Daktronics Inc (DAKT) 2010 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Daktronics fourth quarter and fiscal year 2010 earnings results conference call. As a reminder, this conference is being recorded today, Wednesday, June 2, 2010, 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.

Thank you. Good morning, everyone. We appreciate your participation in our fourth quarter year-end conference call. We'll do our usual thing of giving some comments about the quarter and the future and open it up for a limited time for Q&A. I'd like to first offer our disclosure cautioning investors and participants, in addition to statements of historical facts, this call and our year end news release contain forward-looking statements reflecting our expectation and beliefs concerning future events which could materially affect our performance in the future.

We caution you that these and similar statements involve risks and uncertainties including changes in economic and market conditions, management of growth, timing and magnitude of future orders and other risks as noted in our SEC filings which may cause actual results to differ materially. Forward-looking statements are made in the context of information available to us as of the date of this call. We undertake no obligation to update or revise such statements to reflect new circumstances or unanticipated events as they occur. With that, I will turn it over to Jim Morgan, our Chief Executive Officer, for some comments.

Thanks, Bill, and good morning everyone. First of all, it was great to see a pickup in orders for the quarter. Due to the fact that the orders were back-end loaded in the quarter and due to the nature of some of the orders our backlog increased by approximately $27 million over the beginning quarter backlog. Bill will give a little more insight into our backlog in a bit. As noted in the news release, our commercial business is showing signs of recovery although the price, pressure and the marketplace remains keen. We are seeing great interest in our new 4000 Series billboard product which we are just starting to ship. This product, as we discussed previously, offers improved performance and life cycle costs at a reduced price point.

We are also getting some positive indications from the marketplace that deployment rates may start to pick up gradually starting this summer. While we are seeing some Chinese competitor activity in the commercial market, it tends to be more focused on the national accounts business and it has been a bit sporadic. Orders in both our live events and our schools and theaters business units, both of which are heavily dependent on sports venues, were down over the same quarter the previous year but up sequentially over Q3.

Regarding trends, the sports-dependent businesses didn't turn down as fast as the commercial business going into the downturn, and it appears they will lag commercial coming back as well. We attribute this to the long-term nature of many of the projects related to sports. However, we do see opportunities for upgrades and retro fits that can sometimes materialize in a matter of months. We have seen much more aggressive efforts by the Chinese competitors in the live events business. Their approach into the market is to come in with low pricing. We started shipping our new DVX Video product in Q4, though. We're excited about that. That's, as we again discussed that previously, it offers an improved functionality at a reduced price point, and this product has been very well received in the marketplace.

Also, as noted in the release, our transportation market had a great year in both orders and sales. Again, to put that in perspective, that was about 10% of the total revenue in the transportation business. The transportation business unit situation was a bit different than our other businesses going into the downturn as they haven't previously seen the high rate of growth between the FY2005 and FY2008 that we have seen in the other businesses. So our cost structure there was more contained and while FY2009 sales were down slightly over FY2008, fiscal 2010 sales were up more than 15% over fiscal 2009 to achieve a record high.

We are just beginning to ship our new Vanguard product and we'll be phasing that in and that's again, that's our over-the-roadway motorist information product. We will be phasing that in over the next couple of quarters so that should help us remain competitive and maintain margins in the transportation business. One of the new products that we have been working on is for computer-controlled architectural lighting applications. And while we did some custom jobs for this application we have done over the past three or four years, we have been developing standard products for this application over the past few years as we explored the needs of the marketplace. And we are now offering products in both the linear stick form, as we refer to it, and a round pixel form similar to a hockey puck.

We ended the quarter with two orders for products of this application which combined totaled about $7 million. In both cases this was for the stick-type product element, in one case the elements will be arranged in a flat rectangular pattern and operate similar to a typical video display with commercial advertising. And the other application, the other order of the product is being incorporated into the building exterior in a large property development in China. And will be used more for effect as these are high-rise buildings and will be visible for several miles across an open body of water.

So we believe there is significant opportunity in this niche and we're excited about these two projects as references going forward. We did achieve some significant cost reductions this past quarter, again as noted in the release, cost reduction efforts continue with a focus on reducing cost of sales, which is where we see the biggest opportunity for savings. We will continue to tighten up our operations to reduce the warranty and inventory costs that we have been experiencing. With that, I will turn it over to Bill to give a little more color on the numbers.

Thanks, Jim. First, some comments on gross profit. The gross profit margin increased from the third quarter primarily due to the higher sales level and that has to do with plant utilization and that, in and of itself, accounted for more than 4 percentage points in margin. We did, in gross profit, have greater than expected warranty and inventory costs during the quarter. However, as a percent of sales it actually was less than the third quarter. The warranty costs are actually flat compared to the fourth quarter of last year and just up a hair from the third quarter, so it is generally not worse from a dollars perspective but it needs to be better and we expected better results. And as Jim mentioned it is a focus area for us.

During the fourth quarter, our domestic manufacturing costs increased slightly. We have been decreasing those costs rapidly over the last eight quarters or so. But as mentioned in our last third quarter earnings release, our manufacturing schedule was back-end loaded which meant we couldn't entirely capitalize on a smooth schedule, and that was coupled with some new product introductions which increased the efforts expended in production. Overall, I think we're doing a great job in improving our manufacturing cost structure against sales volume.

In terms of backlog, it is important to put some perspective on it. There is very little revenue opportunity in the first quarter of fiscal 2011 for three of our large orders in the backlog, that being the Florida Marlins, the New Jersey Transit Authority, and the Virginia Department of Transportation contract. That makes about $20 million that is not workable this quarter. While it is typical that some of our backlog isn't workable for our current quarter due to project schedules, this is on the high side. With that being said, I think we have a very good chance at higher sequential revenues, and also based on our backlog, our contract gross profit margin has a good chance of increasing sequentially. So I think we showed some signs of improvement on margin and sales, but as Jim mentioned with the competitive environment margin is still a tough thing to predict. Overall on cost reduction, we did a lot of things this quarter including personnel reductions and office consolidations netting us approximately $6 million in annual savings as stated in the release. We have a lot of various focus on over the next two quarters and beyond and as such we're not planning any additional reductions in payroll over the next two quarters. But we'll work diligently on these other items, most of which are reflected in gross profit such as warranty inventory and service costs.

The impact in the fourth quarter of the office consolidations, most of which was included in cost of goods sold was a little over a $0.5 million. Other severance obligations relating to payroll reductions and spread throughout the income statement were more than $300,000. We mentioned some bad debt expense in the release and that amount was approximately $700,000 and we're still pursuing collections, so we're crossing our fingers that we'll see some of that come back. There are a few other added expenses for the quarter in operating expense that aren't expected to be recurring that exceeded $400,000. Based on that, we expect that we'll see a good increase -- a good decrease in operating expenses in the first quarter of fiscal 2011.

We also completed some restructuring activities that will have an impact on our non-operating income and expense. During the quarter, we restructured a couple of our investments in that area, and the losses recognized in the fourth quarter related to these or for the fiscal year -- I am sorry, were approximately $2.5 million and we expect that to go away for fiscal 2011 in its entirety. The effective tax rate turned out a little bit different than expected but with yearly losses in the implications that larger items have on the effective tax rate, it makes sense how it turns out. We also lost the benefit of certain deductions in one year-end loss situation.

The research and development tax credit has gone away for us effective January 1, so we started to see that. Cash remains good with us and we expect it to grow into the next fiscal year with some ups and downs in the amount as we go through due to the nature of our business. With that, we'll turn it over to the operator to open it up for questions.

(Operator Instructions) Our first question is from Jim Ricchiuti with Needham & Company.

Bill, did you -- that $700,000 in bad debt expense, that was in the selling expense line?

I am sorry, Jim, I didn't hear that --

Sorry about that. Hopefully it is a little better. The bad debt expense that you alluded to, that $700,000, was that in selling expense?

Yes.

Okay. Just wanted to make sure. And then you mentioned some additional added expense. I apologize. I missed it. I wasn't sure what the dollar amount was. I wasn't sure if it was $100,000 or $400,000.

$400,000.

$400,000. Okay. So if we look at the office consolidation, the bad debt expense, and then this other expense, it is somewhere around $1.6 million of expense that you don't see recurring in Q1?

Yes.

Okay. And that's helpful. I was surprised at the order activity in transportation and maybe you could just talk a little bit about that. I guess did you have some big orders in that area, but it looks like it was a record quarter, but at the same time you sound a little bit cautious just with respect to funding going forward and the impact on that business?

I think, Jim, there is always some uncertainty about how funding will continue going forward. I guess, generally, we're optimistic about transportation. You just never know for sure, but first of all we feel we're very well-positioned in that marketplace. We have very good track record. It is the business where you have to bid to specifications, and so having your product specifications is accepted ahead of time is key there, and we are well-positioned in that regard with many states.

Again, typically we're selling to states and some cases to cities, city governments, city DOTs, so generally we're very optimistic about that business. It is just it is dependent on ongoing funding which is always a discussion point on the news these days, but on the other hand there is -- we believe the government has incentivized to keep these projects going.

Okay. Jim, I was intrigued to hear your discussion, your commentary around the architectural lighting opportunity. Can you talk a little bit more about that? Is this an opportunity that you see more in Asia or do you see this having some applications here in the domestic market?

Certainly, there is applications in the domestic market. I think this is one of those things that, again from an architectural lighting perspective, has to be picked up by an architect as something they're interested in doing. I would say -- we see that it is more common in Asia at this point, where it is actually incorporated into buildings and into the facade of the buildings, but it's, again the one application actually is in -- that we talk about here is in South Africa. That's really more for an advertising application and that could be used anywhere, so maybe to talk about those as two separate things, where it is just part of the building design, so to speak, architecturally, in that regard we see more of that in Asia.

Now, this -- we're actually incorporating some of this product, for example, in the Orlando Magic project which we're building now. And it is there, again, used more -- it is a special application of where it will be used to convey messages and animations and that thing. The -- using this stick approach, one of the things that's different about this compared to a typical video display is that the sticks are actually spaced apart. The sticks are about an inch and -- a little over an inch wide and they can be spaced anywhere from an inch to more than -- and that's a variable, depending on the installation. They can be put on different spacings and depending on what type of brightness they want out of a display and what the application is.

So one of the things you can do is you can actually see through the display from the rear because there is spaces between the sticks, so that's -- in the case of the Orlando Magic, that's one of the requirements that they want to be able to see through from the back side. So there are applications domestically. It is a very adaptable product. It is very configurable, so it is really up to the limits of the imagination as where and how it can be used.

Okay. And you feel pretty good about other opportunities in this area as you look out over this year?

A lot of these projects -- the project that we had in China, that's one we have been working on for about a year. This project that we -- the one that's going to South Africa, that came up in about a month. So, sometimes we have longer term visibility and sometimes we don't. We do believe there is a lot of opportunities for this. Some are in our pipeline now, and some could happen this year. We probably don't have visibility to yet.

Okay. I will jump back in the queue. Thank you.

Thanks, Jim.

And our next question comes from Sean Brenckman with Craig-Hallum Capital.

Thanks, guys. Sean Brenckman calling in for Steve Dyer. Just again on this OpEx expense, what can we expect directionally going forward? Are there any other one-time items that will be nonrecurring but will happen in the coming quarters here?

Well, typically with one-time charges in most cases, I believe, they are things you don't expect. So I can't think of any items off the top of my head that I would expect for one-time charges. We took big steps to reduce the operating expenses, and I think then cost of goods sold and we're going to continue to work on cost reductions. So it is hard to say, how can you predict necessarily a bad debt expense, right?

Right. Okay. Thanks. And then just on digital billboards, it looks like there is a new cycle brewing there. How will that look for you guys this time around?

Well, how fast it would ramp up is the question. I guess what we see and now is that maybe a slow ramp up for the rest of the calendar year and then a lot of the larger companies tend to do their budgets on a calendar year basis and based on some of the public statements, indications are that in calendar 2011 that there will be a higher rate of deployment. But that's -- again, we don't have anything firm on that. That's just the indication out there.

Okay. What share would you expect if that ramp up does happen in 2011?

I can tell you that previously we had -- we felt we had a 50%-plus share in the market. We certainly would -- it certainly would be our objective to maintain that level of share. Now we didn't have that here through the past year. We were actually less than that due to the way some bidding took place in the marketplace but we expect to have an opportunity to get back to that level, and that certainly is our goal. No guarantees, of course.

Okay. Good. And then about that bidding, do you guys know if Lamar went back out to bid with their business?

Not really, per se, but I think they're always keeping an eye on what's going on in the marketplace.

Okay. And then what are the economics look like this time around with pricing and the competition factor and that thing?

Pricing has come down significantly over the past couple of years and over the past really, even six months and the way we're addressing that, we have redesigned our product, this 4000 Series product. It's a more streamlined product for us to build. It's actually has improved functionality, improved reliability at a lower price point, but the competition is keen, no doubt about that.

Okay. Thanks. That's all for me, guys.

(Operator Instructions) Our next question is from Dick Ryan from Dougherty.

Good morning. So, Jim, is it too early to get a sense of the upcoming football season, what that looks like from an upgrade in retrofit standpoint?

We just -- we did just book at the end of Q4. We booked an order for an upgrade of one of the NFL stadiums that was -- it came in right at the end of the year. We have already upgraded the Redskins. That's been done, so there's a few that have happened already. I guess in terms of what's going to book here, we'll know within the next, really the next two months for sure. We'll know because if we're going to hit the season, it has to be -- the orders have to be booked by the end of July if not sooner than that.

How does that pipeline look versus maybe where it was a year ago?

I would say a year ago it was stronger. We're seeing maybe not as many -- that the dollar value of projects tends to be a little bit less on the retrofits. Part of that is just price points for the product itself has gone down. The buyers are getting a good deal these days, they're getting -- and again, that's not a new thing. The price point for LED displays has been coming down since LED displays were introduced in late 1990s, but I would say this past year they have reduced at a faster rate. So, that's one of the things that we have to overcome in terms of maintaining or growing revenue is the price reduction of the product.

But generally, there certainly are products or opportunities in the pipeline and just, there is always a little bit uncertainty of -- there could be some of these projects could get put off. You never know for sure until they pull the trigger, and that's one thing that happened in the baseball season. Some of the projects just didn't happen. But we're seeing -- it seems like there is a general sense that the economy is coming back and we're seeing a little more confidence in terms of people moving forward.

So a couple earlier references on the commercial side and live events where you said Chinese are coming in with some price pressure. I mean, are they just lowering the points or are they actually winning the jobs? I mean, does it just get down to, I mean, where you at the point where we're just getting down to its pure price or is it beyond that for a decision making?

If it comes in with a low enough price they will get consideration, and typically they're coming in with, again in live events business, with sports venues -- they're coming in with some domestic partner who acts as an integrator then, and so that's the approach. And so price becomes a factor and typically, we'll have to react to that to some degree to be successful to win a project, so it is both things. It can affect the price at which we win the project and in some cases they have won some projects doing that.

Okay. With -- Bill, with the recent product introductions, do you see ability to bring down product development at all in the fiscal 2011 timeframe?

I think I will defer to Jim to talk a little bit on that if you don't mind.

That's fine.

So, one of the things that's just key to our future here is continue to develop products and bring new products to market. And as we've mentioned here, taking costs out of our products and streamlining how the products are manufactured is key. So we have reduced our engineering cost overall somewhat here in the last couple quarters, but we are not planning to take a big chunk out of our product development investment at this point. We believe that's critical to our future. So, I would say maybe slightly down but not very much.

Great. Thanks, guys.

And at this time, we'll take a follow-up question from Jim Ricchiuti with Needham & Company.

It's normally the next one quarter to two quarters are bigger quarters for the school theater business. Can you talk a little bit about the outlook there?

I am sorry, Jim, can you repeat the question?

Sure.

Jim, the schools and theaters business is looking a little rough at this point. The outlook for first quarter and second quarter is what Jim was asking.

Right. We're seeing that, that's -- there is a little bit of a pullback it seems in that area, just basic -- the general funding for schools and again, a lot of the displays that are purchased typically don't come out of school budgets. But just the general tightening of the budgets and the maybe pullback to some degree on new construction, I think, can affect that as well, so we are seeing, I would say that we see the near term that, that's down a little bit.

Okay. As we begin to see your revenues improve, hopefully, as we go through the year, can you give us some maybe a range of where we might see our gross margins? I know mix clearly plays a role in this, but if we see your revenues begin to approach $100 million, $105 million, can we see your gross margins get back into the mid- to upper 20%?

Yes, Jim, so at this quarter we're 22% roughly, and when you factor in maybe -- so I think the biggest jump we're going to get is result from warranty costs and better plant utilization and inventory costs, and we're focused on those areas in a big way. So I think as they get north of $100 million to $105 million, if things competitive-wise would stay status quo, yes, we should be above the mid-25% margin.

And --

And, again, on that, we've -- that's controlling warranty and inventory --

Right. And are you seeing headwinds at all from on the LED pricing side, whether just -- we keep seeing reports of tight supplies. Is that impacting your cost at all?

No. Actually I think there are some additional suppliers coming online. I think generally there is availability, and I think there is also competition in that area, so at this point, we don't see -- we see that the LED price costs to us will continue to decline. That's our expectation.

Okay. And, Jim, you talked a little bit about national accounts business. Maybe you can just elaborate on what you're seeing in that market, It's also a market, I guess where you're seeing a little bit more competition from the Asian suppliers, but maybe you could talk a little bit about how you see the next couple of quarters and just, in general, if you're seeing some of the customer base beginning to pick up spending?

What we've seen is we've gotten positioned with a number of companies who are considering rolling out some corporate programs, but we're seeing that they haven't pulled the trigger -- a number of these haven't pulled the trigger yet. Some of our customers that we have been working with for a number of years are continuing but maybe at a slightly slower pace, so I would say at this point it is just hanging steady. But there is, I believe, there is great opportunity there if some of these companies would decide to move forward.

If you look at --

I was going to say it is the quick service restaurants or fast food areas is one area that's we're seeing a lot of potential interest in particular. Also, convenience stores is a growing opportunity.

Are you more optimistic over the near term and call the near term the next two quarters, three quarters? Are you more optimistic about the recovery -- potential recovery in the national accounts business or in the billboard business? Which do you see coming on a little faster? I think you're assuming then the billboard business, maybe calendar 2011 but I am trying to get a sense as you look at those two pieces of your commercial business, which you might see some recovery sooner?

So, we're actually seeing some uptick in the billboard already quite frankly, so we're expecting ramp up -- a gradual ramp up in billboard here the rest of this calendar year. So right now I would say we have better visibility in the billboard ramp up than we do in national account ramp up but certainly there is opportunity in the national account side if that would break loose.

Would you guys be willing to say what you think -- I don't know what the billboard business was this quarter, but can you give us a sense as to how you might see that ramping up this year?

I think right now it is a situation that's unfolding on a week-by-week basis as we get more information. I don't know if I have a number in mind.

Our orders under billboard for the quarter were up the highest level of what I am looking at going back through to a year ago, so it is the highest the last five quarters. In terms of how it ramps up, there are a lot of variables. There is optimism out there, but when companies will place orders and if they place them with us, it is hard to say, so there is optimism. We expect it to ramp up. It potentially, I think if we throw out something, if we are successful in quarter two, for example, our order volume may double from what it was last quarter. That would be -- that to us, I think would be a successful deal, and so maybe you're talking an incremental $3 million to $6 million of revenues -- of orders over what we're experiencing now. Somewhere in there. It is really hard to predict what that will be.

And the pickup you're seeing, are these from your traditional existing larger customers or is this also -- is this coming from the Tier 2, Tier 3 billboard companies?

We have seen increased activity from the Tier 3 companies. We're seeing some pickup from the larger customers that we've had in the past. Some that's taken place already, again starting just starting to take place, and then we believe there is more ahead there to still unfold. So it's just starting to get going again is how we see it.

Okay. Thanks very much.

Thanks, Jim.

It appears --

Go ahead, operator.

I am sorry. There are no further questions at this time. I'll turn the conference back over to Mr. Morgan for any additional or closing remarks.

Okay. Thanks for all the questions, gentlemen. Again, I just, in closing, I want to thank all of the Daktronics employees for their efforts over this past year. It has been a challenging year, and a lot of hard work. And we appreciate the commitment and the effort of all of the employees at Daktronics. Again, thanks for being with us today.

That concludes today's conference. We thank you for your participation.