Daktronics, Inc. (DAKT) Q3 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Daktronics Fiscal Year 2013 Third Quarter Earnings Results Conference Call. As a reminder, this conference is being recorded today, Tuesday, February 19, 2013, and is available on the company's website at www.daktronics.com. [Operator Instructions] I would now like to turn the conference over to Ms. Sheila Anderson, Chief Financial Officer for Daktronics, for some introductory remarks. Please go ahead, Sheila.

Thank you, Sean. Good morning, everyone. Thank you for participating in our third quarter earnings results conference call. I would like to review our disclosure cautioning investors and participants that in addition to statements of historical facts, this call and our quarterly news release contains forward-looking statements reflecting our expectations and beliefs concerning future events, which could materially affect our performance. 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 contracts, fluctuations of margins, the introduction of new product lines and technology and other risks as noted in our SEC filings. These may cause actual results to differ materially. Detailed risk information is included in our SEC filings. Forward-looking statements are made in the context of the information we know as of today. We undertake no obligation to update or revise such statements to reflect new circumstances or unanticipated events as they occur. At this time, I would like to introduce Jim Morgan, our President and CEO, who will provide highlights for the quarter.

Thanks, Sheila. Good morning, everyone. Thank you for joining us this morning. Our third quarter is typically challenging for us financially, and this quarter was consistent in that regard. As noted in our news release, some of the work we had expected to complete in the quarter got moved out to fourth quarter due to project schedule changes. Consequently, our revenues were a bit less than we were hoping for, and this constrained our gross profit and our operating margin. We were pleased with our order bookings for the quarter. The solid order bookings bring us into fourth quarter with a nice backlog of $149 million. There's a somewhat higher-than-typical amount of backlog that is not workable in the quarter due to customer schedule, so that has to be factored in, in looking at Q4 projections. Sheila will talk about that a little bit more later. As some of you are aware, we announced that we have entered into an agreement to purchase OPEN Out-of Home Solutions, which we, for short, just refer to as OPEN; a Belgian company that serves the third-party advertising market, primarily in Europe. We see third-party advertising internationally as a growth opportunity even as we see the market in the U.S. leveling off somewhat. We have partnered with OPEN over the past several years in various projects with great success and look forward to the opportunity to bring our combined value offering to the third-party market as a unified entity. As a side note, regarding third-party advertising internationally, this past quarter, we installed what we believe is the largest LED display in Europe, and it is for a third-party advertising application in the U.K. Our product development continues to be key to our future. Here's an update on some key product development projects that we have discussed previously. Our Transportation business unit will begin shipping full color standard Vanguard displays. Vanguard is our trade name for our transportation display product line. We'll ship -- begin shipping those in the fourth quarter. These will be the first of a complete product family, offering full color solutions for everything from lane control displays to larger roadside message displays. This is for a relatively new application, which is called Active Traffic Management, which includes lane control and variable speed limit signs, controlled in real time according to prevailing traffic conditions to optimize traffic flow. The full color graphics capability and the cost effectiveness of full color LED technology makes it the preferred choice for this new application. These displays were designed and manufactured to different technical requirements in our video displays for sports and commercial, due to the unique requirements of the application. So this is a product family unique to our Transportation business. We see this trend to more full color in our Transportation business unit as a growth driver for this market going forward. And on a side note on that, we have been shipping full color displays for the New Jersey Turnpike Authority for several years, which we've discussed previously. But those were of a different design, and they're not -- and they were designed specifically for the New Jersey Turnpike project. Our primary focus in our video products area is the development of our next-generation of outdoor surface-mount LED product, which will offer a wider array of pixel pitches and improve the manufacturability of the product to achieve improved performance at reduced costs. We've been manufacturing outdoor displays using surface-mount LEDs for a number of years, with many installations at both sports and commercial sites. Our new design is the next generation of that technology and will offer a wider array of pixel spacings with improvements in the manufacturability of the displays along with enhanced reliability. We anticipate the first shipment of this product now in the first quarter of fiscal 2014. We began shipping our gas price digits in our commercial market using digits based on our new digit platform that is deployed across the company. We will begin shipping standard scoreboards with those digits based on that new platform in the next couple of months. A more robust design with more commonality across the company, based on this digit platform, allows us to offer an improved product with lower overall costs. We remain committed to our 3-year strategic goal to significantly improve operating margin. We continue to work to improve the gross profit on contracts, as well as standard product, through initiatives in product design, manufacturing and project management, along with a continued emphasis on controlling operating expenses to achieve our goal of realizing and sustaining double-digit operating margins. With that, I will turn it over to Sheila for more color on the numbers.

Thank you, Jim. As Jim mentioned, going into this quarter, we were expecting to convert more of our backlog into sales. We had a couple of projects with changes in production and installation schedules, which moved out and caused the lower sales revenue. This revenue is anticipated to be recognized during the fourth quarter. With sales down, we were able to maintain a positive operating income, albeit a small percentage. In the Transportation business unit, we were able to convert nearly $10 million of backlog into sales during the quarter for the Los Angeles airport project. This, along with further completion of the New Jersey Turnpike project, were the primary reasons for increased sales for the third quarter as compared to the third quarter of fiscal 2012. Live Events sales included work performed on a number of projects, including $1 million college system for an ice arena, work on a minor league baseball stadium upgrade and delivery of a modular system to a video rental company. Sales in Schools and Theatres increased over last year's same quarter, primarily due to increased projects, which include video displays. We are continuing to see interest in adding video displays to high school sporting venues. International sales were down this quarter, primarily due to the timing of converting orders into sales. We are going into the fourth quarter with an increased backlog in our International market, which should contribute to higher sales in the fourth quarter. We continue to see opportunities for growth in International. Our pipeline of projects is strong. Commercial is down in sales compared to a year ago due to the video contract business being higher last year compared to this quarter. Because of the decrease in sales to outdoor advertising companies, which were both offset by an increase on our -- for our on-premise advertising standard order business, which we believe is due to better U.S. economic conditions. We had a good quarter for order bookings for large custom projects in our Commercial business unit and have been seeing success in sales to malls this past year. We have a strong pipeline of potential orders in the commercial custom video projects. Although orders year-to-date for outdoor advertising displays were slightly higher than last year, we feel there is a softening demand in this niche, based on some indications from our primary customers. So we may see some lower orders and sales in future quarters for the outdoor advertising area. Looking forward to the fourth quarter, we expect sales to be up, both sequentially from quarter 3 of fiscal 2013, and up from fiscal 2012's fourth quarter's sales levels. Although we began the fourth quarter with $149 million of backlog, a little over $35 million of that backlog has productions, customer delivery times or installation work that are scheduled to go out into the first and second quarter of our fiscal 2014. In addition to workable backlog, however, we do expect other orders to come in during the quarter and expect revenues to be up significantly more than the third quarter of 2013 and fourth quarter of 2012. Gross profit percentage was 24% for the quarter, which is an improvement from last year's third quarter. A few factors which contributed to the higher level of gross profits include our ability to timely reduce variable manufacturing expenses to match production levels, our continued focus on material cost reductions, a decrease in warranty expense as a percentage of sales and improved sales mix this third quarter. Gross profit levels for the next couple of quarters will be lower than our year-to-date level and similar to slightly higher compared to last year's fourth quarter. We will have more production over the next month on larger orders, which have lower margins. Operating expenses were relatively flat compared to the third quarter of 2012 and are sequentially up, due to increased commissions earned on sales made by third-party agents and an allowance for potentially uncollectible accounts we took this quarter. We estimate our spend levels will only be slightly higher in operating expenses compared to last fiscal year in the fourth quarter. We received a tax benefit this quarter from a reinstatement and extension of the research and development credits during the third quarter and also realized the tax benefit for a portion of our special and regular dividend we paid in December. Our effective tax rate can vary due to the mix of pretax income in the various countries where we do business and have established entities. For future quarters, we continue to forecast our effective tax rate to be in the 35% range. We have generated $33 million of cash from operations this year. We were able to lower inventories this quarter by working through a significant portion of the Los Angeles airport project. And we did have an increase -- a net increase of approximately $10 -- $10 million between cost and excess -- cost and earnings in excess of billings and accounts receivables, primarily due to the timing of payment terms and collections versus production. This is pretty common in our business, and these primarily related to our transportation projects we worked on during the quarter. We expect to collect on these receivables during the next months on these significant projects. Looking ahead, we estimate total capital expenditures for the year to finish around $11 million. Our capital expenditures are primarily for production equipment for our new product lines and/or replacements or enhancements of our information system infrastructure. With that, operator, please open up the line for questions.

[Operator Instructions] Our first question comes from Jim Ricchiuti with Needham & Company. James Ricchiuti - Needham & Company, LLC, Research Division: Was wondering if you can -- Jim, I was wondering if you could size the dollar amount of the revenue that moved from Q -- out of Q3?

I'll let Sheila take it.

It was approximately $7 million, $7 million to $8 million. James Ricchiuti - Needham & Company, LLC, Research Division: Okay. And Sheila, you gave some color on the backlog, and I just -- I may have missed the number or maybe what it was. Related to the $35 million of that $149 million backlog, are you saying that there's a bigger component of that backlog that you expect to deliver in the Q1, Q2 time frame? I wasn't quite clear on what you were saying there.

So $35 million of the $149 million backlog is what we expect to not be workable in quarter 4. We expect to work on that during quarter 1 and quarter 2 of fiscal 2014. James Ricchiuti - Needham & Company, LLC, Research Division: Okay. And normally, normally you'd see, based on the backlog that you have, you would see more of that product being delivered in a subsequent quarter?

I would say yes. Normally, there would be more that we would have recognized or expected to recognize in quarter 4. But we have a couple of these large projects with the deliveries that are moving that out a few more quarters than historically. James Ricchiuti - Needham & Company, LLC, Research Division: Okay. And just a question on the Live Events business. How would you characterize the pipeline of activity that you're seeing as you look out into the fiscal fourth quarter, just given the seasonal nature of that business?

The pipeline for our projects -- large projects, both the Live Events and International and really even in Commercial are all strong. There's lots of opportunities out there in the large projects area. James Ricchiuti - Needham & Company, LLC, Research Division: And Jim, is that -- this business you think you can close this quarter, in the current quarter? Is your statement relating to just the activity level that you see over the next 1 to 2 quarters?

My statement earlier relates to a little broader, longer-term view. But certainly, some of that opportunity would be -- some of the pipeline is to be, and we need to book in the fourth quarter obviously.

Our next question comes from Steve Altebrando with Sidoti & Company. Stephen Altebrando - Sidoti & Company, LLC: Excluding some of the large projects in the backlog, could you talk a little bit about what the margin profile is looking like for the backlog on kind of a same dollar size basis?

I would say our -- besides the big projects, the margins are holding steady and are doing quite well. It's the large projects that do bring us down a bit. We have worked on working with suppliers to reduce our bill of material costs and our total manufacturing infrastructure as well. So we're doing fine on the less-than-larger projects. The larger projects are the tougher competition that we're seeing lower margins on. Stephen Altebrando - Sidoti & Company, LLC: Okay. So that's a good segue, I guess. So is the pricing environment with large projects still pretty cutthroat? Are you seeing any easing?

I'd say it's -- it remains -- we've always said that the competition is the toughest in our gross profit. Margins are the tightest on the bigger projects, and that continues to be true. And certainly, the competition is keen on those big projects. Stephen Altebrando - Sidoti & Company, LLC: Okay. And then just last one. Do you have the billboard revenue for the quarter?

I do. We had about $10 million of billboard revenue this quarter.

Our next question comes from Morris Ajzenman with Griffin Securities.

Just as a follow-up with the billboard environment. You spoke about in the out quarters, it looks a little weaker. I know on previous calls when we looked out to fiscal '14, you said probably overall dollars being spent by the billboard companies for digital, probably flattish, may be up some. I think what you're saying there might be a shift from new billboards to existing billboards that need updating or replacing, et cetera. Is that still a scenario there? And I'm just trying to get a feel for how that's playing out and what it is why you're seeing flattish going out to the out quarters?

So Morris, what we're hearing from our major customers is that they're not yet a -- they're going to be either flat to down in their total spend on digital billboards. Some of that is replacement and some of that is new, so there's a combination there. But -- and certainly, one of the things that's an increasing component of that spend is the replacement of the displays or updating of the displays that have been out there for 7-plus years. So again, we encourage you to maybe tune in. I think both Lamar and Clear Channel are going to be having their quarterly releases here this week, and so you can get some more color on that from their -- directly from them.

Okay. Again, just a further point on that. My understanding is that the ROI is very attractive for the Lamar and Clear Channels of the world. If that's the case, and again, the economic environment, I mean, does not seem that great overall, but why would you be flat to down if your ROI is very positive and incremental to the owners of these digital billboards? Just help me understand your thinking of why we're having this sort of lackluster top line growth there?

Again, certainly what we hear from our customers, that the ROI is very positive. And certainly to that point, there certainly are -- we have many other customers other than the Tier 1 customers that are also deploying digital billboards, and they're telling us they're seeing nice returns to that as well. I think part of it is it still takes cash, and so it's how much cash do you want to deploy, what's your CapEx budget and so, again, I think that's something you'll probably get a little more color by listening directly on their reports and see what their perspective is on that. But that's -- I think that's the other part of it is just how much cash they want to deploy.

And one last question, not related to this, but the gross profit -- gross margin is 24% this quarter. Fourth quarter, I guess, felt some pressure from mix and then improving. Should we then look out in fiscal '14 -- and I'm not trying to have you give specific guidance, but should gross margins then thereafter, this next quarter, be back in the 26%, 27% area here? Or is that being too optimistic? How should that gross margin play out then into next year?

Certainly, I'd like to get it back up in that direction and again, it depends a little how the -- we're able to book some of these projects going forward. But one of the things -- our gross profit level is very revenue dependent because we have this fixed cost of our infrastructure here. So to the extent we can, in fact, book orders and get our revenue up there, that will have a very positive effect on the gross profit level.

But you also talked about this 3-year goal, part of that is controlling operating expenses. So shouldn't it be leveraged in gross margins as each quarter goes forward with better control of OpEx?

We are working on operating expenses as well. But if you look at the gross profit line percentage, we are impacted, like you mentioned, on some of these large projects. And once we work through those and continue to fill up our factories and win orders, we could see gross margins increase as well. And that is the key component for us to achieve our long-term strategies.

[Operator Instructions] Our next question comes from Dick Ryan with Dougherty & Company. Richard A. Ryan - Dougherty & Company LLC, Research Division: Jim, on your prospective acquisition, were they responsible for bringing in the large LED display that you talked about in the U.K.?

I'm sorry, could you repeat the question, please. Richard A. Ryan - Dougherty & Company LLC, Research Division: The prospective acquisition of OPEN, and earlier in the discussion you talked about installing the largest LED display in the U.K. for third-party advertising. Was that business -- did that business come through OPEN?

No, I'm sorry. No, that was a totally separate -- and maybe just to give a little more insight into the OPEN arrangement. What -- a big part of the third-party advertising market in Europe, and internationally in general, is what's commonly called street furniture. And these are smaller displays than we typically see in the U.S. We might see them at the size of some you might see in an airport, where you have walking traffic. But these are then outdoor displays on -- actually right on -- off and on the sidewalks or on the sides of the streets. And so they're much smaller and probably 2 square meters is what's like a typical size. And so the -- because they are looked at from -- viewed from a much closer distance, say, than a typical billboard in the U.S., they require a much more finished-looking cabinet. And OPEN has a very nice system for these cabinets to accommodate various sizes and styles and give a very nice finished look that's appropriate for this street furniture market. So OPEN would not be a way for us to target -- this one that we mentioned in the U.K. is really almost like a spectacular, we might call it. OPEN is not headed toward the spectacular. They're really oriented toward the street furniture market, which the potential there, if you go to Europe, you'll see thousands of these street furniture displays now, and they're using scrollers, either they're fixed printed display that doesn't change or they have a mechanical scroller that will scroll through like maybe 6 to 8 different advertisements just repetitively throughout the day. And so the replacing -- really what we're doing with OPEN is we'd be providing a digital display that would replace that mechanical scroller with LED display. Richard A. Ryan - Dougherty & Company LLC, Research Division: What sort of share do they have in that street furniture market, if you can size it?

I don't know that we have a number for that. Some of the big companies over there, I think, probably have some of their own cabinets. So it just -- it allows us to offer, again, a complete solution. In some cases, we may end up providing just electronics to companies that have their own cabinets. So it's a combination of things. But they're a relatively small company. It just gives us a nice sort of full product offering that we can take and we could build on. So at this point, it's, like I said, a small company, a small acquisition. Richard A. Ryan - Dougherty & Company LLC, Research Division: Okay. So Sheila, one question on the gross margin side. Warranty didn't seem to be an issue this quarter. Did we move kind of beyond warranty concerns, or can they still show up in any quarter?

Well, we certainly hope that, through the efforts we've put into our quality in manufacturing as well as the reliability lab, that we will see less warranty in the future. That's our goal and our strategy. Of course, there always could be something that pops up. But at this point, we didn't have any large issues to deal with this quarter. Richard A. Ryan - Dougherty & Company LLC, Research Division: What was the warranty in the quarter?

One moment, 2.5% of sales.

Our next question comes from Jim Ricchiuti with Needham & Company. James Ricchiuti - Needham & Company, LLC, Research Division: In your press release, you talked about a couple of orders in the Commercial business. You may have issued separate press releases, but I might have missed it, just regarding the 2 video systems that totaled approximately $7.5 million. Can you -- did you -- have you announced anything specific to those? Or if not, could you provide some color?

We have not announced those, identified those at this point. And of course, we don't do that unless the customer desires to have an announcement of something to that effect. But one was a mall, a large shopping mall, a new -- being constructed. What was the other one?

I don't know what the other one was. James Ricchiuti - Needham & Company, LLC, Research Division: Okay. I can always follow up after. And just Jim, you sound fairly optimistic about the International business in general. It's such a broad area. Can you talk at all specifically as to where you're seeing the strength, which international markets?

It's a big world out there, Jim, and we see one quarter, we'll have a nice shot of business from one geographic area, the next quarter, we'll have a shot of business from another geographic area. I would say that we've been pleasantly surprised with the business coming out of Australia here in the last few quarters. That's really -- the top 2 orders this last quarter both came out of Australia. Considering the size of that market, from a population perspective, compared to other parts of the world, it's good to see. But I mentioned this large LED display that we just installed, that was in the U.K. So we're seeing -- we've just established an entity in Brazil here within the last year, so we've positioned ourselves so we can do business down there, which I will say is more complex than doing business in many countries, but we certainly see opportunities there. So there's opportunity worldwide, kind of a big market but also a very challenging market. James Ricchiuti - Needham & Company, LLC, Research Division: And just -- so to talk about the pipeline that you see, nothing specific in any particular region that you're expecting orders from?

So we kind of on a broad stroke, we look at the, what we call the Asia Pacific region, and then we have the European, Africa region. And our pipe -- and we tally up the pipelines kind of in those 2 major categories, and we've got strong pipelines in both of those.

I'm not showing any other questions in the queue. I'd like to turn it back over to Jim Morgan for closing comments.

Well, thank you, everyone, for being with us this morning. Thank you, gentlemen, for the questions, and we wish you all a good day.

Thank you, ladies and gentlemen, and thank you for your participation in today's conference. This does conclude the conference. You may now disconnect. Good day.