Daktronics Inc (DAKT) 2016 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Daktronics fourth-quarter 2016 financial results.

(Operator Instructions)

As a reminder, this call may be recorded. I would now like to introduce your host for today's conference, Miss Sheila Anderson, CFO. Please go ahead, ma'am.

Thank you, operator. Good morning, everyone. Thank you for participating in our fourth-quarter and year-end earnings conference call.

I would like to review our disclosure, cautioning investors and participants that, in addition to statements of historical fact, we will be discussing forward-looking statements reflecting our expectations and plans about our future financial performance and future business opportunities. All forward-looking statements involve risks and uncertainties which may be out of our control and may cause actual results to differ materially. Such risks included changes in economic conditions, changes in the competitive and market landscape, management of growth, timing and magnitude of future contracts, fluctuations of margins, the introduction of new products and technology, and other important factors as noted and detailed in our 10-K and 10-Q SEC filings.

FY16 is a 52-week year and FY15 was a 53-week year. The extra week of FY15 fell within the first quarter. At this time, I would like to introduce Reece Kurtenbach, our Chairman, President and CEO, for a few comments.

Thanks, Sheila. Good morning, everyone. FY16 has proven to be a challenging year financially for Daktronics. Global macroeconomics factors, including low oil prices, growing US dollar, flowing GDP, political instability and other uncertainties affected order volume. Orders specifically slowed for the year in the commercial segments of billboard and spectacular and also in our international business.

In our billboard segment, orders declined due to the decreased demand from our large national billboard customers, although we continue to maintain good relationships with these customers, and estimate our market share will remain strong. Spectacular marketing commercial is generally comprised of large projects. Those with prices ranging from $0.5 million to a few million dollars. From time to time, mega projects could exceed $10 million in this area.

Many of the large projects we expected would converted to orders in FY16 were delayed and caused a decline in orders year-over-year. However, this variability is not uncommon occurrence in what we describe as a large project business. In addition to economic conditions affecting orders, we continue to see aggressive pricing in many foreign markets from competitors, especially those from Asia.

Industry mergers and consolidations occurred and we continued to learn how the new joint forces will compete. These combination of factors most affected orders through the international business. During the last 15 months, we discovered and allocated resources to a display performance issue.

The issue consumed and continues to consume resources that would otherwise have been focused on value-added activities, such as developing new product releases and providing services to our customers. We have qualified our new designs to higher levels of long-term reliability (inaudible). However, the change in priorities delayed certain product releases and caused us to delay production on some orders, decreasing sales for the quarter.

We incurred or reserved approximately $9 million to correct the issue, and we expect the remaining reserve will see us through the foreseeable future. However, this is an estimation based on the best information and analysis that we have today and will be monitored closely. Both the decline in order or sales volume and this warrantee issue reduced our gross profits for the year.

Order bookings were down for the fourth quarter, with the biggest decrease in our international and live events business units. Both units had unique multi-million dollar project quarters last year during the same period and, as stated above, order bookings in our large project account base businesses are inherently volatile. This creates unevenness in order flow, creating difficulty to make meaningful comparisons over short-term periods.

Orders rose for the year in the high school park and recreation market, due to demand for large display systems, and in transportation, partially due to increased funding availability because of the Federal Highway Funding Bill Act. While this past year was not stellar, Daktronics continues to be the world leader in the marketplace and we strive to maintain this leadership through ongoing investments in our future performance in products, in services, in processes and in systems.

Even with our challenges, we had a number of significant accomplishments. One of these was the development of a family of outdoor products that provides more competitive pricing along with performance levels targeted for specific applications. One such application is for out-of-home advertisers that have short-term operating deferments of three to five years, which drive similar expectations of product lifetime. We also released new outdoor designs which will improve lifetime reliability and visual quality as we continue to lower the overall cost.

We completed an exciting acquisition with Adflow in March. Adflow is an industry leader in delivering digital signage, interactive kiosks, and marketing solutions for some of the most recognized retailers and brands in North America. Their interior and interactive offerings complement our current commercial business unit on premise solution and they bring to us an impressive list of existing customers. The acquisition of Adflow provides Daktronics an opportunity to grow and strengthen our solution offering in digital media networks.

AIM [seral] Daktronics also contributed to continuous improvements and built various capabilities throughout the organization this past year to reduce waste and improve profitability. For more detail on the financial results, I will turn it back to Sheila.

Thank you, Reece. Sales for the year declined approximately 7.4% from $616 million to $570 million. Approximately 2% of this decline is due to the decrease of one week in FY16 and the remaining decline was primarily due to decreases in sales and live events, commercial and international business units.

Live events declined due to the timing of orders converting to sales based on customer delivery expectation and needs and due to the slight order decline in the year. Backlog for live events increased $14 million going into the new year and we expect to realized those into sales for FY17.

The commercial billboard niche sales decline was driven by decreased demand from our customers during the year for the factors Reece noted. Spectacular was down slightly due to order timing. Out on-premise business had a successful year for sales and experienced increases with national [law] account activity.

International orders declined nearly $44 million for the year, and in turn, impacted sales. Overall, global market conditions, strong US dollar, competition, and the timing of large project orders caused the decline.

Sales for the fourth quarter of FY16 declined 12.4% to $138 million as compared to $158 million last year. Sales declined in the international, commercial billboard and spectacular niches, and live events business unit. The decline is due to the factors already noted due to timing of orders, production scheduled to align with customers needs by date, and lower order volumes.

Gross profit for the year declined to 21.2% as compared to 23.5% in FY15. The decline is attributable to the impact of warrantee expenses, which impacted gross profit by 1.6%. Gross margin levels were unfavorably impacted by volume levels, changes in the mix of business and increased competitive bids.

For the fourth-quarter, gross profit was 20.2% compared to 22.3% last year. The warranty charge in the quarter affected gross margins negatively by 2.2%. Total warranty as a percent of sales was 3% for the quarter and 4.1% for FY16 as compared to the FY15 rates of 1.6% for the fourth quarter and 2.2% for the year. The increase in rates is primarily due to the warranty issue noted.

We have accrued our best estimate of the most probable ultimate cause for this issue based on the estimated failure rates, prevention measure, the performance of the signs and site ages. Our balance sheet includes reserves for approximately $5 million to cover costs for future warranty activity. We will continue to monitor and adjust this reserve as necessary.

Commercial market was primarily impacted by this warranty charge. In addition, commercial gross profit was impacted by the decrease in sales volumes in the billboard niche. For the year, gross profit improved in transportation by 1.4%, primarily due to increased volume. Live events gross margin remained relatively flat and was impacted by decreased volumes through the mostly fixed class infrastructure and offset by improved sales mix, with less subcontracted installation activity this year as compared to last.

High school park and recreation business unit gross profit decreased approximately 0.5% as compared to last year, after removing the impact of the FY15 nonrecurring theater rating division sale. This late decline is attributable to the sales in exchange. And international gross profits were impacted because of lower volumes and the impact of competitive bidding.

Operating expenses increased 4.6% to $118 million for the year or approximately 6.6% when adjusting for the extra week of FY15. Product design and development increased approximately $2.3 million for work performed on new or enhanced video display model and in control systems. General and administrative expenses increased by $2.1 million, primarily due to increases in information technology maintenance, personnel related costs and in professional fees.

During the quarter, we consolidated Adflow for a portion of the quarter, which included sales of less than $1 million with a slight loss of approximately $0.2 million. Our overall affective tax rate was 34% for the year due to our lower income and the continued research and development credit offset by a $0.9 million international deferred tax asset valuation. We forecast the forward-looking effective annual tax rate to be approximately 34% with the research and development restatement.

Our tax rate can fluctuate depending on changes in tax legislation and geographic mix of taxable income. We reported negative free cash flow of $3.6 million for FY16 compared to a positive free cash flow of $35.4 million for the same period in FY15. The cash usage was primarily due to lower cash provided for operating activities due to the lower net income level, timing increases in working capital due to projects, cash receipts and payments for inventory, and we incurred $17 million capital expenses for the year.

Looking into FY17, we began the year with $181 million of backlog, which is down approximately 4.9% or $9 million as compared to the beginning of FY16. Because not all backlog is expected to convert to sales in the first quarter due to customer delivery expectations, primarily in live events and transportation units, as well as uncertainty to order timing, we believe Q1 sales volumes will be similar to slightly down from FY16's first quarter.

Gross profit predictions also remain dynamic pending the conversion of sales, but we expect gross profits to be similar to last fiscal year's first quarter. We anticipate operating expenses in dollars to be slightly up as compared to the first quarter of FY16 due to general increases in personnel costs, information technology expenditures, and increased design and development activity.

For the year, we are expecting modest sales growth. We expect live events, high school park and recreation to continue to grow slightly. We believe transportation has room to grow nicely with the demand picture in stability and funding. While it is more difficult to predict the commercial spectacular segments, there many opportunities in our pipeline that position us for an increase year-over-year.

For commercial billboard niches, we expect similar volume. In our commercial on-premise activity, we will be actively promoting our outdoor network solution and new product lines. Internationally, we see opportunities to grow, but find it difficult to know how the year will shape up due to macro economic factors Reece mentioned.

Because of the uncertainty, as Reece will further discuss, we will work to constrain cost growth in fixed cost and manufacturing, selling, services, and general and administrative areas in the coming year as to manage our expenses through expected sales volumes. We also planned allocate additional resources for our design and development areas to complete developments and enhance our designs in our display and control systems. Our cash and marketable securities positions remain positive at $53 million at the end of the quarter.

We expect our capital usage to be approximately $19 million for FY17. Uses of capital expenses is for manufacturing equipment, or newer enhanced product production, expanded capacity, demonstration equipment for new products, and continued information infrastructure investments.

With that, I will turn it back to Reece for additional comments on our outlook.

Thanks, Sheila. As Sheila mentioned, we plan to accelerate activities in our design groups to complete development for a number of solution areas. A few examples would be the continued improvement of our control platforms to allow customers a better experience as they operate our best-in-class systems as well as lower our overall cost of maintenance and upgrades.

We also continue to focus development efforts on the video hardware capabilities for higher and higher resolution displays. Finally, we're focusing efforts on achieving lower cost target systems for certain applications to meet varied expectations around the globe. While this will increase development expenses, we believe this will drive our ability to capture continued global market share and meet requests of our customers.

While we continue to see digital as a growing global segment, our outlook for orders and sales in the coming year is for modest growth. We have maintained our US market share over the years and our customers remain pleased with our solutions. Our pipeline of boarding activity is strong in the live events, commercial spectacular, transportation and high school park and recreation units.

In live events, our customers continue to focus on providing a unique experience to those attending sporting events and our products are a key element to create this atmosphere. There are a number of projects expected for the upgrade or replacement of existing equipment. A number of uniquely designed mega projects are in the marketplace in the commercial spectacular business with the desire to attract customers through advertising or creation of a destination.

Our on-premise and out-of-home customers continue to turn to digital messaging solutions that advertise or communicate information to their audiences. In transportation, ordering in North America remains strong, heavily influenced by the passing of the US transportation bill this past year. This allows for longer-term planning at the state DOT levels and more availability of projects for the foreseeable future.

The number of larger sports complexes at high schools has been on the rise as this market continues to adopt video technology for sporting events. Also, high schools continue to use lesson centers to communicate with parents, teachers and students throughout the year. This demand continues to grow as well. We continued to consolidate Adflow into our revenues and have gained some reoccurring revenue models with this platform.

Our strategy is to continue to serve Adflow's existing customer base well and expand Adflow's reached throughout our on-premise business in commercial. While the business has historically been under $10 million in sales, we expect to grow over the long term as we integrate both interior and exterior signage solutions for this market. The commercial billboard market is expected to be at similar levels as last year.

In all business units, we continue to have returning customers. Our solutions in these markets have natural replacement cycles as the products have a known end of life. This provides us the outlook to continue to invest in customer centric solutions to meet demands in the market.

Our marketplace is competitive, however. We continue to experience price pressures from Asian competitors entering the US market. We also continue to see these low-cost competitors target international markets, which we believe has had some impact in our international order volume. This pressure and a dynamic world economy seems to have impacted decision timelines and depressed orders in some areas, which may continue in the near-term.

Other economic headwinds, such as the US election, the proposed Brexit, oil prices, uncertainty in interest rates, currency fluctuations, and regional political unrest has created volatility and some uncertainty for order, timing and forecasting in the marketplace. While these challenges may have some short-term impacts on orders, our strategy is to continue to focus on the things we can control, serving our customers and the growing market with high-quality, reliable solutions which meet their business needs. We believe this is the path to long-term profitable growth.

As the order picture for short-term becomes clearer, we continue to monitor and limit the amount of cost added for personnel, our largest non-inventory cost. We are also carefully evaluating capital expenditures and working to carefully manage our other expenses for this year. We have challenged our managers to be frugal throughout the Company as we position our organization for success in this fiscal year and beyond. To this end, we are supporting our development teams to bring solutions to the market with higher velocity. We continue to see many opportunities to grow and to be successful in this business and overall are optimistic for our future.

With that, I would ask the operator to please open it up for questions.

(Operator Instructions)

Morris Ajzenman, Griffin Securities.

Hello. Just a few questions. The first question is the competitive pressures that you've spoken about for a little while already, a handful of years, and highlighting this time Asian pricing pressure, which again, you've highlighted in the past. Any concerns that this is causing market share loss beyond just the more difficult pricing? I know you touched on saying market share appears to be stable, but in any of your divisions, any concerns that this has led or can lead to market share loss?

It appears, Morris, that in the key markets that we participated in, we still have a significant market share and are able to maintain that. There has been some growth at our Asian competitors in [regilent] staging, in the ultra high def, and some of these other areas where our market segments that are made interesting to us but we're not players in those today. Is that helpful?

Yes. Okay. On a different front then, moving to the income statement in the core side, in this quarter, revenues are down 12.5% but operating expenses were up 12.1%. And even excluding product and design, there's still about 10%. Is there any sense of urgency that the expenses really have to be called in and brought in dramatically to right size things during the interim until top line starts improving?

Yes, Morris, we are, as Reece mentioned and I mentioned, we are working with the managers to be frugal and to really be sensitive to those costs and to control costs. Many areas are meeting regularly to ensure that we are watching as our orders come in to reduce costs or maintaining cost levels.

Anything specific you can talk about that you are discussing as far as reining in costs or any examples you can give us?

I don't have anything specific that I would like to describe today. I think and maybe to provide greater color to Sheila's statement, we don't see it as one specific thing or a few things. We see this as a tightening really across the globe to carefully manage our expenses.

Thank you.

Tristan Thomas, Sidoti and Company.

Good morning.

Good morning, Tristan.

A couple questions. First, on the previous call, Sheila, you guided for sales slightly down year-over-year and fourth quarter. Could you maybe kind of explain what changed in the last couple of weeks for the quarter?

So for my last call, that would have been just getting into our fourth quarter. A lot of times timing changes on the customer demand side. So the backlog is still there, as I highlighted. It's just the timing of the delivery and production of that revenue.

Okay. And then kind of following up to Morris's question earlier just regarding some of the increased competition, I know there's been a lot of talk about Yesco. Could you maybe give a little insight on maybe have they come up with a little more developed strategy as you're butting heads against them a little bit more than maybe you thought?

Yesco was, of course, was acquired by Samsung and their recently came out with a new naming strategy. They're calling their company Prismview. We've seen some activity by Samsung Prismview of worldwide, not anything that I would describe as a strategy yet that I could articulate.

We're still seeing how these mergers will impact the marketplace. There's also the Leyard Planar acquisition that happened in the last fiscal year as well.

Okay. That was actually, that was helpful. Thank you. And then for Adflow, just a quick question, or two kind of questions. One, why Adlfow, specifically? And then how does it kind of benefit your other segments outside of their core business?

Adflow is a Canadian company and they have been very active in what we would call the commercial on-premise base, but really inside the stores, inside their brick and mortar. And we have been active in that same space, but mainly outside on the curb or on the roadside of similar businesses, so we believe together, we have a stronger value statement and we'll be able to grow the orders on both sides without significantly adding to the underlying resources ever.

Okay. And then are there any new technologies or anything Adflow kind of provides that would benefit some of the other segments outside of the OH advertising?

Certainly the types of systems that they've put in place have application in other areas, maybe in sporting venues and in shopping malls and concourses, and we would continue to explore those types of applications into the future.

Great. Thank you.

Jim Ricchiuti, Needham & Company.

Hello, good morning. I just want to go back to the question of the weaker revenues in the quarter. Sheila, you talk about the timing of deliveries. So are we talking about larger deals that there were some timing issues that caused some of that business to slip in the current quarter? I mean, can you elaborate a little bit more on the weaker revenues other than just talking it in broad terms?

Sure, and maybe another factor to that was some of the orders that we've talked about that have slipped into the future quarters, we had thought maybe they would land into the quarter and be able to be some of that revenue recognized. So it would be a combination of both of those things.

So were these orders in live events in the professional sports market? In the college market? I'm just trying to get a sense as to where the shortfall occurred and how long do you think it's going to take before that is potentially converted into orders revenues going forward?

We had a softer second half of the year for international, so there was some at the international, a little bit of the spectacular maybe as well in our commercial segments, and a little bit of live events that, again, that timing of when that revenue is recognized changed that up a bit.

So when you look at the current year, do you have much visibility, much line of sight into when some of these push-outs potentially can come back or is it still uncertain as to whether you actually see orders on some of these?

Some of the orders, as we've outlined, we think are keyed up and ready to go, but it has been slow this past year and maybe will continue to be slow with the macro economic factors we've talked about.

We do have the $180 million in backlog and we will continue to work on that. As we go through Q1, we will have customers that will come to us with opportunities, often at a shorter-than-normal lead time and if we have room in timing with other projects, we would tend to take those opportunities. So the schedule can be a little fluid in our summer if that's helpful.

So fluid in a sense, Reece, that potentially some of the business that you're anticipating for the current quarter, some of that could slip into the fiscal second quarter?

Yes, especially if we would have an opportunity, if it would arise, for Q1, and have something in our schedule that it doesn't need delivery until Q2.

Yes, it sounds like you're characterizing the pipeline in live events and I don't want to put words in your mouth, but it sounds like you're seeing a reasonably good pipeline for larger deals. Is that a fair way to characterize it or is it --? And I wonder if that in fact is true. If you could maybe elaborate on that a little bit.

In our live events pipeline, a fair amount is truant. We've been seeing a lot of activity over the past few years and that continues into this year. As Sheila mentioned, we had a softening in our international as well as our commercial spectacular in really the second half of last fiscal year. I would say right now, we're seeing more activity in both of those areas as we have entered Q1 and are proceeding through this quarter.

But as we described, there are, especially in our international business, we benefit a little from diversity, but in every area of the globe right now, they have their own things that are our top of mind and that's impacted the decision timeline on many of these larger orders.

Okay. And Sheila, did you say that gross margins are going to be similar to last year?

That is our current expectation.

In the current quarter?

Yes. Correct.

Okay. How do we get comfortable with that? Just in light of what we've seen with margins over the last couple of quarters? Are there some -- is the warranty issue less of a factor this quarter? Is it a mix issue that you're anticipating based on the revenues you're expecting for this quarter?

It would be true that we expect warranties not to be up high in the first quarter. That would be a factor as well as then, as you mentioned, the mix of what we see available to be built and scheduled out for this quarter.

Okay. And I just have one final question from me, just regarding OpEx. I think it was alluded to in one of the prior questions about the decline in revenues and yet the increase in OpEx, roughly 12% or so. I'm wondering, how much of that was due to the fact that the quarter came in lighter than expected as you are going through the quarter and you just weren't able to adjust expenses quickly enough. Was that a factor in the weaker earnings in the higher operating expense levels?

I would say that is true. We had, as I mentioned, the backlog to produce and it's hard for us to change mid-quarter those kind of fixed costs, so that more of a longer-term play that we need to make.

Okay, so if we look at your operating expense levels, you're going to have the, it sounds like continue to spend at roughly these levels on the product engineering side. How should we think about your general and administrative expense, which was up quite a bit sequentially and year-over-year?

Yes, we expect that, for product development, we expect to invest a bit more this next year than we did last year to add velocity to the design and development work that we're planning, to bring out new product lines to the marketplace. For G&A, I would expect a slight increase, but we are, as Reece mentioned, working with the groups to be frugal and to manage their costs and to hold or decline expenses where they can.

Okay. Thank you.

Thank you. That does conclude our Q&A session for today. I would now like to turn the call back over to Mr. Reece Kurtenbach for any further remarks.

Yes, thank you. Thanks to everyone for your participation on today's call. As we complete our fiscal year, I'd like to have a special thanks for some of our key stakeholders. I'd like to thank our customers, your years of support and trust in Daktronics to deliver results for businesses.

I'd like to thank our employees. They all had a tremendous effort over the past year to provide our customers a high-quality experience, even as we ask them to solve many of the problems that we faced as well as capitalizing on the opportunities we encountered. Our suppliers have been very valuable. I'd like to thank them for their continued partnership in making our operations run smoothly and their advice and guidance in our future developments.

And also to you, the investors on the call for continuing to take your time to learn more about Daktronics and realize we're in a lumpy business and to understand the ups and downs that we face on a year in and year out basis. We're looking forward to future success in 2017 and we hope to see any of you that are interested to attend our annual meeting here at late summer. Thank you. Have a great summer, everyone.

Well, ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day.