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Daktronics (NASDAQ:DAKT)

Q4 2011 Earnings Call

June 01, 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

Neil Chatterji - Craig-Hallum

Richard Ryan - Dougherty & Company LLC

James Ricchiuti - Needham & Company, LLC

Stephen Altebrando - Sidoti & Company, LLC

Morris Ajzenman - Griffin Securities, Inc.

Operator

Good day, ladies and gentlemen, and welcome to the Daktronics Fourth Quarter and Fiscal Year 2011 Earnings Results Conference Call. As a reminder this call is being recorded today, Wednesday, June 1, 2011, 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 in our year-end conference call. We'll give some brief updates about the quarter and then open it up for questions and answers.

I'd first like to 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 on 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 the 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 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. Good morning and thank you for joining us this morning. We were generally pleased this quarter. We wrapped up fiscal 2011 with a reasonably strong quarter with our Commercial and International business units leading the way out of the downturn. And we were especially pleased to see that the Digital Billboard business has come back quite nicely, and the public outdoor advertising companies that are some of our key customers are continuing to report good financial performance on their digital investments. It is also notable that our ongoing investments in international market development have gone through with a record year for orders in the international front.

Our Transportation unit had an excellent quarter in revenues, as we were able to increase the throughput of our transportation factory. We were up 64% year-over-year for the quarter, and we were up 36% sequentially for the quarter. And this was done to a large degree through product and process improvements with minimal headcount increase, which is great to see and is a testimonial to our progress and our lean manufacturing, which has been a key initiative for us for a number of years and continues to be a key initiative for us. So it's great to see that execution. We maintain a strong backlog in our Transportation business, so we have a good outlook there, a strong outlook.

As we mentioned in the news release, we are seeing slower recovery in our sports-related businesses, partially due to the turndown in the economy and partly due to the low-cost Asian competition. And particularly on the Live Events side, also because we had extremely strong performance in that area with some amount of new construction prior to the downturn, so tough comparison there. However, we are pleased with the gross profit margins in our large video display business for the quarter, and the outlook for the future as the cross benefits of product improvements, along with the benefits of some confident price reductions to date are realized.

We were disappointed to see working costs running higher than we would like for the quarter, which pulled our gross profit down about a percentage point. However, new products shipped over the past year are still performing much better. And I’d also like to add that despite the condition of Japan and the earthquake, we have managed to avoid any significant supply chain issues and don't foresee any at this time. We are excited about 2 new growth opportunities that we have discussed in the past, IPTV, which is Internet protocol television for sports facilities, and also architectural lighting.

We’ve had some nice reference installations in both of these product areas and have a good sales pipeline going in both areas as well. And we're continuing to invest in product development in both of those areas to continue to capitalize on the opportunities there. It was an exciting quarter for us on the baseball front with our completing 4 major league baseball installations. You can see one of Daktronics' latest DVX video displays control with Daktronics Show Control system in action at a baseball game with the Texas Rangers, the Milwaukee Brewers, the Houston Astros or the Philadelphia Phillies. I trust that everyone has had a chance to read our news release. So with that, I will turn it over to Bill, with a few comments on the numbers before we open it up for questions.

Bill Retterath

Thanks, Jim. Starting with the top line, which exceeded our expectations from going into the quarter. As some of you may have noticed in the prior quarter, our inventory levels were a little higher than one would expect, given forward-looking sales going into the quarter. This higher level of inventory allowed us to capture and deliver on a number of smaller projects in the Live Events unit that were booked and delivered in the quarter. Secondly, as mentioned by Jim, we were able to make significant progress in increasing throughput in our transportation plan and reduce the backlog more than expected. Finally, international came in higher than expected. I should note that we discussed on the last call that sales were dependent on product development initiatives, and all went well in that area.

On a forward-looking basis, we expect that the first quarter of fiscal 2012 will see sales rise sequentially from the $114 million in fourth quarter. On an annual basis, we also believe that sales will rise. However, at this point, the range of the increase is fairly wide. The key areas up within the range are the international business unit with all its opportunities and what we're able to book in that area; and Live Events, which is still difficult to forecast for the year given that the overall state of the marketplace; and finally, Commercial and whether or not we can see some additional economic improvement, which can drive more of the non-billboard area of that marketplace. I would also mention that there are transactions out there still to be awarded that could impact sales this quarter on the upside.

Next, some comments on gross profit. For the quarter, it was in line with our expectations. We see some upside as we look forward, as our costs associated with the new products, primarily DVX-related technology, is coming on much better than expected and seems to be making headway in dealing with the cost side of the gross profit equation. We completed the large baseball projects, as Jim mentioned, during the quarter and the margins were better than expected, enough to offset the expected costs that Jim mentioned. We're also seeing noticeable reductions in some component costs. And finally, as we enter the busier time of the year, stronger top line helps us gain margin.

With that in mind, we're expecting gross profit will rise sequentially in the first quarter of 2012. In addition, we continue to find that the new technology, as Jim mentioned, is performing noticeably better from the warrantee perspective.

Operating expenses were higher on a sequential basis. This was net of some reductions due to lower employee benefits cost. With regards to product development, keep in mind that we allocate our engineering time between product development and contract fulfillment. And overall, our engineering costs were somewhat flat, so it's more of an issue of allocation between costs of goods sold and product development. Then, selling expenses, we had some higher payroll expenses and T&E expenses. It's not unusual for T&E to rise in the fourth quarter as orders increase and trade show attendance is higher.

On the G&A spending, last quarter, we talked about a sequential increase, primarily due to international expansion. That increase did not happen in the fourth quarter and has pushed out into Q1. So we expected an increase in Q1 G&A and then, potentially, some reduction after that as these onetime costs are reduced. Overall, on operating expenses, we're getting to the point where we need to expand in some areas to maintain the business and take advantage of opportunities. We expect to see slightly higher operating expenses year-over-year, however, we believe that increase will be well less than 10%. And depending on sales and how they turn out, operating expenses as a percent of sales could show some slight improvement.

On cash flow, we said that CapEx would be down from our $13 million target for the fiscal year. However, we ended the quarter much less than we thought due to delayed timing of deployment of some success. And so it's a matter of items getting pushed out, not savings. For fiscal '12, we're looking at roughly $16 million. We could end up slightly less due to timing on projects over the course of the year.

Finally, just a brief note on the effective tax rate. It's a little higher for the quarter due to some fourth quarter computations, primarily related to the international business. For the year, as a whole, we're at 35.5%. We think that the tax rate going forward will be higher due to some international issues, primarily, the expiration of our tax holiday in China and greater foreign income taxed in the United States as our international footprint expense. So 37% is likely still a good estimate, but have some volatility due to our international activities.

With that, I'll open up the call for questions and answers.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Steve Altebrando of Sidoti & Co.

Stephen Altebrando - Sidoti & Company, LLC

So fiscal '11, there was a significant number of baseball orders, and I know your visibility is usually limited going forward, but is there anything in the pipeline, I guess, that gives you conviction that you'll be able to hold the Live segment, Live Events segment flat at least in fiscal '12?

James Morgan

Yes, there's still a lot of activity out there, and people are upgrading facilities both at the college level and the professional level. So certainly, that's our expectation, Steve.

Stephen Altebrando - Sidoti & Company, LLC

,

Okay. And in terms of the football strike or lockout, any potential disruption that you're seeing?

James Morgan

There's limited activity in the NFL in terms of upgrades for the season at this point. So how much of that’s because of the potential strike and how much just is the natural ebb and flow of the business is hard to say. And there's -- I don't that we can correlate exactly there, but there isn't going to be a lot of NFL activity in the display side for the season.

Stephen Altebrando - Sidoti & Company, LLC

Okay. And then lastly, Bill, do you have the digital billboard revenue for fiscal '11?

Bill Retterath

Yes, I do. Fiscal '11 Digital Billboard segment was in excess of $30 million.

Operator

Our next question comes from Jim Ricchiuti of Needham & Co.

James Ricchiuti - Needham & Company, LLC

Bill, what were the billboard revenues in Q4? The number you just gave was...

Bill Retterath

Q4 revenues were between $12 million and $13 million.

James Ricchiuti - Needham & Company, LLC

Okay, great. And you talked about the outlook for fiscal '12, and you said there were some transactions that potentially could provide some upside. I wonder if you can give us a sense what areas you might see these upside opportunities?

Bill Retterath

Yes. It's a good question, and it comes back to Steve's earlier question. On the large sports venue business, we have gone through years where major college is significantly up compared to NFL. And so one being high or low doesn't always give the state of the business, overall. And so the NFL doesn't look good. But right now, there's a couple of transactions, one in particular that's a large college football transaction that could give us some upside this quarter.

James Ricchiuti - Needham & Company, LLC

Okay. And are there any -- you guys had a very strong year in international, and it looks like another strong bookings quarter. Can you talk a little bit about where the strength is coming from? And whether you see any potential upside opportunities in international?

James Morgan

International has a lot of variety to it, and we're seeing some success in both in the European side and the Asian side. It tends to be more on the commercial than on the sports in general. We’ve had some nice mall business with a major mall owner, a worldwide mall company. That's one, that’s kind of a nice ongoing business from that company and had some nice orders here just recently again. So that's an example. There's potential going forward in the outdoor advertising side of things. And that's, I think, is picking up a little bit. And it’s slow to get started in Europe, but I think that it's getting going, and we'll continue to move forward. So just a variety of things, really, across the globe.

James Ricchiuti - Needham & Company, LLC

Okay. And Jim, I just had a follow-up question, final question for me and I'll jump back to the queue. In terms of the newer growth opportunities, you seem to be getting some traction in architectural lighting, and it seems like that straddles, perhaps Live Events and International, or I should say Commercial. Maybe you can -- I don't know if there's a way for you to maybe aggregate if it's significant, the architectural lighting piece. And then the final question just relates to the IPTV opportunity. I don't know if there's a way to talk about that in terms of penetration in the professional market?

James Morgan

I'll start with architectural lighting. And really, that's a product or an application product that's specifically designed for a type of application. And that really, it applies and then can be sold through our commercial market, our Live Events market and serve in international. So it could be a contributor to revenue in any or all of those. And our pipeline there is actually quite strong now in that there's orders in that business can be anywhere from a couple hundred thousand to multimillion dollars. So there's just a lot of opportunity and again, it's quite new, so be interesting to see how it does going forward here and how it's accepted. But it's really, in the U.S., we're seeing a lot more interest in it and it seems to be picking up rather quickly in terms of just the quoting activities. So we're excited about that. In terms of IPTV, we have a couple of major installations at this point. So in terms of penetration, we're just kind of getting started on it. And in terms of how many facilities have IPTV at this point, I don't have the number on that but I think it's a rather small minority at this time. So I think there's opportunity there.

James Ricchiuti - Needham & Company, LLC

Okay. Jay, can you give us a sense of what an IPTV project might be for either an outdoor or indoor arena on average?

James Morgan

There, again, it can vary. It depends on how extensive, how many displays are included. But it could be a couple million dollars, that's product, or down from there.

James Ricchiuti - Needham & Company, LLC

Okay. And just a follow-up on the architectural lighting side. Revenues for fiscal '11 in that area, is there way for you to size it? Was it $5 million, between $5 million and $10 million? I'm just trying to get an idea how big a business it was last year.

Bill Retterath

Yes, Jim, I don't have that, but just thinking back on the projects, it’s definitely in excess of $10 million. A couple of projects that we've talked about before, we did an ad on for the Minnesota Twins, we did the Target headquarters building in Minneapolis, we had a big project in China. There were a number of projects in the second half of the fiscal year.

Operator

Our next question comes from Morris Ajzenman of Griffin Securities.

Morris Ajzenman - Griffin Securities, Inc.

I had a question on gross margins. You referenced in the quarter that you saw some improvement, and really, you highlighted, you put and came from better cost effectiveness, discussing DVX specifically there. Just talk me through this again. I mean, I've heard this in the past, but you basically deal in oligopoly, particularly Live Events and colleges, et cetera. And your pricing has become such an issue, I guess, part of being blown out by the downturn we were in, but understand that this area has not come out yet from this, let’s say, downturn, that it’s taking longer. But do you hope or expect to see any alleviation on pricing? I understand gross margins can improve by better cost controls, but what do you see happening this year on pricing, in perspective, you to your customers?

James Morgan

Yes, this is Jim Morgan. The price competition remains keen in the sports world. We're seeing China competition there. And peoples’ budgets are tight, and so low pricing certainly is attractive given peoples’ budgets today. So I think, it’ll continue to be -- I think, the price competition will continue there. And so our approach there is to continue to work to take costs out of a product while at the same time offering improved quality in the product. There are some – and one of the tradeoffs, there is what LEDs one might use, and in some cases, we'll give customers a choice of which LED they want, so that's one way to address that issue. And depending on the application, in some cases, a lower cost solution is acceptable. So there's different ways to approach that, but in the end, it comes down to our having a product that’s at a cost point, that we can deliver at a cost point that can give us the margin that we're looking for. And having to hit the customer’s price point at the same time.

Morris Ajzenman - Griffin Securities, Inc.

Okay. Let me just switch gears. On the cash flow, you generated healthy levels of free cash flow, I guess, before financing activities. And when I look at the numbers there specifically, a year ago, it'd be part of that contribution was working capital, really scrunching that down at a $21 million. And this year, to your credit, revenues were up materially, but you were still able to generate $3.4 million in cash flow by managing working capital. You haven't given guidance next year, but assuming the divestments out there, revenues can be up, it’s 8% to 10% or so. But in that sort of environment, do you still believe you can keep working capital kind of flattish? Or how does that play out as revenues gear up in this coming fiscal year?

Bill Retterath

Well, working capital for us can vary significantly depending on the types of business that we're dealing. I mean, if you have a chunk of business in China, that tends to hurt our working capital a little bit more. Contrast that to billboards, that helps because those are quick in and out for bigger dollars. And so ultimately, our working capital is dependent on the type of business, and I'd say the inventory levels that we take, as we look forward on our business. And so at any point in time, it's really hard to say how it will come out because it can change significantly. But with that being said, I think from a general trend standpoint, there is a lot of improvements we can make in the working capital as opposed to eating it up. So on a free cash flow basis, we remain optimistic that we can improve and do better in those areas.

Operator

Our next question comes from Dick Ryan of Dougherty.

Richard Ryan - Dougherty & Company LLC

Say, can you give a sense on these Live Events, what the -- I think you talked about the NFL side, but what you're seeing opportunity-wise on the college side? And also, a question back on the competition. I think the Asian competitor was, I think the past cycle, you thought they didn't have staying power. Do they have staying power now? I mean, are they winning jobs that you thought would be yours? Can you kind of address that a little bit more, Jim?

James Morgan

I don't know that we said that they didn't have staying power necessarily. I said they were relatively new back in the game in the last couple of years. So I guess, time will tell how things play out there. But I think the key there is that we have reduced the cost point on our product, and so our margins, we were pleased with how our margins came out this quarter on the product there. We are winning orders. We are being price competitive, and we're going to continue to take costs out of our product, and be more price competitive. So that's how we're addressing the competition, and it's not the first time we have encountered this in our history. It's not unusual. So we have to react to it and have to address it, and I think we are. In terms of the opportunities, the activity is primarily, for the summer here, it can be heavily weighted towards the college university side, and there's a lot of activity in that area. And we're planning to get our share of that. So I hope that answers your question.

Richard Ryan - Dougherty & Company LLC

Yes, that does. Good perspective.

Operator

Our next question comes from Neil Chatterji of Craig-Hallum.

Neil Chatterji - Craig-Hallum

I'm just calling in for Steve Dyer. Regarding the, I guess, the NFL lockout, and kind of given the comments you've already made, I guess, is it safe to assume for the year that we won't see any projects there? And then just quickly a second question, regarding NBA bidding activity, what are your expectations there?

James Morgan

Yes, in the NFL, we're not expecting any significant NFL revenue for this summer season. I didn't catch your question on NBA.

Neil Chatterji - Craig-Hallum

Just what are you seeing on NBA in terms of bidding activity and what are your expectations there?

Bill Retterath

We just booked a nice one here for the New Jersey, the Nets off in New Jersey this last quarter, so that was a nice one. I don't think there's any significant big projects going on in the NBA that come to mind. To put this in perspective though, maybe I'll -- because a few questions have come up that are related. Overall, what we're saying on Live Events is, there's opportunities in the college market that can offset what's the lack of NFL projects. And so it’s not like we're suggesting there's a rebound, but there are opportunities out there, overall, in the pipeline. I think, Jim mentioned on last quarter’s call that we had a lot of opportunities in the pipeline for Live Events overall. So there's business out there and enough opportunity to offset the fact that there's not the NFL projects out there or much in terms of NBA that come to mind.

James Morgan

Yes, nothing off the top of my head here that comes to mind at a moment.

Neil Chatterji - Craig-Hallum

Okay. But I mean with the NBA, with any possibility of a lockout there, would that potentially limit activity on that side as well?

James Morgan

Yes. Again, we haven't heard anything that would say that there’s -- because of that potential, that people are holding back on decisions in the NBA. We're not aware of that in particular.

Operator

I'm showing no further questions at this time, and would like to turn the call back over to Mr. Jim Morgan for any closing remarks.

James Morgan

Well, thank you very much. Thanks for the questions, gentlemen. And with that, we'll wrap it up. So thanks. Have a good day.

Operator

Ladies and gentlemen, this does conclude today's conference. You may all disconnect and have a wonderful day.

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