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Daktronics (NASDAQ:DAKT)

Q3 2011 Earnings Call

February 22, 2011 11:00 am ET

Executives

Bill Retterath - Chief Financial Officer, Principal Accounting Officer and Treasurer

James Morgan - Chief Executive Officer, President and Director

Analysts

Richard Ryan - Dougherty & Company LLC

James Ricchiuti - Needham & Company, LLC

Steven Dyer - Craig-Hallum Capital Group LLC

Operator

Good day, ladies and gentlemen, and welcome to the Daktronics Fiscal Year 2011 Third Quarter Earnings Results Conference Call. [Operator Instructions] 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 in our third quarter conference call. We'll give some brief updates about the quarter and then open it up for questions.

I'd like to first offer our disclosure cautioning investors and participants. In addition to statements of historical facts, this call and our news release contain forward-looking statements reflecting our expectations and beliefs 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 mentioned during this call and in our press release and our SEC filings, which may cause actual results to 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.

So with that, I'll turn it over to Jim Morgan, our Chief Executive Officer, for some comments.

James Morgan

Thanks, Bill, and good morning, everyone. Thanks for joining us this morning. As we have said previously, third quarter is typically our lowest quarter for revenues due to the sport seasonality and the greater number of holidays in the quarter. After the difficult third quarter we had last year, our objective was to at least be profitable this third quarter, so we were pleased to achieve that. It was great to see that activity and major league baseball came back this year, and it's great to see that digital billboards have been coming back as well.

One of the areas that we have continued to emphasize as we work through the downturn is product development. I'll just make a few comments on that front. This past quarter, as we noted in the news release, we introduced our series 4100 digital Billboard, which includes improvements to further simplify installation as well as increased reliability, and there's ongoing cost reductions involved in that development as well.

We also released a new version of our larger Galaxy displays, which offer a reduced price point, easier installation and enhanced reliability. And again, the Galaxy displays are for commercial applications primarily. One of the new applications we've also discussed is IPTV for sports facilities, that's Internet protocol television, where video is streamed over the Internet to TV displays in the concourse and the suites in the sports facilities. We completed our largest installation to date at the Yum! Center in Louisville and are currently installing a larger system for the Texas Rangers, which will be available for the opening of baseball season, in conjunction with new LED video displays that we're installing there.

Also, we're continuing to see some nice opportunities for our new architectural lighting product. We also refer to these as free-form displays. These displays are constructed using either narrow column elements or round pixel elements that are individually mounted and connected on site to form the intended display, which provides a great flexibility in how these can be deployed in any given application. We will be completing the installation of a number of these projects in the fourth quarter, namely, for the Minnesota Twins’ ball field, the Target Corporation headquarters in Minneapolis and the Boston Convention Center.

While the use of these products is more prevalent in Asia, it's relatively new in the U.S. and so as we -- we're excited to get these installations online, because as more people see these and see how they can be used, we believe it will open more opportunities. So we continue to develop new products in this area and find new opportunities.

On the competitive front, the price pressure in the industry remains quite intense. We are continuing our efforts in implementing the cost reductions to allow us to offer improved products at a reduced cost, that remains the top priority. We will be continuing our focus on cost reduction looking at all aspects of our business, while we continue to work hard to book orders.

With that, I'll turn it over to Bill Retterath to give more perspective on the numbers.

Bill Retterath

Thanks, Jim. As mentioned on our press release, baseball contracts have certainly helped us last quarter. We’ve booked over $20 million of multimillion dollar professional baseball contracts over the last two quarters, which is in addition to that large contract booked last fiscal year for the Florida Marlins. During the quarter, we recognized over $15 million of revenue and have roughly 15 more to go with approximately $11 million left in the fourth quarter. We're also in contract negotiations for two orders approximating $12 million for Live Events that have slipped into the fourth quarter, that would contribute to revenues in fiscal '12.

Based on these order bookings in the fourth quarter, we should see a rise in orders for Live Events in the fourth quarter this year versus the fourth quarter of last year. Perhaps an important milestone for the help of this business will be orders for the fall sports season, which we should begin to understand better in May or June of this year.

On the international side, the business orders were a little lower than we expected, but our pipeline remains strong. We're in contract negotiations on one order for $3.5 million that slipped out of the third quarter. There's a wide range of potential outcomes for the fourth quarter orders for international, but a lot would have to come together to beat the $15 million in orders for the fourth quarter of last fiscal year, but it is possible.

In our Commercial business unit, we mentioned in our press release some issues with the weather. We had a number of billboard displays that were delayed in shipping for the quarter, but quantifying the weather impact on orders is difficult. Orders were lighter than expected in both billboard and in large video systems for commercial applications. This could help drive some incremental growth in orders in the fourth quarter.

One final comment on net sales for the fourth quarter that we mentioned in the press release, we have a number of projects that are dependent on product development initiatives. And depending on how that goes over the next month or so, will determine our sales level for the fourth quarter.

It's looking like a good chunk of the work will get pushed out of the quarter, which is freeing up time in April for new orders. We're nearing the time where new orders can be converted to revenue this quarter. So our best guess is that sales, although slightly higher than the third quarter of this year on a sequential basis, would likely be less than the current consensus estimate of $116 million, but there are a lot of moving parts to the fourth quarter yet.

A couple of quick comments on gross profit. We had minimal excess warranty costs this quarter, and there's not much in terms of changing the competitive environment, as Jim mentioned. So it's generally status quo on gross profit margins for the fourth quarter. The largest items that could impact our gross profit percentage is the level of sales, that I just mentioned, and the cost variability on some of the large contracts that we have in the works currently.

As you all know, our operating expenses increased with the increases in G&A being offset by declines in selling expenses. That’s on a sequential basis from Q2. There are some cost pressures that we're seeing on G&A related to international expansion primarily China systems infrastructure from an IT perspective. This could lead to somewhat higher G&A expenses in the fourth quarter as compared to the third quarter.

We also reinstated some costs that were eliminated during the downturn such as our 401(k), a portion of our 401(k) match. We rolled out a new health insurance plan this quarter that carried some additional cost of approximately $250,000 in the third quarter. Given that the first and second quarter of fiscal '12 still remains somewhat unclear, primarily because of the Live Events business, we're working hard to control costs, especially personnel costs, and will remain focused on that. The press release mentioned two items of notable operating income. As the release noted, these are one-time costs that increased our earnings for the quarter and are not recurring.

Finally, we ended the quarter with over $75 million in cash from marketable securities, and that's after almost $25 million in dividends paid this fiscal year. That compares to a cash balance of $64 million at the end of fiscal '10. Last quarter, we said that CapEx could end up at the year about $13 million. It looks like we'll be down slightly from that due to primarily timing of rolling off CapEx in the next fiscal year. We could see a slight rise in CapEx, but we believe we'll continue to generate free cash flow over the long term.

With that, I'll turn it back to the operator to open it up for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Steve Dyer with Craig-Hallum.

Steven Dyer - Craig-Hallum Capital Group LLC

Just a question on the gross margin, I'm wondering if the lower level this quarter was a function of, just kind of the same competitive pressures on a lower revenue number. Or if you've seen competitive pressures increase or decrease? Or are they fairly static over the last couple of quarters?

James Morgan

Steve, the general competitive pressures never really changed much in the last few quarters. Pretty much status quo over the last few quarters.

Steven Dyer - Craig-Hallum Capital Group LLC

Just with respect to the potential lockout of the NFL and the NBA, what are you seeing on that front and, sort of, what are your expectations? I don't know how much is up necessarily for bid for the next NFL season, but would your expectation be, I mean, would you lose a season potentially? Or how should we think about that?

James Morgan

Well, it's certainly a risk that's out there. I think there's certainly a lot of reason for both parties to come to some form of agreement because there's a lot at stake there. So certainly, it's something we're watching closely, and it's not something we necessarily can predict what's going to happen there, obviously, but it certainly can be a factor and something we're watching closely.

Bill Retterath

I'll just add. There are some projects for the NFL that are in the works now and, we think, will go forward, but it's too early to see what will all come out yet. That's one of the things I mentioned we’ll know in May, due in time for May.

Steven Dyer - Craig-Hallum Capital Group LLC

So you sense that a drop dead date, so to speak, to fill or kill a project is probably sometime late spring, early summer?

Bill Retterath

Right, just due to the lead times, if it gets too much later than that, then it's difficult to get it in, installed in time for the season, ahead of the season, because it really needs to be installed in late August, very early September at the latest to be -- to work...

Steven Dyer - Craig-Hallum Capital Group LLC

Could you quantify digital billboard revenue this quarter? I know it's folded into the commercial line item, but what was it this quarter? And maybe versus last and a year ago?

James Morgan

It is up. It's more than doubled from one year ago. I will get -- Just bear with me one minute here.

Steven Dyer - Craig-Hallum Capital Group LLC

And just maybe, I guess, while you're looking for that, anecdotally, what are the digital billboard guys telling you in terms of are we still very early in kind of the ramp up here in 2011? Or are we kind of at a level that is sort of the level you're expecting going forward?

James Morgan

Well I think for 2011, it's kind of been a projection for the year and our major customers kind of look at an annual kind of a calendar year basis. And so, I think that level is going to set for the year and we're working kind of against the projections at this point.

Bill Retterath

Our revenue is worth roughly in the $10 million range, or it's just under $5 million a year ago for the third quarter.

Steven Dyer - Craig-Hallum Capital Group LLC

And what were they in the October quarter?

Bill Retterath

In the October quarter, I believe they're in the $5 million to $6 million range.

Steven Dyer - Craig-Hallum Capital Group LLC

So it's -- I guess what I'm trying to get at is $10 million a quarter kind of a reasonable run rate going forward? Or does that ramp as we kind of get into the spring and summer?

Bill Retterath

I think we need to see more, as I mentioned in my prepared comments, the orders were a little bit less than expected for the quarter. And so, it's hard to quantify how that will shake up in the end, but it could be higher, but it's hard to know.

Operator

Our next question comes from Jim Ricchiuti with Needham & Company.

James Ricchiuti - Needham & Company, LLC

Just a follow-up question on the issue of the NFL and potential for a work stoppage and possible impact that it could have on you guys. Is there a way for you to go back and maybe tell us in previous, say, two years, was the NFL a meaningful part of the revenue stream or the booking stream in the fiscal first quarter of the year?

James Morgan

Good question, Jim. As I recall, if you look, we did some transactions last year between the fourth quarter, first and second quarter, and I frankly did the reg scans [ph] was $3 to $5 million in the fourth quarter a year ago, and then we moved into a few other projects, first and second quarter then on an aggregate, I think, as I recall were less than $10 million for the NFL. So last year, for the whole -- during that three-quarter time frame, I don't think the NFL contracts exceeded $15 million. I think they were well less than $15 million. But keep in mind in -- when we get into these large facilities, if you look us over an historical period, sometimes the major college venues are up a lot higher and -- as compared to the professional football facilities. So if the NFL is down, that doesn't mean that major college can't be up. So it's hard to see how that Live Events and aggregate shakes out at this point for the first two quarters. And I should mention one thing in those numbers; that excludes a significant contract for the Jets/Giants stadium, those are deals aside from that one.

James Ricchiuti - Needham & Company, LLC

Just with respect to what you guys are seeing in the college/university market, what's your sense in terms of to build up pipeline?

James Morgan

I think the overall list of potential projects there, Jim, is, I think, probably as strong as ever. I think it's probably just maybe the confidence factor and how those will play out is what's -- we still need to get a little closer to the season to have a better visibility there.

James Ricchiuti - Needham & Company, LLC

But, Jim, if we were to look at the opportunities set in that market, that segment of the Live Events market versus last year, you'd characterize it as, as strong?

James Morgan

I think the list of opportunities is as strong. I think that's true.

James Ricchiuti - Needham & Company, LLC

And then if you could talk a little bit about the -- maybe to some slippage, I think in international orders, and I wonder if you could maybe elaborate a little bit more on what you're seeing there? Is that a competitive issue? Is it just potentially some business slipping from the quarter into Q4 orders?

James Morgan

Yes, I think one thing about international that – that is our lumpiest of our businesses and because pretty much the only thing we do internationally is bigger contracts. We don't have any sort of much of a flow of smaller projects there. And so, some of these bigger projects, I know if the time line slips a little bit, they can move from one quarter to the other very easily. And so, it'll be up and down. I mean that’s just the way that business is going to be. One quarter down or up doesn’t constitute a trend, I guess, and shouldn't be construed as such. So we did have one, as Bill mentioned, there's an international project that we're in final contract negotiations. We thought we'd get booked in before the end of the quarter, we didn't, we’re still working on that. So sometimes these things just take a while to bring home.

Bill Retterath

Jim, I’ll mention international has been a bright spot for us. We're up on a year-to-date basis over 50% and slippage of an order in the third quarter. I think, overall, international is doing well and the pipeline looks great.

James Ricchiuti - Needham & Company, LLC

One last question, if you could just talk a little bit about what you're seeing in the other areas of the commercial business and some international account business, what are you seeing there?

James Morgan

I'd say right now, we're seeing that still tends to be a little bit on the soft side. Altogether, the kind of standard products, you see that a little bit soft. The other part of that business that we've grouped in there is the contracts, the larger contracts in the commercial business. And there's opportunities there. Again, timing on those, that can bounce around a little bit. So we've got some opportunities there. I think, we see that as being reasonably strong in terms of opportunities out there.

Operator

[Operator Instructions] Our next question comes from Dick Ryan with Dougherty.

Richard Ryan - Dougherty & Company LLC

Jim, you mentioned push outs or projects getting pushed, you talked about the international one here. Did you mention a Live Events push outs? I wasn't sure if I caught that correctly.

James Morgan

Yes, I'd mentioned it in my comments in terms of orders. There's one for sure that had a darn good chance of accumulating in the third quarter, but slipped, and the other one is a much larger one. So in total, $12 million slipped out from the third quarter, booked in the fourth quarter, hopefully, and that should drive a nice fourth quarter increase year-over-year in orders.

Richard Ryan - Dougherty & Company LLC

And which sports were they in, Bill?

Bill Retterath

The smaller one was in college football. And the other one, I don't want to jinx it quite yet, so I'd rather be silent on that one.

Richard Ryan - Dougherty & Company LLC

With the lower price points on the digital billboards, do you see any, I mean your opportunities with maybe Tier 2, Tier 3 kind of billboard suppliers out there? Is that changing at all?

James Morgan

We see continued interest from the Tier 2 and Tier 3 suppliers. And certainly, the lower price points make it a little easier for them to get in and to justify seeing ROI.

Richard Ryan - Dougherty & Company LLC

And on the architectural lighting, you talked about three opportunities there. Can you give a little perspective on the kind of range those projects might be in? I mean are they million-dollar-plus types of opportunities, less than that, can you kind of...

James Morgan

Certainly, thinking very widely but it just depends on how much area the customer wants to cover with this lighting, but a couple that we mentioned here are in the $2 million or $3 million range each.

Richard Ryan - Dougherty & Company LLC

And going to market, with the new lighting there, what's -- is that direct? Are you using your distributors there? Or how are you getting that to market?

James Morgan

For the most part, these are -- take a lot of interactions, some even involved with some kinds of engineering. So at this point, we're working direct with consultants for the most part. And then we work with local resources as far as installation and that sort of thing.

Richard Ryan - Dougherty & Company LLC

Bill, you mentioned a couple of projects hanging out there for a new product development. What's needed to bring those to closure?

James Morgan

Yes, this is Jim. I'll maybe take that one. It's just the normal product development cycle. And, again, it's just a timing thing. These things are moving along, but there’s like a little bit of variability in bringing new products along and no major hurdles, but it's just slipped into the next quarter here. So no problems in terms of meeting customer requirements. It's just that it slips from one quarter to the next.

Operator

Our next question is a follow-up from Jim Ricchiuti with Needham & Company.

James Ricchiuti - Needham & Company, LLC

It might be a little early yet to talk about this, Jim, but I wonder as you look at the school and theater market, how is the business shaping up in that area of the business as you look out at the potential order flow in the July-August time frame?

James Morgan

Yes, it is a little early. We've had some nice orders with some larger projects for HS -- for the high school market that have come in here recently actually. So that's good to see. But I think it's a little early to know exactly how that's going to be. We don't expect it to be really up a lot from last year, if at all. So, it's -- again, time will tell on that one. But it's, I'd say, it's really on order of flat going into this as we can see it at this point.

James Ricchiuti - Needham & Company, LLC

And then, Jim, in the past, I mean you talked about this, I think, that in any case, the funds allocated for these displays typically come from outside the school budget, and I'm curious in terms of what you're hearing from your salespeople, just in light of just the pressure that the districts, some school districts, are under, is that an area of sensitivity in terms of going forward with some projects?

James Morgan

I think, there certainly is a lot of concern about school budgets in general in the country, I think is a true statement. I think the counter to that is that sports are still very important in our high schools in the U.S. and it’s the community support that funds these projects almost exclusively. So I think that interest is still there and the resources to fund these are still there. Is there a possibility that some projects might be put off due to the other concerns that are going on just because of a perspective there? It's possible that, that could happen in some case but, in general, there's a lot of enthusiasm for sports in the high schools.

Operator

Our next question comes from Steve Dyer with Craig-Hallum.

Steven Dyer - Craig-Hallum Capital Group LLC

Just a couple of follow-ups, I just want to make sure I'm clear with respect to gross margin. We should expect sort of the same level of gross margins and associated revenue levels as we have over the last couple of quarters, is that right? There's nothing that’s changed one way or the other there?

Bill Retterath

We're just guessing gross margin at least similar to third quarter. There's -- remember our gross margin for us can vary a lot on these big projects. But overall, it looks pretty status quo from the third quarter.

Steven Dyer - Craig-Hallum Capital Group LLC

In the second quarter -- in the first and second quarter, it had made a nice move, and there was a lot of commentary about how things seem to be getting better on that front. What's changed now that we're kind of talking 24% levels instead of 26% levels, if anything?

Bill Retterath

I think the biggest thing that's changed is really what we're booking: large video system projects. When we saw that gross margin on order bookings go down, as I recall, in the second quarter. And that's the competitive environment.

Steven Dyer - Craig-Hallum Capital Group LLC

What about as you look out onto fiscal '12, are we thinking 24-ish percent? Are we thinking 26%, 27-ish percent?

Bill Retterath

Well, our goal is certainly to get that up there. As Jim talked about, there's a lot of things we're doing on the product side. We haven't rolled out completely our DVX line of displays, we're working hard at that. That creates a lot of cost savings. There's a lot of things going on internally that drag that gross profit up. To get north of 26%, we probably have to do a little bit better at what we're booking, some nice projects there. But certainly, our vision has a lot of increases, and we're doing everything possible, certainly on product development and operational front to drive that up. It’s hard to know what it looks like for the year, but our goal is to get it up there.

Steven Dyer - Craig-Hallum Capital Group LLC

And then operating expenses, how should we think about that directionally in fiscal '12? I assume it bumps up a little bit. Any idea, 5% something like that, maybe more, less?

Bill Retterath

Well our goal on operating expenses as we sit here today is, to a large degree, dependent on how we see the first and second quarter shape up. We will do everything possible to keep those costs from rising until we see sales rising. There are some unique things that we're doing, for example, in expanding our infrastructure in China. That's primarily to build the architectural lighting products that Jim mentioned. There's some costs with that. And there could be a couple of hundred thousand dollars of costs incremental over the next couple of quarters on that and GIM [ph] like that. So we're going to work hard at keeping that in check, but yes, there will be a slight increase. At this point, I don't know whether we can quantify what it looks like for the whole year because we're still in a quarter-by-quarter involvement. For right now it’s doing everything that keeps us flat as opposed to rising.

Steven Dyer - Craig-Hallum Capital Group LLC

Tax rate has kind of jumped around over the last number of quarters. How should we think about that in a normalized basis?

Bill Retterath

Think about the 37% range. It all happened -- a lot of it I think it was in November, December -- December is when it was, Congress reinstated that R&D tax credit, which caused us to pick up on the tax rate going all the way back to January 1st of last year. It took Congress that long to get that resolved. So the year before that, it’s because we’re in a marginal loss position. So I think we're back, we should be back go forward basis on a normalized state like we had been for years, and that's in the 37% range. Some variation will arise as a result of the mix of our income in the different countries. And that's hard to sometimes see where revenue comes, certainly in China, to the extent we get more business in China it lowers our tax rate because their tax rate there is lower so...

Operator

There appear to be no further questions in the queue. I'll now turn the call back over to Mr. Jim Morgan for closing remarks.

James Morgan

Well thank you, everyone, for being with us this morning, and thanks for the questions, gentlemen. With that, we'll wrap it up. Thanks.

Operator

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

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