Daktronics Inc (DAKT) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Daktronics third quarter fiscal 2007 earnings results conference call. As a reminder, this conference is being recorded Wednesday February 14, 2007, and is available on the Company's web site at www.daktronics.com. During the call all participants will be in a listen-only mode. Afterwards there will be a question-and-answer session.

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.

Thank you, Danielle, and good morning to everybody. We appreciate you participating in our third quarter earnings conference call. Prior to getting into the details of the quarter, I would like to offer our disclosure cautioning investors and participants in addition to statements of historical facts.

This call and our quarterly 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 noted in our SEC filings, which may cause actual results to differ materially. Forward-looking statements are made in the context of the 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.

With that I would like to turn it over to Jim Morgan, our CEO, for some highlights on the quarter.

Thanks, Bill. Good morning, everyone. Thank you for joining us this morning. This was another excellent quarter for us at both top and bottom line. We came in at the center of our range, top line at over 106 million, and we're also in the center of our range on the bottom line before we had some one-time adjustments that took us to the top of the line at $0.17 a share. I would like to thank all the Daktronics employees for another excellent effort this quarter.

A few comments on capacity. Those of you that have been following us for a while know that for the past seven or eight quarters we've talked about capacity being the constraint on what we could generate for revenues. We've made significant investments in facilities and equipment this past year to increase our capacity. A couple things are noteworthy in that regard.

First of all, the Sioux Falls plant handled all of our billboard production this past quarter. We have a very focused and dedicated team at Sioux Falls and they've gotten off to a great start. You may recall, that we shipped our first unit out of that plant at the end of the first quarter in October. We are in a position now to expand our outbook there reasonably quickly just by adding additional work shifts. So capacity for digital billboards is not a limiting factor at this time. We had a lot of expansion readily available.

It is also noteworthy that we were able to generate revenues 50% greater than Q3 last year. And this was done with very little overtime. This is evidence that we are now at a point overall where capacity is not the constraint for us. Notwithstanding that fact, we will continue to make strategic investments in manufacturing equipment in potential bottleneck areas. We are continuing to pursue improvements to our manufacturing processes through our lean manufacturing programs and we are very pleased with the results we have seen to date with our lean manufacturing efforts. We're doing this in conjunction with aligning of factories with our markets to allow us better synchronization of plants with market demands.

Orders for the quarter were as we anticipated. The baseball business was not as strong this year as last year. It wasn't that we lost orders there just wasn't quite as much activity at the professional stadium level. Also, orders for digital billboards were down for the quarter. We do not see that as a trend, just part of the normal irregularity of the business. We are seeing some of the second tier regional outdoor companies putting up some digital, which -- and that is good to see and we're getting some of that business.

There remains a lot of excitement about the use of digital billboards. I would like to comment, however, that as we have always stated, there are constraints on the rate of application for the digital billboards. One of the primary constraints in the regulatory environment in some municipalities. In some cases, these regulations slow the process of installing digital and in some cases they prohibit the installation. This again varies from city to city and is important that investors understand that this constraint exists to balance the picture in light of the potential growth that exists.

The underlying factors that are driving our business remains strong. Sports facilities appreciate the impact of the electronic displays and there's an ongoing trend to larger, higher resolution displays. The Super Bowl, at Dolphin Stadium, Miami, featured two high definition displays, actually, that we installed a year ago. The largest of which is approximately 50 feet by 100 high by 130 feet long. These displays along with our pro-ad displays on the facia of the second deck were part of both the game and the half-time entertainment. So we do expect there'll be a trend toward high definition displays in large sport venues.

Orders in our commercial Galaxy product, which is used primarily in on premise retail advertising continued to be strong. The driver in the commercial market is the effectiveness of our LED displays as an advertising medium, both for on premise and also third party advertising, and the attractive price points of the product at all levels, especially with full color.

Orders in our transportation market were excellent, actually, this quarter. That's, again, less than 10% of our business, but it's a nice little growth area for us. And so, they had a great quarter in transportation.

Our new Vortek hoist division, which we purchased this fall, got off to a great start this quarter. Our Vortek manufactured sophisticated stage rigging hoist systems, we are now in regular production in Victor, New York, which is near Rochester, and working on further developing the sales force for Vortek. It's a relatively small operation with a run rate of 2 to 3 million a quarter but we see nice growth opportunities in that market.

Our private development costs were slightly under our 4% benchmark for the quarter. Our engineering capabilities are one of the fortes for Daktronics, and we have historically invested about 4% of our revenues in product development. In our product development effort is applied in our four product areas; namely sports products, which includes scoreboards and sports-specific products; our commercial products, which is primarily our Galaxy display line; our video products, which is centered around ProStar video technology; and the transportation displays, our Vanguard product lines, which is specifically designed to meet the Department of Transportation requirements.

At this point I'm going to turn it over to Bill Retterath to talk a little bit more about some of the numbers.

Thanks, Jim. Starting out, I would like to add some detail on the gross profit margin for the quarter. We had anticipated margins would be up a little bit. Overall, our large contract business performed very well from a margin perspective and was a key factor in driving up margins. Increase was offset by some increased costs of capacity, as we still deal with rolling that out and the continuation of building it. [inaudible] fees associated consulting fees primarily in connection with our lean initiative. And we also had a little bump again on some health care costs that remain somewhat volatile. And, keep in mind, during the third quarter, also, we deal with a lot of affects of the holidays the vacation time and things like that. And that does affect overall margins in the third quarter.

Looking forward, we're optimistic on our gross profit margin, which, during the most recent quarter we saw a rise in average margin at the time of booking contracts during the quarter. So that was nice to see. The mix between the smaller orders and larger orders was also slightly better during the quarter compared to the second quarter of this year. And I'm happy to report that the contracts that we originally reported, I believe, in the first quarter, that were negatively affecting margin are now completely in the past. And, in fact, it's turned around to be a positive impact, the difference between the rate of booking the orders and what we actually achieve on completing the orders.

I would reiterate a lot of the factors we talked that can impact gross profit margin that might get a little bit boring. So, I'll just remind you, there are a lot of factors that can cause gross profit margin to vary, and added to the mix this quarter also is a greater dependence on order bookings during the quarter to generate the margin targets.

I would also like to reiterate something that we make it a point to pass on to investors in understanding our business. The backlog is not always an indicator of the business for the long-term and high and low backlog numbers do not always indicate trends in our business. It's a function more of timing and success in booking larger contracts. For the third quarter, as we said, there just wasn't the number of projects out there and it was not a matter of losing orders or changes in the competitive environment. In fact, we remain just as optimistic on the future as we have throughout the current fiscal year. We're expecting to be in a good position for the start of the next fiscal year if orders perform in the fourth quarter as expected.

I think that our general and administrative cost structure warrants a little mention here. We've been investing a lot in building up the infrastructure associated primarily with our personnel and IT departments and this involves a lot of staffing and initiatives. Our hope is that our percent of revenue its hit its maximum level, which typically the third quarter because of the amount of revenues as a percent of revenues, it typically does. We believe these initiatives are necessary to support the long-term development, and as a percent of sales, are expected to decline in the fourth quarter.

Adding a little color on recent investments, we have made our investment in the hoist business, as Jim mentioned, its proven to be very timely and exceeded our internal estimates for the first quarter since acquisition. Our media businesses on a whole also seem to be on track as our FuelCast investment has rolled out well over 200 stations in the Chicago, L.A., San Diego, San Francisco markets with more on the way. The level of interest both with the petroleum retailers and advertisers seems to be extremely high. We're also in the fourth quarter through Arena Media, our other investment we made, rolling out a number of new major league baseball facilities for concourse advertising of digital displays. Both of these businesses are having a small negative impact on nonoperating income, but our optimism is on solid ground.

As mentioned in the press release, we were able to generate a favorable tax rate during the quarter, primarily due to the retroactive restatement of research and development tax credits back to 2000 -- January 1 of 2006. So in effect, we recognize the full year's benefit, which had not previously been recognized. Also, due to the success of our Asian business, our overall tax rate is less and that is something we expect on a go-forward basis.

On the balance sheet and cash flow, you may have noticed our level of debt at the end of quarter. We expect to see that decline. Much of the increase was due to the increase in inventory, which we will work down this quarter. We're not satisfied with those levels of inventory and are putting a lot of effort into bringing that down.

Also, our CapEx was exceeding expectations, and for the year we think our total CapEx may now approach somewhere near 50 to 55 million. We renegotiated our line of credit during the quarter, primarily to obtain lower rates once we saw that we were going to be in a borrowing position. Our expectation is to not utilize the increasing level for traditional debt financing, but we're finding a greater need for letters of credit, which goes against your capacity with our foreign businesses, especially in the Asian market.

With that I would like to turn it back to the operator, Danielle, to open it up for some questions.

Thank you. [OPERATOR INSTRUCTIONS] We will take our first question from Jim Boyle with K.L. King.

Good morning. C.L. King.

Hi, Jim.

The lower-than-expected billboard orders, are they due to just one client or many clients that either did not order at the expected higher pace, or is it a timing shift, or is this a new trend?

There's a -- we do have a couple larger customers in digital billboards, and certainly how they decide to schedule their demand is -- has a big impact on what we see there. So that's -- it can be heavily influenced by a couple customers in that case. We don't see it as a trend. It's just a matter of -- I think the unknown here is how fast it can really grow. As I mentioned, there's the constraint of the regulation. I think there's also the reality of there's some limit to the capacity for the digital billboard companies just internally and operationally to deploy these. It takes a finite amount of planning and manpower and effort to make this happen, so -- and it's relatively new to the billboard company. So I think how fast they can and will ramp up is still to be determined.

I will add maybe a little bit of color to it as well, Jim. In this quarter, already, we've seen some for the first two to three weeks, we've seen a nice level of order bookings for that business. In our business, with our lead times on ordering materials and all that, to have a major impact, orders have to come in early in the quarter. But we are -- we have seen first two weeks some nice orders in that business.

So that's why you would say this is not a trend? Can either of you quantify why these nice level of orders give you comfort?

For the long-term?

Correct.

I would say there is uncertainty on how fast this will grow in terms of our comfort. But I don't know that we can predict that. What we've done is put ourself in a position to be able to respond. Obviously, we can't control the rate at which customers -- we try to be a very reliable supplier and put ourself in a position that we can respond to the demand and continue to be a reliable supplier. And so -- yes, and that for us to predict how fast our customers are going to want to deploy these, that's rather difficult for us to do. I mean, we expect it to continue to grow, but the rate of growth is hard to nail down.

So the recent decline, that was just a timing glitch?

We see that as a -- it was a timing thing. We don't see it as a trend.

Okay. Moving on, then, to the lower-than-expected professional baseball orders, is that two or three orders that didn't happen, or is that, too, a timing shift?

I would say overall, the baseball season happens once a year, and so, in general, there is some larger projects that just didn't happen, and just in general, there just didn't turn out to be as much activity there in the end.

And that's, you think, a trend, or a timing shift, more?

The big -- one of the challenge with the large products, and we always say our business is lumpy and hard to predict what's going to transpire from one year to the next, it's tricky. And certainly, there's a lot of variability with a number of large projects can come together in one season and there can be fewer in the next season. It doesn't necessarily mean it's a trend. We see, again, that there's still a underlying demand in sports to go to larger displays, to go to higher resolution, and we're still seeing good order bookings there. Again, the rate of growth is probably what's hardest to predict in that.

I would also add, there's a lot of, just in terms of baseball, there's a lot of activity over the next couple of years, too, in terms of some of the big, mega projects for new construction, which, over the last two years, new construction has really been at a lull point. So for the future, the trend that we think that there's a lot of larger transactions out there over the next year or two. There's a couple of teams in New York, for example. A lot of new, big projects potentially coming on the horizon. Now, we've got to be successful in winning those contracts, but our optimism on professional sports as a whole has not changed at all. In fact, it's remained the same. We've seen a lot of neat things coming out there in terms of large sports facilities and the increasing size and amount of displays. None of that has changed this quarter.

An example of that, the Dallas Cowboys announced their new stadium they'll be building. One of the point that was highlighted in the news release was how larger the displays were going to be in that facility. That's just indicative of the -- how the displays are important -- have become an important architectural part of these facilities. They're an important part of the entertainment. We see that as a strong underlying driver for the business.

Sports lumpiness is a fact of life.

Yes.

But finally, could you give us a feel, you mentioned in the press release that all divisions were 30% or higher. Could you break those out for us, please?

Our transportation business is up 30%, that's kind of what set the bar -- these are in terms of orders. Commercial market is up almost 55%, and sports is up 30% year-to-date, roughly.

And what was digital inside of commercial?

You're talking about the outdoor advertising?

The digital billboards.

I don't have that at my fingertips. I'll get that and talk about it later in the call.

Okay. Thank you very much.

Thank you.

[OPERATOR INSTRUCTIONS] Next we will hear from Michael Friedman with Noble Financial.

Hi, guys. Kind of as a follow-up, can you give us the breakout as percentage of sales for sports, commercial and the transportation/government?

For the quarter?

For the quarter.

One second, here. Yes, for the quarter, commercial was about 46%, sports, overall, 48%; and transportation, a little over 5%. That is stronger comp on our commercial than we have had historically.

That's due to billboards?

Year-to-date, sports has done about 55 and commercial at about 40.

It's good to balance those and realize that because of the seasonality, we have some shifts quarter to quarter there.

Right. The commercial growth is mostly billboard; is that right?

Pardon me, Michael?

The commercial growth is largely the billboard --

That's the biggest segment, but we're experiencing good growth in our Galaxy display market. And also, another real positive highlight that's had a lot of other positive repercussions is the casino business in the Asian marketplace, primarily Macau.

Okay.

There's a few areas, but clearly the fastest-growing one is the digital billboard.

Can you give us a little color on where you think gross profit margins are going to fall out in '08, and do you think you'll be able to continue to widen that with the process improvement plans?

There's two parts to that equation, the cost and the price. Certainly, we believe we can continue to bring our costs down, we're -- we're -- I think we're making really good progress in the overall area of lean manufacturing and we'll certainly continue our efforts there. The other side of that is the pricing and how we will do there. Certainly, our goal is to reduce our cost faster than the price will come down. Historically, our pricing for a product has come down. That's what's helped grow the market here. We expect that our pricing will continue to go down in the future, and we have to be very efficient manufacturer and provide a quality product at a very competitive price. Certainly, our goal is to gain in that spread between cost and price and we're working aggressively on that.

Do you have a target for '08?

Michael, our target, more so, where we're focusing more is on operating margin target. And year-to-date, now, I think we're at about 9.7%, and for the quarter we are at 9.2% for the quarter in terms of operating margin. And the third quarter is always the -- or typically the toughest quarter to achieve growing the operating margin. So our focus is more so on that. In terms of targets, we're in the midst of all of our strategic planning right now. We'll give more guidance at the end of the next quarter, but certainly, it's to be well in excess of the current year-to-date of 9.7.

Okay. And can you give us a little bit more color on capacity? How much capacity in square footage, and I guess in dollars do you expect to add in fiscal '07? And then how much more do you plan to put on for fiscal '08?

In terms of -- again, I always like to clarify how we define capacity or what makes up capacity. Of course, you need space to start with, but in addition to that, the capacity is, it's equipment for automation, especially, and then the people to do the work. So we have invested a lot in facilities. In fact, we have another facility that's in progress here, now in Brookings that will add about 80,000 square feet of manufacturing space. That will be available this summer. But space is not a constraint for us right now. So, that's kind of -- it's not part of the short-term equation as far as how we're performing. We're in the process of bringing the Redwood Falls plan online and we hope to start running some products through there in March. That takes -- it takes time to ramp up a plant, but we hope by the end of the fiscal year that that will be in pretty much a steady state run mode over there and we'll focus our Galaxy product line, primarily our commercial market Galaxy product line over in that facility.

So we'll have just a lot more capability by the end of this fiscal year than we had at the beginning. And we will have close to 1 million square feet when we get -- of total, not just manufacturing, but total for offices as well as manufacturing, I don't [inaudible] manufacturing, by the time we finish this building here in Brookings that's under construction. We'll have a lot of space and I think our goal -- or intent would be not have to build another building in the next year or two here.

Again, by getting -- we were constrained in terms of people, the rate of which we could grow our manufacturing personnel, especially in Brookings, and that's one of the reasons for us to get established outside of Brookings and Sioux Falls and Redwood Falls and we believe we can find the people we need there to grow as -- in those two particular areas as the demand comes along. And Brookings is a growing community, it's just that we were ramping up so fast, we were out stripping the growth rate. So certainly, long-term, we intend to still be able to have some growth in Brookings as well. I don't know if I answered your question?

Yes, it did, thank you. Two other quick questions. One, what do you think the annual tax rate would be going forward, is there just a little glitch here? And then, if you could, just give us an idea of what your CapEx budget was originally for '07? I think you said about 50 million, and what you think '08 will look like, for CapEx?

Good question, Michael, on the tax rate, should clarify that. For fiscal '08, it will be in the 35 plus percent range. A big factor that is still to be determined is our international business and how that affects it. if we continue with the success in Asia, that will tend to drive down the range. And so how we -- we get through our planning and we see that effects can cause a change in that tax rate. In terms of CapEx, our original budget, going back, if I remember, was somewhere around 43 million and now we're saying 50 or 55, likely to be at the higher end.

That's for '07. What about '08, and what kind of a --?

'08, again, we're going through our planning process, but our expectation is that declines substantially.

Two of the big components for the '07 were the buildout of the Sioux Falls facility. That was an existing building. Just to be clear, we didn't purchase that building, we are leasing that, we have an option to buy, we intend to buy it, that would be within the next couple of years. So, that will -- we intend for that to happen. And then also, the building that we have underway here in Brookings. So we have two significant building projects that -- what was the total, probably, Bill, would you say for those two?

10 to 12, plus we still had some for this other addition.

Yes, we're still completing an addition here in our main building. So we have a lot of building, just, building costs --

And a couple million on land, too. So at least of that 15 -- it's got to be 10 to 15 million was the long-term building real estate buildout.

And we don't see anything of any significance at all in that category for FY '08. And in terms of manufacturing equipment, we also expect that to be significantly less. We don't have that -- the numbers for that yet, and we'll have more visibility on that next quarter as far as what we see coming down the pike. Some of that will depend on how things evolve through the year, too. Again, having the space available allows us to be in a position where we can react to opportunities more -- in a more timely basis and we don't have to guess ahead so far. So, I think we're well-positioned and we'll throttle our CapEx as we see the demand unfolding.

Great. Thank you very much.

[OPERATOR INSTRUCTIONS] We do have a follow-up question from Jim Boyle with C.L. King.

Good morning, again. Two quick things, please. What trend surprised you the most in the last two months? And second, if you don't add one more square foot of land or factory, roughly, what revenue capacity do you have available by fiscal year end '08?

Without adding anymore buildings, what we already have underway, you're saying?

Yes. Knowing you can't control your sales orders, but what's available?

Well, again, the space could allow us to do a lot more than we have capacity for right now in terms of people and machines. So that's kind of a tough question to answer. If we were to make a decision at this point, we would ramp up as fast as we could as the order of demand was there, that -- we could probably, I don't know, maybe be up 40, 50% by the end of the year. But that's all dependent on how things evolve here and we would have to bring on more equipment and people to do that, so.

Understood.

Base is just one part of the overall equation and just allows us to build and react better and faster than we've been able to in the past couple of years.

So roughly, presuming orders, presuming you could add the equipment, presuming you could add the trained personnel, 40 to 50% might imply you're capable of handling 600 to 700 million run rate sales?

Just to emphasize, that's just -- you asked about the space capability, that's what I'm --

Correct.

And that's what I'm talking about, not that we're set to do that.

Understood. I'm asking a hypothetical.

[inaudible] In terms of space, I think that's a conservative answer.

Okay. And what trend most surprised you most recently?

I don't know, again, we've -- we don't look at one quarter, ever, as a trend, so I don't know that we conclude that anything is a trend here. We always -- the future is never real predictable, and so our approach is to be able to position ourself to be able to respond to what the market brings us for opportunities.

Well, let me change that then to a more appropriate question. Which lumpiness surprised you the most, sports or billboards?

Yes, probably the fact that the billboard orders slacked off during the quarter. That was probably the biggest surprise for us.

Along those lines, Jim, your earlier question, I think I've got it right. I don't have it precise, but I can give you somewhat of an indicator. In fiscal year '06, trying to recreate a little bit of the timing here, the big growth in orders started at the tail end of our second quarter last year. We did roughly 8 million on billboard business in Q3 of last year, on sales, not orders. And in Q3 of this year, we are above 15 million.

Okay?

For the last two quarters, fiscal '07, we're somewhere near about 25 to 30 million. I think we had very -- we had some in the second quarter of '06, so you're looking at somewhere at 25 to 30 million for the last two quarter this is year. I just don't have the first quarter numbers, which I apologize --

25 to 30 a quarter a piece or for combined first two quarters?

Combined quarters.

Combined?

Okay, and then, the combined quarters last year, second and third, were probably somewhere near about 8 to 12 million, probably near 8 to 10, more so.

Okay. So high class problem, but still lumpy?

Yes. Now, if I were to attribute that to orders -- and this is the orders aren't going to show that same trend. I think the orders -- I should have gotten those too. They're not going to be as dramatic on the orders, because we start second quarter of '06, is when we start to get the big influx of orders.

Okay. Thank you.

And with no further questions in the queue, I would like to turn the call back over to our speakers for any additional or closing remarks.

Thank you for the questions, and again, thank you for being with us here. I would like just to acknowledge, we had one of our former directors, Bill McDermott, who served as a director for Daktronics, actually back before our IPO days, back in the 80s and early 90s, and he passed away recently and his funeral actually is going on as we speak. So, I just want to pass on our regards to Bill's family, and certainly appreciated his efforts and support back in Daktronics' earlier days.

Again, thank you for being with us. It's a chilly day here in South Dakota, but spring's just around the corner. I think we're about somewhere around 6 to 10 below there this morning, but, nice, bright, sunny morning. Thanks for being with us. Hope we talk to you in the quarter.

That concludes today's teleconference. We thank you for your participation and hope you have a wonderful day.