Daktronics, Inc. (DAKT) Q3 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Daktronics Fiscal Year 2012 Third Quarter Earnings Results Conference Call. As a reminder, this conference is being recorded today, Tuesday, February 21, 2012, and is available on the company's website at www.daktronics.com [Operator Instructions] I will now turn the conference over to our host, Mr. Bill Retterath, Chief Financial Officer for Daktronics for some introductory remarks. Please go ahead, sir.

Thank you. We appreciate everyone's participation this morning on our third quarter conference call. I'd like to first offer our disclosure, cautioning investors and participants that 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. 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. With that, I'll turn it over to Jim Morgan, our Chief Executive Officer, for some comments, after which, I'll follow and then we'll open it up for questions.

Good morning, everyone. Thanks for joining us this morning. We ended with a nice backlog and we delivered a relatively strong topline. The bottom line, however, was disappointing for us. We had a number of cost shifts that added up to a couple percent reduction in margin from what we were expecting. We're also in a bit of a valley in terms of professional sports opportunities, which is compounding our situation at the moment by holding orders at a lower level than we would like to see. But overall, the pipeline for fall sports is strong, especially in the college area for the 3 months we'll set the stage for sales for this sports season for our first and second quarter. Although we are typically positioned very strongly on these projects, we are seeing new competitors intent on buying some projects, which we have found in the past is not something competitors want to do and can afford to do on an ongoing basis. And in the meantime it can sometimes when a project for them with a customer decided to take the risk, given the price. There are a number of large projects i.e. that is in the $10 million range, both in Live Events and in Transportation that occur in the mid-stage. And we feel that position on at least a couple of these, we've got a positive verbal indications on a couple of them. But they're not yet in our backlog. They're not yet firmed up. If we can close on a few of those it will get our order and sales picture heading back in the right direction. Our basic customers in the digital billboard business are still announcing intentions to continue rollout of digital and reporting good returns on those rollouts. We believe we are well positioned to continue to participate in that business and certainly those customers. Orders, first part of [indiscernible] have been a bit light, but this is not unusual, and we are anticipating an uptick in the coming months. We are also entering the replacement phase in some of our displays for some of our national account customers. These are displays that were installed approximately 10 years ago and have reached the end-of-life. In some cases, these are competitor's displays. So we're excited about that. We're actually expecting to see a couple million dollars worth of replacement business here in the end of Q4 and early Q1. So that's something that we expect again, that's just the beginning of the replacement phase. And that's also, we expect that in the digital billboard area, we'll start to see some replacements here within the next couple of years. So that's -- we hopefully add new business for us. The lower level of orders has caused us to give increased emphasis on cost containment. We are curtailing headcount growth and addressing other discretionary spending through this quarter. With that, I'll turn it over to Bill for some more color on the numbers.

Thanks, Jim. As Jim mentioned, our sales were strong through the quarter and exceeded the consensus estimate of $117 million. As mentioned last quarter, this increase was driven by the order bookings in the second quarter, which was higher than expected. I want to give some updates, again on our Major League Baseball business, because that is a big factor this quarter. Last fiscal year-to-date, through the third quarter, we have booked approximately $20 million of Major League Baseball orders. And this year-to-date, we booked approximately $10 million. Because of this and the generally flat orders for the third quarter compared to last year, we'll be challenged to prevent sales from declining on a sequential basis in the fourth quarter from the third quarter. However, as Jim mentioned, there's some opportunities out there for some quick turn business that could help drive Q4 revenue, if we could book those orders over the next couple of weeks. So a range of our outcome for this quarter is somewhat wide at the topline. I want to focus on gross profit next as that's a disappointment for the quarter and the 1 thing that continues to be a challenge. Even more importantly, one of our largest concerns is we increase the top line long term. During this quarter, we have much higher health insurance on workers' comp claims than expected. We're self-insured on both of those items. We think some of these could linger a little bit into the fourth quarter this year that could put some pressure on gross profit, but it's hard to tell this early in the quarter. These employee benefit costs were approximately $1 million higher in Q3 than in Q2, and are actually higher than they were 1 year ago, which was unexpected as we had made some structural changes in our health plans. Also factors into this equation, this is an issue. And it's tough to quantify some issues with manufacturability of some of our newer products, which are costing us on the labor side of things and are being worked on. And we have a long history of being successful on overcoming challenges like them, so we'll take care of that. Also during the quarter, we lost approximately 1 percentage point on gross profit compared to our expectations due to our services infrastructure, which occurred not only due to higher spending, but compounded with lower utilization of our field service force. Working hard to turn that impact around, and we should be able to turn that around in the fourth quarter as we gear up baseball season starting again, preseason checks and things like that addressed. Finally, less material were some infrastructure projects that we took on in the quarter that had a smaller impact on gross margin, less than 0.5 percentage point. As we look forward to the fourth quarter on gross profit, on the positive side, again the utilization of our services infrastructure should improve. We've cleared, for the most part, any significant headcount growth, and we started to build limited amounts of inventory for the summer selling season, primarily on our Schools and Theatres business. And as I mentioned, we have some opportunity for some quick turn business in the quarter that's not booked yet or factored into our outlook. All of those things should help gross profit. On the other hand, we have to address the sequential -- expected sequential decline in sales and the fact that our margin on our large project backlog has declined due to some large projects booked during the third quarter at lower margin levels. Putting all this together suggest that gross profit could be more or less flat to up for the fourth quarter. And there's a range here that's important to note, it's tough to narrow in due to these -- some of these large contracts on natural volatility we have in our business model. On the operating expense side of things we came up where we thought we would for the quarter. We're expecting these costs to be generally flat into the fourth quarter, as we've put some cost controls in place that Jim and I both previously mentioned. Very surprising negative on cash from operations which, for the most part, is based on the next of our business and how our cash can get tied up in large contracts. We did a lot of work. For example, just to digress here a little bit, our large contract in Mexico, for example, this quarter. That can tie up and that did tie up a bunch of cash just based on the timing of deliveries versus the timing of billing. So nothing unusual, but something we think will turn around again in the fourth quarter. Our cash balances are down primarily for the quarter due to those items I just mentioned, but also the $20 million plus we paid in dividends during the quarter in the form of a regular and a special dividend. With that, I'll open up the call for questions and answers.

[Operator Instructions] We have a question from the line of Jim Ricchiuti with Needham & Company James Ricchiuti - Needham & Company, LLC, Research Division: The question I had relates to the pipeline. You talked about potentially some larger orders, $10 million or so in Live Events. I wonder if you could just give us a sense how many of those projects you see out there and when you might see bookings. Because you also talked about some quick turns business. And I wonder if you could just elaborate on that portion of the business, perhaps even sizing that. Do some of that relate to some of these projects you alluded to?

In terms of the overall pipeline, there's several $10 million size projects out there in the Live Events, Sports World. Some I think -- one in professional comes to mind and a couple in the college university side that come to mind. And in terms of whether that would be worked for fourth quarter, I would say there wouldn't be much work for fourth quarter, that was your question, Jim. But certainly, it's important we book orders now for first quarter and second quarter as well, of course. And then the other one I mentioned was in Transportation. And again, given the booking time for that one, it probably wouldn't be much in the fourth quarter, probably more starting in the first quarter. James Ricchiuti - Needham & Company, LLC, Research Division: And the quick turn business that you talked about, can you maybe expand on that, Jim?

In the national accounts side? James Ricchiuti - Needham & Company, LLC, Research Division: Yes. Don't know is this the state you see possibly coming in Q4, and maybe you can just elaborate? Is it a national accounts business?

Yes, the one thing that looks like could start to turnaround in Q4 here is the replacement project that or one phase of replacement project for one of our national accounts. In fact, one of the reasons they're giving us the businesses, we've got the capacity to do the turn for them and meet their delivery expectations. And that's again -- how much of that will be in fourth quarter versus early Q1, that is very little hard to know for sure. But overall, it's a couple million dollar opportunity. So if we got that split half-in-half in the quarters, that might be a good guess at this time. James Ricchiuti - Needham & Company, LLC, Research Division: And then just with respect to orders in Commercial and International, you continue to show pretty good year-over-year growth in this area. In the past, you've talked about architectural lighting. Are you seeing traction there, continued traction there? And just in general, what's the pipeline like in the International side of the business?

So our architectural lighting, that's a new product, and really a new market for us. And so I'd say the adaptation of the U.S. here is probably going to take a while for that to really pickup. And internationally, again, they might say it's ramping up rather slowly for us at this point as we identify where the potential applications are. And there are different sort of form factors that are required for different applications as we try to understand more of that. But certainly, there are opportunities there. In general, the international pipeline still is -- there's a lot of activity out there. You hear about the European economic or economy issues on the news regularly but not necessarily the government are spending the money for fraud products, so there's still opportunities over there. We're seeing that we're -- we are, mentioned in our news release, we've got our first order from Brazil. That's an area where really just starting to be proactive again, so there are opportunities there. So we do see ongoing opportunities internationally. James Ricchiuti - Needham & Company, LLC, Research Division: And just one question for you, Bill. I'm just -- on looking at the selling expenses, up quite a bit sequentially even though your revenues were down. Can you talk a little bit about the factors driving that? I don't know if there's some of that health care expense that you talked about being in there, but just in general, what could be impacting that line?

Well, on selling expense, I actually think, Jim, overall, we're doing somewhat well in selling expenses. Growth in that area results from investments on the international side, some increases in our Commercial business, areas where we're seeing order would ramp up. So I don't know. I think selling expense on a net basis, we're doing the right things there, but there are some investments being made, there are no questions about it in places like Singapore, Spain and Brazil, where we've mentioned, for example on the international side.

Our next question is from the line of Steve Altebrando with Sidoti & Company. Stephen Altebrando - Sidoti & Company, LLC: Just kind of a big picture on the gross margins. What's the main obstacle, I guess, getting back to again the previous levels of kind of in the mid high 20s and particularly kind of comping to fiscal 2008 where revenue is based pretty similar to what you are likely to do this year. Is it pricing the main story?

Well, clearly, pricing is a significant factor. But internally, there is a number of areas that we're working on, that we think we can control. And it doesn't happen overnight, but we think we can improve gross profit internally for a lot of reasons. Pricing isn't always within your control, but the stuff that is, for example, in our manufacturing side of our business, we've done, I think over the last couple of years, a good job at lowering our total conversion costs as a percent of our total cost of goods sold. And that we're having to put more products through as a result of pricing decline. So we've got some great things on manufacturing. We've got some challenges in our services business, as I mentioned before. There's some efforts there that we have to put in place. We've also talked about this a lot in the past. And to some degree, this is within our control for the long term, and that's our warranty expenses. Last quarter, we did fairly well in warranty. We've had one project that had some problems for the few hundred thousand dollars plus but we've had a pretty good quarter for warranty exposure, could be better. So in terms of getting up to the upper 20s, we need help in the marketplace to get above 24 -- to get above 25, I think a lot of that's internal if pricing stays the same, but it doesn't happen overnight. Stephen Altebrando - Sidoti & Company, LLC: Okay, that's helpful. And then just last 2 quick ones. Your billboard revenue for the quarter and the year-earlier period, and if you're seeing any change on the regulatory side of on digital? I know there's some debate around where you guys are located.

I'll start on the first part on revenue side. Year-to-date, on billboard products only, not the service part of billboard, which is actually turning into a big component. But we're just about at $40 million for a total billboard revenue. Orders are a little bit less than that. I will point out that this -- our billboard orders for the third quarter, I think Jim alluded to this, were a little bit light, but that's not unusual for a third quarter. They were just under $10 million and there were some orders that came in already this month on billboard that kind of catch us up a little bit there. So billboard, just under $40 million year-to-date compares about $15 million year-to-date a year ago, $15 million or $17 million, I think it was. Jim?

Yes. As far as the regulation, is there anything really changed there? I think nothing fundamentally changes that there -- it's an ongoing thing. That there are municipal and state regulations and there are, of course, those who would prefer to see no billboards anywhere. So finding the balance there I guess is the challenge. And our approach to that, as a company as we actually work with both state governments and municipalities and helping them update the language in their ordinances so that it is applicable to today's technology. A lot of the ordinances were written and they haven't been updated in the last few years. They are back from the neon sign days and address -- and that's really what they're applicable to. So we're supportive of regulation, but trying to help the governmental entities have the language and the tools to be able to regulate it in a balanced way. So it's an ongoing thing. There's nothing really new. Those discussions continue.

Our next question is from the line of Steve Dyer with Craig Hallum.

Just wondering if you're seeing any pent-up demand in either the NFL or the NBA given that essentially, neither one had a season, at least, as it relates to any new signage. Can you see maybe a burst this year now that they all seem to be back and going?

I don't know that I'd say that there is a burst. I think there's certainly some things that were put off and will come back around. I wouldn't want to overstate that as being a burst of any kind. But certainly, there is an ongoing interest in venues being -- not becoming outdated in their appearance and in their technology, so that underlying driver remains and to the extent they put something off, I think there ought to be some pickup there.

And what, I guess to stick with the sports analogy, what inning are we, do you think, on the move over to HD? I know that was thought to be a big driver a couple years ago, for sure, everything new that was put in but also a lot of the retro fits. Has that largely being done or are we in process? What are the thoughts there?

It's a good question.

There are a lot of good HD opportunities out there.

I guess to me the challenge with an inning approach, it just means that there's a game over at 9 innings and there's an ongoing upgrade and opportunity to get more, even those who have HD, to add more to those facilities. So I don't know if that analogy is 100% applicable here. Certainly, there's been a lot of facilities that have been upgraded, no doubt about that. But technology continues to advance and expectations continue to increase. So it's an ongoing upgrades for many years and HD is the latest catalyst, but we see that as an ongoing opportunity.

And then just sort of touching on a previous caller's question about gross margin, it seems to me that we felt the focus on remanufacturing and really modularizing your production and you're still kind of bumping around in the low-to-mid 20s. How much room, I guess, is there to get that back even into the 25, 26 range like you had it about a year ago?

Steve, I'm still not following the question completely. We've got capacity -- don't have these numbers right in front of me, but our manufacturing conversion costs overall, we've done a remarkable job with lean. When you think about the amount of product that we're putting out and what our total conversion costs are in the plant, and then the ability of our plant to take on the higher revenue level at slightly higher cost there's, as time goes on, I see more and more leverage coming out of that area. But to really see it show up in gross profit, we need the top line up there. And so there's still a capacity drain that we're feeling and that lower revenues in the fourth quarter, that's tough.

Yes. Okay. And then operating expenses have sort of crept up back up, I guess, in the $26 million range. Is that a good number to think about on a go-forward basis? Or does that go up, down? How do you think about that as we get into next fiscal year?

I think we're going to -- we're instituting some things to keep those -- all of our cost infrastructure in line. It's hard to say it will be flat. But just to give you some examples, G&A for example, that's ramped up we invested especially over the last 2 quarters, a lot on international type development, that's a onetime thing starting up a business in Brazil is not cheap. Much of those costs are behind us. And so our goal is to -- first of all, what drives those headcount for the most part. And the headcount growth in those areas is not going to ramp up at the same pace as it did this last year. I think we're committed to that. So there should be flattening out of those costs.

Our next question is from the line of Dick Ryan with Dougherty. Richard A. Ryan - Dougherty & Company LLC, Research Division: See, Jim, you mentioned competition. Can you talk a little bit further whether you're seeing any new players in the market? And is there any shift in the specific segments that's really kind of competitive? Any change there?

See the only thing through our different markets, as are as the only market that we've really seen a change is our domestic Live Events business. There's been some number of competitors over the last few years that weren't in the market, maybe had been in 10 plus years ago, that have come back and taken a run at it. And so yes, we're seeing some of that. And of course the way to get back in is you come in and you buy some jobs. We've had some success with coming in with some real low pricing. Again, how long that's sustainable? Our experience is that those things don't last but they happen. It's not the first time that's happened in our history. Richard A. Ryan - Dougherty & Company LLC, Research Division: Sure. In the press release, you're talking about some imminent orders, a couple orders on the international side totaling $5 million. Have they come in, in this quarter yet?

One of them have, in fact. There was a nice order and nice outdoor advertising company in Australia, so that one is in. The other one has not. The other one actually was dependent on us getting our Singapore operations up and running and we've got a couple of orders there. But no, that one has not yet. Richard A. Ryan - Dougherty & Company LLC, Research Division: Okay. And then the baseball season, I know obviously like the large projects in the baseball season that you've completed or done with. But is there anything else in the baseball season that could come in that you need quick turn there?

I'm not sure exactly where we are in the Minor League. And at this point, that will be the only thing in the Minor League. And we'll see those out there, but they tend to be smaller in size.

On the positive side though, we did sort of -- the team announced this last week, we were fortunate during the quarter to get to the Detroit Tigers transaction this last quarter, which is fairly large. It's north of $5 million. Richard A. Ryan - Dougherty & Company LLC, Research Division: And what will be the timing of that, Bill?

That will be fourth quarter work. A lot of it is geared up and running for baseball season.

We have a follow-up question from Jim Ricchiuti with Needham & Company. James Ricchiuti - Needham & Company, LLC, Research Division: You show the shipment for digital billboards, were they about $15 million in Q3?

It's just a hair under, Jim, yes. James Ricchiuti - Needham & Company, LLC, Research Division: Okay. And is there a way for you guys to maybe help us understand the size of the replacement market? It sounds like there are displays out there in the field that have been in operation around 10 years or so. Can you perhaps put some numbers to it? Whether it's competitions' product for your own product? It sounds like this could be more meaningful over the next couple of years. What's been your near-term opportunity, say looking out over the next year?

Yes. So the 2 different things that we talked about here. One is the replacement on national accounts, which is smaller on premise retail type of displays. And the national customers that we've been working out there, they started those rollouts of those programs before the digital billboard really ramped up. So they've got a couple years start on the billboards. And so we see that and we mentioned that replacement, we see some that started to happen now in fairly significant. And we think that could ramp up and continue operating nicely from this quarter on. Digital billboards, they started rollout maybe a couple years later, and so there's a little bit of lag there. So maybe the question, as much as anything, is how fast will they ramp up? And I don't know we've got a way to quantify that off the top of our head. But overall, you'd expect it to more or less track how the digital billboards of sales ramped up because they'll be kind of a fixed lifetime there, expectancy on those displays. So as they reach a certain lifetime out there, it will be time to replace them. James Ricchiuti - Needham & Company, LLC, Research Division: So just looking at the Commercial business in total, Jim, could that be -- in what percent of -- in rough terms of your Commercial business, could replacement be perhaps in 2013? Does it move the needle at all?

Digital billboard in our fiscal 2013, I don't -- there might be some going on there. I think the bigger noticeable amounts will be beyond there. But I think the firsthand information, in terms of timing on that, will come from announcements by the major billboard companies. I know some of them have begun to talk about the replacement cycle. But I think they've mentioned it in the context of beyond our fiscal '13 when it really starts to get noticeable. James Ricchiuti - Needham & Company, LLC, Research Division: And then on the national accounts side, is that potentially a meaningful source of revenue next year on the replacement side?

I think it will be meaningful, certainly in the millions of dollars, we would expect. But if it gets into the 10s or beyond that, I think, time will tell how aggressively they decide to go after that. James Ricchiuti - Needham & Company, LLC, Research Division: Got it. And then just switching gears for a second. On the transportation side, you alluded to a large order that's out there. Can you elaborate on that at all? Is it a domestic order? And I don't know, if you can put some dollars to that?

Yes. it will be about a $10 million business for us, and it's domestic transportation. That's all I can say about it at this point since it's a preliminary stage for us, but we have gotten some positive feedback on it. And as to the timing on that, I think that would start probably shipping maybe first quarter and would be spread out over a period of time. I think it could span even more than a year in terms of phase shipments. I don't have the exact schedule, but it wouldn't all happen in 1 quarter, that's for sure.

Thank you. This concludes the Q&A portion of the conference. At this time, I'd like to turn the call over to Jim Morgan for closing comments.

Well, thank you, everyone, for being with us this morning. Thank you, everyone, for your questions, appreciate that. Our focus going forward number one, is to get our order level up and top line growing at a little faster pace. But we will be -- in the meantime, we're going to have a renewed emphasis on the cost reduction here going forward and very focused on the operating margins. So again, thanks for being with us this morning.

Ladies and gentlemen, thank you for your participation in the Daktronics Fiscal Year 2012 Third Quarter Earnings Result Conference Call. This does conclude the program, and you may now disconnect. Thank you, and have a great day.