Daktronics Inc (DAKT) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Daktronics fiscal-year 2012 second quarter earnings results conference call. As a reminder, this conference is being recorded today, Tuesday, November 22, 2011, and is available on the Company's website at www.Daktronics.com. Later, we will conduct a question-and-answer session, and instructions will be given at that time. (Operator Instructions).

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, and good morning. We appreciate your participation in our second quarter conference call. I would first like to offer our disclosure cautioning investors and participants.

In addition to statements of historical facts, this call and our news release contain forward-looking statements reflecting our expectations and beliefs on future events, which could materially affect our performance in the future. We caution you that these and similar statements involve risks and uncertainties, including changes in the economic and market conditions, management of growth, timing and magnitude of future orders, and other risks as mentioned during this call, and in our press release and our SEC filings. 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 will turn it over to Jim Morgan, our Chief Executive Officer, for some comments, after which we will open it up for questions.

Thanks, Bill. Good morning, everyone, and thanks for joining us this morning. We were generally pleased with our execution this past quarter. We ended the quarter with a healthy backlog, which positioned us for a strong quarter. We did have the challenge that the product mix in our backlog had taken a rather strong shift towards surface mount technology LEDs as opposed to through-hole technology. So we had some execution challenges adjusting our capacity to meet demand. And thanks to the hard work of, and the close collaboration of, a lot of our people, we were able to meet the many tight deadlines this entailed. I was disappointed to have the cost [dips] that we described in the press release, which in total reduced our operating margin by more than 2 percentage points. As noted, we do expect most of these to be one-time costs.

I would like to shed a little more light on a new market and product family opportunity that we are becoming increasingly excited about. We have mentioned this in the past. That is what we refer to as architectural lighting, also sometimes referred to as LED mesh product. A key characteristic that differentiates this product from our traditional video display is that this product has a degree of transparency. In other words, you can see through it, somewhat analogous to window blinds. This in turn results in some unique advantages in terms of weight, wind loading, and power consumption, which makes it the preferred, if not the only solution, in a wide variety of applications. We are excited to have just completed an installation at the WinStar World Casino located in Oklahoma. That is our first where we have married our LED technology with the unique mechanical mesh technology provided by a new business partner out of Europe.

This mesh design is very robust, and has been proven in applications without electronics for many years. We have a nice pipeline of opportunities utilizing this unique mesh design in combination with our LED technology. We do enter third quarter with a relatively strong backlog, considering that third quarter is typically our weakest quarter, so we are pleased about that. How we end up for the fiscal year will, for the most part, depend on how orders book in the third quarter.

A few comments about areas where we are investing in. We continue to invest in product development to deliver improved products at reduced price points, as well as bring new products to market such as the LED mesh product I mentioned earlier. Our increased product development investments are a reflection of aggressive development schedules, along with more thorough prototyping and design testing, which adds to the initial development costs but provides a more robust and more cost-effective design over the life of the product. Our focus for the next couple of quarters in the display development area continues to be in the tighter pixel pitches for outdoor video displays and the next generation of our high-resolution video products for indoor.

We are extending our platform strategy to these products like we did with our larger pixel pitch outdoor products over the past couple years. This strategy increases the commonality of parts of the product that share a platform, which in turn reduces inventory handling as well as set-up costs and manufacturing. At the same time, the new designs take costs out of the bill of materials.

We also continue to invest in our control systems, and in fact, approximately half of our product development investment is in the control system side of things. We have two platforms there, our Show Control platform for Live Events applications such as sporting events, and our Visiconn for scheduled program and applications which is typically advertising. We continue to see opportunities for IPTV, that's Internet Protocol Television, in stadiums with the strength of our integrated control systems controlling and synchronizing displays throughout the stadium. We have now completed several major IPTV installations. Last quarter, we received an order for a major IPTV system for the Florida Marlins' new stadium, which will debut for baseball in the Spring. All of these product developments will position us to be more competitive, and enable us to improve our gross profit margins.

We also continue to invest in expanding our International business, which takes investment both in terms of selling expense and administrative expense. This is a very lumpy business, as it is almost all large project work. Orders were down a bit for the quarter, but that was mostly due to project decision dates sliding out. Overall, we are very pleased with how our International business is performing, although price pressure is always an issue these days.

On the cost side, in general, we have opportunities for efficiency gains on all expense line items on the income statement, from the cost of goods sold through SG&A. Some of these improvements will take some time to develop. We continue to be cost conscious in all areas of the business, and continue our efforts at streamlining our processes and our procedures to eliminate costs, which typically means time, out of our processes here at the Company. So in short, we continue to focus on generating more revenue while curtailing costs to ultimately get more to the operating income line. We have the opportunity for leverage as we grow the top line.

With that, I will turn it over to Bill for a little more insight into the numbers, and then we'll take your questions.

Thanks, Jim. As Jim mentioned, our sales were strong for the quarter, and exceeded the consensus estimate of $129 million. The higher level of order bookings in our Live Events business and the ability to add projects into our manufacturing schedule was the largest contributor to that upside. From a guidance perspective on net sales for the third quarter, we have a lot of positive things going for us, but we are constrained by the holidays and the capacity complications of the higher levels of SMT product, as Jim mentioned. In spite of that, we expect net sales to exceed yesterday's consensus of $109 million.

The gross margin results for the quarter were laid out in the press release, and essentially involved various items that caused a 200 basis point decline in gross profit that we consider to be non-recurring. The increased cost estimates on the international project involved approximately $400,000 to conform certain equipment to local government regulations similar to UL-type requirements. That's certainly a one-time cost, and we believe we excel on cost estimate execution overall.

And the warranty claims, those were primarily adjustments to prior reserves for an increase in the cost estimate to cover pre-existing obligations, as opposed to any new claims that amounted to more than $2 million. We may still have some risks on some of those old items which are dependent on how product performs in the field that's still covered under warranty. So, we'll need to watch that as we go forward. The good news here is the products we are shipping today are performing much better, and we are making long-term progress.

On the new product introductions, we had charges of approximately $400,000 to address new product in the field that had some design issues, and was one of the first runs of the product, which is not an unusual thing. In summary, we believe that we'll incur significantly reduced issues of this nature in the third quarter. There were a few other less significant items that added to the total reduction.

Moving forward, we saw a slight decline in estimated gross profit on large contract orders booked during the second quarter, although that's more a reflection of the volatility of our large contract business rather than a change in market conditions. When you combine the foregoing reduction of the one-time costs with these order bookings and the lower level of sales in the third quarter, we think we can get back on track with gross profit improvement, but keep in mind the inherent volatility we have with large projects.

On the operating expense side of things, we're increasing our sales infrastructure in International and Commercial business units where orders are improving. We're also physically expanding in a number of countries as noted in the release, including Singapore, Spain, and Brazil. This expansion, especially in complicated trade areas like Brazil, carries with it added costs in G&A and selling expense, but we have opportunities in these markets that we want to exploit that can help overall revenue and bring more into operating margins.

Focusing a little bit more on the G&A costs, we've ramped that up more than we would like to. Much of the increase over the first quarter of this year was in our IT infrastructure, and a big part of the increase has been costs associated with improving our service systems and other developments. We're working towards a sequential reduction in G&A, but with the IP systems work, international expansion, and things like that, it could be a challenge in the short term.

In terms of cash flow, we continue to manage the non-income-statement drivers of free cash flow, which have driven our cash and marketable securities to higher levels again this quarter to more than $90 million. Our response to uses of the cash remain unchanged. We continue to study options to return excess cash to stockholders. Historically, dividends have been our method of choice. We also continue to look at acquisition opportunities that come forward, although for the most part they tend to be smaller transactions.

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

(Operator Instructions)

Stephen Altebrando, Sidoti and Company.

Hi guys, how are you?

Hi, Steve.

So the shift toward SMT from a legacy product, can you talk a little bit about what the margin implications are for that moving forward?

I guess generally our outlook for margins, as I mentioned, the product that we're in the process of redesigning and bringing out a new platform, so we will have an improved product there with an overall lower cost of manufacturing. So our goal is to see the margin come up in that. That's certainly the intent. The other side of that, of course, the price pressure in the industry is still pretty keen, and so that's the offset to that. We will take cost out of the product. We will have an improved product, that we are confident of. The other side of the equation is a little harder to predict.

Okay. As this shift occurs is there a material investment required on the manufacturing side?

There is. The equipment that places surface mount is a different -- it is different equipment that replaces through-whole LEDs, and we have some of that -- we have some of that planned in our CapEx because we anticipate that, that demand will continue to increase. And to give you an idea of surface mount line, it's the upper $1 million-ish type of thing, $1 million plus.

Okay so not that -- your CapEx has actually been trending pretty significantly low. Do you expect that to -- versus prior years to continue for some time?

Generally, we're expecting to have CapEx contained, I think we had said $60 million for the year. We're still thinking that, that's a good number.

Okay, last one and then I'll hop back into queue. The Live Events orders was a pretty positive surprise. Are you comping -- the orders, are they comping off of the sports -- the baseball orders you booked from last year? Or is that third quarter of last year that they comp? And if you could give a little color on what you're seeing for this year's baseball season?

Sure. Baseball last year was $20 million to $25 million -- last fiscal year was $20 million to $25 million. I think it was right in the middle there for Major League Baseball. We do a lot of minor league baseball, but this is just on a professional level. Remember last year was coming off a year of very little business, and so it doubled up a little bit. This year, our best guess is it's somewhere south of $10 million. There's one large project out there that I think looks like it will come our way, but aside from that there's not a lot a big baseball projects out there. Did that answer it, Steve, or was there more to it?

That pretty much did, but with the orders of last year, were they booked probably in your third quarter? Is that correct?

They would have been booked primarily in the third quarter, yes. I believe so. I should check that, Steve, but I believe so.

Okay, thanks, guys.

Thank you.

Jim Ricchiuti, Needham and Company.

Hi, thanks. Bill, could you show on that warranty expense for the year, the pre-existing warranty claims, was that $2 million hit to cost of goods?

Yes.

Okay. So, that goes away. I guess what I'm trying to get to is, if we assume you have the revenues close to the Q1 levels, can you get back to a Q1 type gross margin in the quarter, or is that -- are there some mix issues that might make that a little difficult?

Well, that's what's in our sights. There's a lot moving -- there's a lot going on with the holidays and capacity and whatnot, but that's -- clearly if I recall, Q1 was in the 25% -- just south of 25%, and so that's -- we're definitely shooting for that, but there is volatility in gross profit.

Okay. And I just wanted to, Jim, pursue a little bit more the comments that you made about the LED mesh product. Is this -- can you give us some sense, does this fall into both the Live Events and Commercial revenue segments? And what's a typical installation in terms of project size for you? And if you could also comment just in the margins on a piece of business like this?

So the demand for this, it is a new product family for us so I think the market is still developing. The project that I mentioned this in our Commercial market. The International is also an area where we see good demand opportunity for this, and that in fact, International has really led the way on this historically for us. On the other hand, we have this type of product installed on the arena in Orlando, we did that a few years ago, that's a new arena down there. So, it's got application everywhere, probably more so International and Commercial, but there'll be some in Live Events.

In terms of margin, I think to the extent we have uniqueness with this new product configuration. I think that will give us maybe some pricing flexibility that we would enjoy there, so we're hopeful for that. Again, it's very new, and this project that we just installed we did a lot of process development along with that. So our costs haven't really come to a stable state on this yet. It's very much a new developmental project, but it went through very well once we got the processes set up. And the installation went extremely well, and I've seen photos of it. It looks great actually. So we're excited about it. Certainly, I'd like to think that we could see some improved profit gross margins with that.

And would these be, in terms of project size, similar to some of the larger Live Events not necessarily not the big projects that you do for arenas. I'm just trying to get some feel for what the revenue potential might be from some of these?

So certainly the $1 million projects would be common with this product. Certainly we could do smaller applications for less, and it could be multi-million dollar projects. So I'd say anywhere from sub-million to multi-million is anywhere in there depending how big and how much area they're trying to cover with the board.

And I'm not completely clear on your ability to really differentiate yourself in the market. How competitive is this market, Jim? Is this something where you're seeing -- beginning to see more players in the market? Or do you feel you have some lead here in terms of the partner you are working with?

There's a lot of different approaches to doing a mesh type product and for different applications. I'd say it's too early in the development of the market for us to really understand where it is all going to land in the end. But certainly we see a different mix of competitors in this. And there's some mesh product coming out of China. I think the challenge there is how is that going to be supported. So we feel we have some very strong advantages that we offer with the product and with our support. It's relatively new, so there's not a lot of history to rely on here, but we're very optimistic about it.

Okay, last question for me. Bill, could you provide the revenues in the quarter for billboards and if you have the bookings numbers as well?

Yes, I can. The billboard orders were somewhere in the $12 million range and sales were in the $15 million plus range.

Okay. Normally you'd see some seasonality in this quarter in terms of deployments, shipments on the billboards and then picking up in Q4?

On the order front, there's volatility on orders. Last quarter we had a big quarter for bookings. Those are volatile based on timing, primarily of the big players in the marketplace.

Bill, if I could add to that, our billboard factory is very well booked right now. We do not have a slowdown in terms of shipments this quarter. We're busy in that area.

Great, thank you.

Morris Ajzenman, Griffin Securities.

On the architectural lighting again, you said in the presentation, pipeline of opportunities. Obviously, you're talking excited about this, but what can you tell us about with this pipeline looks like? Is there anything you can give us, some sort of granularity? Just anything that's near-term, or your pipeline simply looking out several years down the road?

I don't have the details with me here, but I'd say this pipeline is opportunities that would be within the next 12 months and anywhere from near-term to further out in that timeframe, and a wide variety of applications. The application, just to maybe get a little more insight into how this can be used -- the application down at the casino is actually in the outside of a parking garage, and it's a way to make the exterior of the parking garage, to give it a little more utility and make it a little more attractive basically and give it functionality. Basically, they can put messages out there at the same time it's -- air can move through it so it doesn't block the airflow through the parking ramp. So, that's just an example and there's just almost limitless types of applications like that. So again, it's a new product we're just getting out there, but there's a wide range of applications and there's near-term and further out pipeline opportunities.

Is there any backlog associated with this at this point?

I don't know exactly what we have, but we don't have a large backlog at the moment. We have a little in backlog, but--.

Last question, just shifting gears back to the one-time that you discussed for the second fiscal quarter, any of this impacting the third fiscal quarter or is this one-time all done as we look at the third fiscal quarter?

It's done. The one thing we continue to worry about is you set up estimates based on how you think products will perform in the field. And for example, one of the issues that we're dealing with is something that was larger a couple of years ago that is still hanging out there is we had a paint issue on some products out in the field. And as we went through this, the fall season when all these outdoor scoreboards business geared up, we found that the problem was bigger than we had estimated it to be. And so, that's coming to the end of its life, that's products that went out, I believe in 2008, and the warranties expire and the product has been out there. So we try to do the best we can on estimating those types of things and believe, as we sit here now, that we've got a good estimate for it, but things can change.

Thank you.

Neil Chatterji, Craig Hallum.

Hi, guys, filling in for Steve Dyer. I think you actually answered my question partly. Just in regards to the SMT shifts in the CapEx spend, I think you mentioned that $16 million is still the target for this year. What about next fiscal year? Are you anticipating more based on this quarter?

No, I think we're fairly committed that, absent something unusual, that we stick with this 4% of sales as a cap and we believe that we can do that. In normal circumstances the thing that would be abnormal I think is if we'd have to build out facilities and there's just no need for us to be thinking or talking facilities at this point.

Okay, all right. Great, thanks.

Dick Ryan, Dougherty.

Thanks. Bill, you mentioned in your commentary on sales and marketing expense that you moved that up for opportunities International and Commercial. I think you hadn't hit the International side. But, what are you seeing on the Commercial side? Is this particular reference to what you're seeing in billboards or is this the other side of Commercial, are we seeing a pickup there?

Good question. In the non-billboard part of Commercial, yes, we're seeing some improvements in that area. And maybe I'll let Jim talk on our GalaxyPro product and some of that stuff in addition to architectural lighting.

GalaxyPro product basically is -- and our Galaxy display is our -- it ranges from the smaller displays that you might see in front of retail on-premise advertising applications. And then the GalaxyPro, we've taken that size up to a point where it can operate from our less-expensive control system, and have a price point that's basically lower but still provides very great functionality, and that's been very well received. So we have some good traction there.

The other thing I might mention, we've had some nice projects in Times Square recently. We just installed one of our 10 millimeter outdoor displays. We talked about surface mount outdoor, this is an example of that interesting product that, that resolution. And we just installed that here just within the last month and that looks great. We've got some other projects. We just installed a number to Times Square there, one for Hyundai. That just got completed here a couple months ago. So that's been some of the interest we've seen lately. Some nice pickup in what we put in Commercial in our contract, we call our contracts business. Also we've had -- we just installed some billboards in Las Vegas, That's a first for us, so that's exciting. There's some more going into Las Vegas. Those are some of the new developments and positive developments I would say on the Commercial side.

Okay. Back on the mesh question, Jim, there you've got the one you've installed at Target headquarters in Minneapolis here. That isn't mesh here, is it?

That is -- it's another -- it's a variation on mesh. And that's actually what we call our ProStick product. So in that case it's actually constructed out of vertical members or members that are oriented vertically, whereas in the case of the one down in Oklahoma we just installed, that's got horizontal members on it. But it's the same basic idea in that you have a strip of LEDs and then you have a space between that strip and the next strip. So, it's arranged differently, but it's the same basic concept.

So will the mesh replace the stick version or can you do either one?

Yes, we can do different solutions for different applications.

Okay.

We'll have a family -- we envision having a family of mesh products because there are so many different possibilities of applications here that it will just require different applications.

Sure. What are you seeing on pricing across the landscape? Still pressure there from competitors, is it lifting at all?

The pricing scene, it's still very keen. Once in a while we see our competitors doing things we consider a little bit crazy, but, that's -- it's keen. And we realize we have to continue to offer an improved product at a reduced cost and that's the direction we're headed. And we want to, again, offer a product that is the top end of the quality spectrum in the industry as well, and we think some of the competitors that maybe aren't doing that, it may be starting to catch up with them.

Okay, one last one for me. On digital billboards, Jim, are you -- when could you see a refresh cycle start there with some of the new products you're bringing out? Is that a fiscal '13 occurrence or is it later than that?

Yes, I think in '13 and '14 here, we'll start seeing some replacements cycles starting because we've had products that are out there seven plus years anyway.

Sure.

And that will start and then that'll be an ongoing thing, and certainly the new product will offer some real advantages in terms of power, efficiency, and reliability, and overall operating costs. It will offer some benefits for the billboard companies as well. So we think that will be interesting to them.

Good. Okay, that's it for me, thanks.

And at this time, I would like to turn it over to our speakers for any closing remarks.

Thanks, everyone, for joining us this morning. Appreciate your time and wish everyone a happy Thanksgiving.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect. Everyone have a great day.