Reece A. Kurtenbach - President and CEO Sheila M. Anderson - CFO.

Jim Ricchiuti - Needham & Company Morris Ajzenman - Griffin Securities Stephen Altebrando - Sidoti & Company.

Good day, ladies and gentlemen, and welcome to the Daktronics Fiscal Year 2015 Second Quarter Earnings Results Conference Call. As a reminder, this conference is being recorded today, Tuesday, November 25, 2014, and is available on the company's website at www.daktronics.com. At this time, all participants are in a listen-only mode.

Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. I would now like to turn the conference call over to Ms. Sheila Anderson, Chief Financial Officer for Daktronics and Mr. Reece Kurtenbach, Chief Executive Officer for Daktronics for some introductory remarks. Please go ahead..

Thank you, operator. Good morning, everyone. Thank you for participating in our second quarter earnings conference call.

I would like to review our disclosures cautioning investors and participants that in addition to statements of historical facts, 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 include changes in economic condition, changes in the competitive and market landscape, management of growth, timing and management of future contracts, fluctuations on 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.

Please note that fiscal 2015 is a 53-week year versus fiscal 2014 being a 52-week year. The extra week of fiscal 2015 fell within the first quarter. Year-to-date results included 27 weeks versus a 26-week year-to-date comparison. At this time, I would like to introduce Reece Kurtenbach, our President and CEO, for a few comments..

Thank you, Sheila. Good morning, everyone. As you have likely seen from our news release, in our fiscal Q2 we significantly increased sales revenue compared to the same quarter of fiscal 2014 but also saw a decrease in gross profit percentage in the same comparison.

This decrease was mainly in the large project area of our business and specifically more focused in our Live Events business unit than our international or commercial, spectaculars businesses.

We feel that some of this change can be attributed to the overall competitiveness of these large projects and product mix for these order, however, we believe this is only part of the story. To better understand the gross profit picture, we need to look more closely into our large project business.

Back in Q1, as we looked forward into the fall, we estimated the overall market size by looking at the number of projects that were active and the probability that we would win any particular job. Of course, not all projects move forward for a variety of reasons and we do not win all the available projects.

It is important to note that we pay close attention in Q2 because we have a seasonal increase in work in many areas of our business, which can impact lead times but the sports work comes with firm deadlines that can compress this demand into a tight window.

We have found it important to fine-tune our market approach in this time of year as we can sometimes overstretch our factories and other areas of the value stream.

While we had good success this year as many of our customers choose to move forward with their equipment purchases and we were able to win more of this work than originally projected, we feel that our strong brand of high-quality systems, installation expertise and ability to meet customer commitments were some of the keys to our successful win rates.

We feel the fact that so many projects moved forward is a testament to the overall strength of the marketplace. The higher than expected order volume with tight lead times caused stress on the operations of the organization and we experienced capacity constraints in various areas of the company.

To meet our customer expectations in the short timeframe for building these projects, we exercised various countermeasures to alleviate these constraints. While we were successful in delivering customers high-quality video systems, these efforts created additional costs that negatively impacted our realized gross profit margins.

We spent more on overtime, expediting and shipping costs to meet their critical event deeds. Margins were also impacted by the mix of work this quarter driving down our overall margin profile. The focus of work turned indoor where we often have more installation subcontracting and additional margin pressure.

While the margin profile was lower than past quarters, we remained profitable in this area. Also, during this period, we saw increases in our other businesses. High School Park and Recreation grew in both sales and gross profit as the standard video work in this market continues to do well.

International sales grew in the sports and advertising businesses as well as increases from our new subsidiary in Ireland, Data Display. Data Display is focused on sales, design and manufacturing for the transportation market.

Our commercial market continues to do well with large video projects and billboards and our transportation in the business in the U.S. remains even. I would like to thank the entire Daktronics team for their hard work over the summer and fall in serving our customers. In addition, we continued to work on long-term strategic projects.

As mentioned earlier, we finalized the acquisition of Data Display and began the integration process during this quarter. Our design and manufacturing groups continue to work on quality implementations to better detect any defects in the product early on in design and manufacture.

We also continued to develop and test final designs for our Surface Mount Technology product lines and enhancements to control systems. For more information on the financial results, I’ll turn it back to Sheila..

Thank you, Reece. As Reece mentioned, we were successful in delivering to our customers this past quarter. Sales for the quarter increased 7% to $173 million compared to $161 million for the same quarter last year.

International sales was the increase as sales for this unit were up $6 million due to the timing and delivery of projects, which included a multimillion dollar billboard application project of our sports stadium and for sales realized from our new entity in Ireland.

As Reece mentioned, High School Park and Recreation sales increased $5 million this past sports season, as the demand for larger video projects increased. There was also an overall higher level of projects available in the marketplace as compared to prior years.

Live Events sales increased $4 million with the continued interest in upgrading sports venues. Sales in the transportation business unit decreased for the quarter as compared to last year, due to the timing of projects being led by governmental department of transportation. Commercial business units sales dropped slightly year-over-year.

Gross profit was 23.6% in the second quarter as compared to 26.8% in the second quarter of last year and 26.1% in the first quarter. Mix of business played a large factor in a lower margin. Our sales for the quarter were weighted heavily on projects in Live Events, international and the spectacular piece of commercial.

As Reece discussed, product mix and competitive marketplace on the larger order sizes were also factors for the lower gross profits. Our margin profile was also heavily weighted on projects, which include on-site subcontracting work.

Our installation subcontracting was approximately $16 million of costs this quarter as compared to $8 million of costs last year during the same quarter. Because we act more like a general contractor on this type of work, we generally earn a lower gross margin as compared to video display system sales only.

And finally, we incurred expediting costs in either customer or event date as mentioned in the release and in recent comments.

Gross margins in the commercial business unit dropped slightly as compared to last year’s – during the same quarter, primarily to the spectacular large project business for factors previously described, which was offset by improvements in warranty expense as a percent of sales.

Operating expenses in dollars for the quarter was $28.6 million compared to $25.8 million for the second quarter of last year. Increases in operating expenses are primarily due to personnel-related costs and to the addition of the Data Display’s operating cost infrastructure.

Our effective tax rate was 36.8% for the second quarter of fiscal 2015 as compared to 35% for the second quarter of fiscal 2014. The U.S. research and development credit is not available this year causing the increase in tax rate.

We are forecasting our effective tax rate to be approximately 36% for the fiscal year 2015, however, the rate can fluctuate depending on changes in tax legislation and the location of sales in related rates in those tax jurisdictions. Our balance sheet remains strong and we are debt free.

We have generated $27.6 million of free cash flow to-date compared to $24.9 million last year. Our cash and marketable security position was $83.7 million at the end of the quarter. We estimate our capital expenditure to be $25 million for fiscal 2015.

Looking ahead to the remaining fiscal year with our current backlog, estimated customer delivery schedules and predicted order booking, we estimate sales in the third quarter to be up compared to last year’s third quarter.

Ongoing gross profit measures are expected to be a bit lower than last year due to the mix and non-utilized capacity during the holiday season. With that, I’ll turn it back to Reece for additional comments on our outlook..

Thanks, Sheila. We continue to see strong activity in our different market segments in North America as well as other regions of the world. Our large sports business has been active over the past year and we have a number of orders booked for spring baseball and activity for fall sports also appears strong.

We continue to see interest in large video spectacular projects such as Time Square, Las Vegas. Billboard business remains stable with orders for new locations as well as increasingly refurbishment or replacement of existing digital displays. We’ve continued to have a positive outlook for our commercial on-premise business.

In our international business, we continue to see strong interest in sports, spectaculars and third-party advertising sometimes referred to as digital out-of-home or DOOH. We are excited about the transportation segment this next year, due to the addition of Data Display to our team.

The trends in commercial and Live Events drive our high school business as these customers purchase systems that plays outside of their schools as well as in their sports venues and the desire for larger systems is seen in this market as well.

We see modest growth year-over-year on our High School Park and Recreation market during the fiscal year 2015. Our transportation business is still strong and we see the core business continuing to grow even though the year-over-year comparison in sales was relatively flat and orders were down primarily due to project cycles.

The highway trust fund or primary funding mechanism for state departments of transportation was extended at the current level for eight months refunding our traditional transportation projects and public-private partnerships are also becoming a more commonplace in the market.

We believe infrastructure investment will continue and we’re expecting modest growth in this business segment during fiscal 2015. Overall, our markets are still very dynamic and competitive and we remain optimistic about the future of sales opportunities and expansion in our business.

We continue to make selected capital investments to support manufacturing and operations for new product lines in automation, as we size our capacity to the overall market. We also completed the building expansion in our Minnesota facility this past quarter to enhance our flexible factory production during peak demand times.

We have a strong focus on both product development and process improvements to be successful over the long term. In product development, we will continue our strategy of the creation of product platforms for both display and control systems with goals to lower overall cost of production while enhancing the systems value with our customers.

We subscribe to the lean principles of continuous improvement of our production and business processes. We believe it is important to prioritize our activities in highest value areas through knowledge and understanding of our markets and careful planning between our team.

We continue to focus on our goals of improving operating margin and decreasing revenue over the long term, and we believe we have the plan in place to be successful. We believe we are positioned to serve our customers well as we continue with our fiscal year 2015. With that, I would ask the operator to please open up the line for any questions..

Certainly. [Operator Instructions]. Our first question comes from the line of Jim Ricchiuti from Needham & Company. Your question, please..

Thank you. Good morning.

First off, I wondered, can you tell us what Data Display contributed in the quarter?.

Sure. They contributed approximately 3 million in sales and then we’re breakeven from an operational net income perspective..

Got it. Okay. And just with respect to some of the pressure and stresses you faced in the quarter from orders that you were trying to either expedite or that came in maybe later than expected, it wasn’t quite clear.

Were these in both the commercial and Live Events markets and in international? I wonder if you could just maybe go little deeper into that and to what extent you feel that’s now behind you? It sounds like you’re going into the seasonally weaker part of the year, at least in the current quarter, and you should be able to catch up.

And I wonder if you could just talk a little bit more about what led to that gross margin decline in some of those markets?.

No worries. What we saw in early Q2 was all of those areas you just mentioned were strong and that was a bright spot of our quarter. What we find in our sports business because the opening days tend to align at the same time across all of these customer groups.

There’s less flexibility in the delivery date than in, mainly the international or the commercial market segments and that high attention and importance of meeting that first date as well as the different projects that came in, in that time is what caused us to choose to expedite both the materials and factory work as well as on-site work to meet those critical dates.

Is that helpful?.

It’s helpful, Reece.

I guess what I’m trying to get at is, did some of this – some of this business was unexpected that came in late?.

As we said in June and May, we can see the active projects out there but history has told us that not all those projects come through. All kinds of different budget cycles and decisions need to be made for a customer to really green light a project.

And we have a certain range of what we think our winning rate will be and that’s how we approach the fall.

And in this year, we were very fortunate of a lot of the projects, matter of fact I think almost all of them came through and they actually choose to invest in a system, and we were at the high end of our estimate for win rate and that’s what created more work than we expected..

Okay, now that’s helpful. Now on the orders that you announced that came – or at least that came after the quarter, is there any way of sizing those baseball projects? And I assume those are MLB projects..

Yes, the examples would be – I don’t know, the West Coast started early, maybe Oakland A’s and the Padres are firm orders. I don’t have a size of those projects in my mind, so I apologize..

Okay.

Is this something where you’re still – what kind of pipeline do you have into that part of the business or do you see additional orders coming through?.

As we said, the fact that so many people choose to invest this last fall, we think the optimism in the market is high and we’re seeing that today not just in our sports business but in other areas of our business as well..

Okay. And last question, I’ll jump back in the queue. Sheila, if you could, could you give us a revenue number for billboards and order number for billboards? Thanks..

Sure. I have the billboard revenue of 13.5 million for the second quarter of fiscal 2015 that compares to 12.8 million last year. And order volume was 15.1 million for Q2 and 10.9 million last year same quarter..

Thanks a lot..

Thank you. Our next question comes from the line of Morris Ajzenman from Griffin Securities. Your question, please..

Good morning. .

Good morning, Morris..

Hi. Just to go back to the gross margin issue. You were down 300 basis points year-over-year. Could you somehow give us some sort of estimate of how much that decline was related to – you talked overstretched factories to expedite orders. Let’s phrase it differently.

If you had perfect hindsight and knew that these orders were coming in well ahead and were able to gear up properly, what sort of gross margins would we have had this quarter assuming we had perfect visibility into the quarter, going into the quarter?.

I think I understand the question, Morris, I appreciate that. I think we have some competitiveness in our marketplace but it wasn’t near to what we saw in Q2. It was single digits maybe would be all that would be there. And then we would have an impact because of the mix. We had this high level of subcontracting that came in.

Those two things would have been impacted gross margins slightly and then this other came on top of that.

Is that clear?.

Yes, I guess what I’m trying to lead in from that is into this current quarter and to the next quarter, again assuming there’s not huge lumpiness and unusual large orders in the large projects, gross margins revert back to 26%, 27%.

Is there any reason to believe that it will not revert back?.

I think there is a strong reason to believe it would be similar to previous times in the last year and that would be impacted somewhat by the products that were ordered and the configuration of the projects, which is hard to predict..

Okay. And you talked about transportation. Orders were comparable but you referred to softness and I guess release of government projects.

Is there something that – that softness, is that going to continue or do you expect those funds to be released and those projects to be released in the next couple of quarters?.

A lot of that has to do with how the wheels of the government process turns, Morris, and it’s difficult for me to even state an opinion on that. What we do see is that there is two sides. There is getting the funds approved so that the orders will be placed and then there is moving the projects along so they accept delivery of the products themselves.

A lot of these are major construction projects that extend on many months. And so that’s what makes it challenging to predict the last two quarters of this fiscal year. However, we think the trends are solid. The investment in infrastructure includes signage as they try to maximize the volumes on the highways that we have or that they choose to build.

And that as the different entities that are building these roads are trying to find ways to fund, they’re moving to these public-private partnerships, PPPs, to find the funds to move the projects forward and we see that as a positive sign as well..

Okay. One last question, I’ll get back in the queue. Live Events, I think last quarter you referenced that into the fourth fiscal quarter this year very difficult comparison versus last year based on the improved business coming on.

And correct me if I’m wrong, but did you state that fourth quarter would be a difficult comparison versus the last year? And has that changed with the current flow of the business in Live Events?.

I think Live Events – part of our fourth quarter is impacted because of the business in Live Events. So depending on what Major League Baseball does and other spring sports, I think that’s maybe what we’re referring to..

And last year we had some sizable NFL orders come in early and fell into our Q4 and it’s still difficult for us to predict if the falls sports will order that early..

Okay. Thank you..

Thank you. [Operator Instructions]. Our next question comes from the line of Steve Altebrando from Sidoti & Company. Your question, please..

Hi. Good morning.

Can you talk a little bit about the margin profile, the backlog and if some of the issues that you saw in the quarter are contained or do you suspect they’ll bleed off into the second half a bit?.

We’ve looked at our pipeline and what the upcoming work would be and have started to do margin analysis on that. We’re fine tuning our tools to help understand what the impact of that would be on our capacity, so we have better visibility going into next fall.

As we sit here today, we believe this spring will be much more manageable and our timing of growth in our capacity and how we would predict that is geared for summer and fall of next year when we would typically see another growth in business..

Okay.

But is it – so am I correct in thinking that some of the issues that you saw in the quarter would also be because maybe it’s similar projects you’re recognizing revenue on, that would impact the January quarter as well?.

I think the work we did in Q2 is through and will be working on other projects in our Q3 and we won’t have tighter capacity constraints, so we won’t have these additional costs. And if there would be margin changes, it would be due to the projects that we’ve been booking.

Not that we don’t see competitive pressures and we don’t see mixes in installation, but the content of the work that we win we haven’t seen a dramatic change in the gross margins from the types of business we were booking last year..

Okay, that’s helpful.

And then given the win rates that you’re seeing, does it suggest maybe there is room to push pricing a little bit?.

Certainly that’s an area that we’re analyzing. We are selling out our capacity and there’s more work available, we probably have some areas that we could look at pricing. And also as we continue to see increasing volumes of our international business, how do we continue to deliver on that successfully all of these are part of our analyses..

Okay.

And then just last question, the baseball orders, were they included in the backlog?.

These ones that were mentioned booked after the end of quarter, so they wouldn’t be included in the backlog number..

Okay. Thank you..

Thank you. Our next question is a follow up from the line of Jim Ricchiuti from Needham & Company. Your question, please..

I’m wondering if warranty expense was a factor at all in any meaningful way in the decline in gross margin?.

We were able to hold warrantees as a percent of sales to 22.7% this last year that compares to 3.2% on the previous quarter, about the same amount in dollars because of the increase in revenues..

Okay. Thanks.

And just looking at the international business where you’re showing good growth in revenues and in orders even apart from the acquisition, I wonder if you could spend a little time going into where the growth is coming from by either country or vertical market?.

So our international business has strong activity in the large sports projects, in the what we call commercial on-premise whereas where we would put these large spectaculars as well as third-party advertising or out-of-home. We’ve seen strong business in Europe, the Middle East, Africa area.

Asia has been good, especially Australia and the Asian regions. We’ve had a few nice orders out of China. I think we would look for that to increase in the next six to nine months. Our China business tends to be focused on architectural lighting, these large building decorations where you light up the whole exterior or a good portion of the exterior..

Got it.

And just if we look at maybe comparing international versus Live Events and in a normal period where you don’t have these kind of pressures that you face with gross margins, how much of a difference is there in gross margin between those segments?.

Gross margins in international I think that general sense it’s a mix between all of these, it tends to be slightly better, but because we don’t have as near a market penetration and we have these people placed worldwide, their selling expenses tends to be higher for international..

Okay. Thanks very much..

Thank you. This does conclude the question-and-answer session of today’s program. I’d like to hand the program back to management for any further remarks..

We really appreciate everybody’s time this morning. As we said, we’re excited by the strong demand in the market. We wish we have predicted it better, so we would have managed Q2 better. And we look forward to a nice Q3 and Q4 for end of the year. Wish you all Happy Thanksgiving and hope you all have a good holiday season..

Thank you. Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program. You may now disconnect. Good day..