griffin Securities

Should we expect a meaningful reduction into next year for warranty expense? Assuming 3.1% this year, should it be down meaningfully into next year?

Sheila Anderson

We are working towards that goal and it takes time to work out and get out new products and new things through our systems. So over time, we feel that's an achievable goal.

Operator

And our next question comes from Steve Altebrando of Sidoti & Company.

Steve Altebrando - Sidoti & Company

Just with the release, it looks like specifically points out some pricing pressure. Does that kind of suggest that you're maybe thinking operating margins could be down in fiscal '15 or are you just pointing out really what the trajectory of the business has been over the last few years?

Reece Kurtenbach

Steve, I think you're right in the second part of that. We're continuing to say that the market is competitive. We don't see any of our major competitors dropping out of the business. However, we continue to see the same players and they're still active in our business. So we don't predict a major change in the competitive landscape going forward, certainly over the next fiscal year.

Steve Altebrando - Sidoti & Company

So there is nothing new that prompted that statement?

Reece Kurtenbach

No, we're just continuing the discussion over time.

Steve Altebrando - Sidoti & Company

And then in the release, mentioned that you won six of the seven NFL bids. Would you characterize those seven bids, are they all main displays for these stadiums or some of them are more ancillary?

Reece Kurtenbach

No, there were some other smaller projects active in football, but those were the main displays, the big video systems [were about seven] [ph].

Operator

And we do have a follow-up question from Jim Ricchiuti of Needham & Company.

Jim Ricchiuti - Needham & Company

Yeah, so I was just wondering on the G&A expense line, should we assume these kind of levels going forward, the Q4 level, as we think about the quarterly level run rate going forward?

Sheila Anderson

For all of our operating expenses we are predicting slight increases for the coming year. However, we are working to keep them at a lower percentage of sales than we had this past year. We'll continue to work on being more efficient in those areas of sales growth.

Jim Ricchiuti - Needham & Company

And just switching gears for a second, going back to live events and you alluded to contracts orders relating to the NFL, I was wondering how the backlog and the pipeline in general is shaping up for college football? How much activity are you seeing there? And what would be the timing on that? Are you seeing most of the orders or do you anticipate booking orders in the next month or two?

Reece Kurtenbach

So in our football business in college, university or any markets, they're really in the 11th or possibly beyond the midnight hour for placing an order and still expecting delivery for this fall. And so most of our live events business is most active right now on indoor facilities, arenas for basketball and hockey and other types of (inaudible). In general, though, the college market is busy and we see that the live events business, even with its growth for this year, will remain stable as we move in through FY '15.

Jim Ricchiuti - Needham & Company

And indoor, pipeline on that, the activity that you're seeing there again is fairly, fairly strong at the college level?

Reece Kurtenbach

Yeah, from our pipeline, we're seeing activity for indoor arenas. And also, those are still in the bidding process. So it's hard to know how that'll all come together for the fall.

Operator

Next question comes from [ph] Miles Henderson.

Unidentified Analyst

I had a couple of questions. One, given your past order backlog, I was expecting sales to come in for this quarter. I guess I called in meaningfully higher than what was realized. Can you quantify for me any negative winter impact on the fourth quarter sales results?

Sheila Anderson

We did have a number of standard order products that weren't shipped out at the end of the year, which caused an increase at approximately, say, $5 million to $6 million accounted for that winter push-out.

Unidentified Analyst

And then I had somewhat of a related question. Orders have been, as you know, seasonal and peak in the July fiscal quarter. Is there any reason to believe that that will not be at the same pace in the fiscal 2015?

Reece Kurtenbach

Q2 does tend to be a strong order period for us as well as Q4 in certain years.

Sheila Anderson

I was just going to comment that large projects can push those order volumes around. But as Reece mentioned, those are historically our higher quarters.

Unidentified Analyst

Right, but there is no reason to believe that the July quarter will be a seasonal high for you as it has in the past, is that correct?

Sheila Anderson

It's hard to predict the exact amount, but we are of the feeling it will be comparable or some modest growth this next year, which will take orders to get there.

Operator

We have a follow-up question from Morris Ajzenman.

Morris Ajzenman - Griffin Securities

Touching on transportation again, I think you stated expect modest growth for fiscal '15 and I think you answered a more broader question earlier for the overall modest growth should equate to approximately 6% or so, plus an extra week. Does that statement apply for transportation too?

Sheila Anderson

We have opportunities in transportation. It may be a bit flat compared to this year, but as Reece mentioned in his comments, we are optimistic about that business.

Reece Kurtenbach

The transportation business continues to see acceptance with DoT and other road agencies, especially as they increase the intelligence in this what they call advanced traffic management. So we see that that business will continue to grow. But it is based on orders through governmental agencies and their funding can flow from multiple sources and it's sometimes difficult to predict when projects will free up, which makes it difficult once again to forecast in any fiscal year what the growth rate would be in that business.

Morris Ajzenman - Griffin Securities

So in this case, you take a conservative posture based on lack of clarity. But you would be willing to be more optimistic should this open up from different municipalities?

Reece Kurtenbach

Yeah, I mean the seasonality also in all the areas are favoring RGB over amber and monochrome and that tends to be our higher-priced products for the display type.

Operator

And I'm not showing any further questions at this time.

Reece Kurtenbach

Well, we thank everybody for attending the call and really the interesting questions that we received today. We appreciate all of your attention. And we hope you have a buzzing summer. Look forward to talking to you in three months.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone, have a great day.

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Source: Daktronics' (DAKT) CEO Reece Kurtenbach on Q4 2014 Results - Earnings Call Transcript

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