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Daktronics Downed

Early Wednesday morning, big-screen electronics king Daktronics (Nasdaq: DAKT  ) put out a fiscal Q1 2007 earnings release chock-full of good numbers -- sales up 28% year over year, backlog up 48%, cash burn and accounts receivable both down in comparison to fiscal Q1 2006. And good news -- a new plant in Brookings went into operation, and "considerable progress" was made in getting the new plant in Sioux Falls up and running. The former Motley Fool Stock Advisor pick painted a picture of a company maxed to capacity on production, and making continued sizeable investments to exploit its success by expanding production capacity.

The stock fell 28% on the news.

Yeah, well, that's why it doesn't pay to judge a press release by the headline. You need to delve into the picky little details of the news to see what's really going on. Details like:

  • Profits per share grew just 9%.
  • Operating profit margins declined 290 basis points, as SG&A costs rose faster than sales.
  • Inventories grew twice as fast as sales, continuing a pattern of slack working-capital management that has plagued the company for at least two years.

Addressing the operating margin decline, CFO Bill Retterath blamed the costs of moving into the new Brookings plant, higher-than-expected costs on the firm's self-insured medical plan (shades of another Stock Advisor pick, Amerigroup (NYSE: AGP  ) ?), and "a few ... isolated ... large sports projects" that cost more than Daktronics had anticipated to complete.

Show me the money
And speaking of costs, Daktronics predicts that its expansion plans will cost so much this year that I'm pretty sure they will eat up all of the company's free cash flow -- and more. Last year, the company generated $32 million in operating cash flow, and incurred $19 million in capital expenditures (capex). Yesterday, the firm upped its estimated capex costs to $41 million, plus an additional $10 million in "investments in digital media operations." These investments are almost certain to outstrip cash from operations, meaning that we'll soon be watching Daktronics' balance sheet slowly deteriorate as it burns through its cash hoard.

Now, don't get me wrong -- it's great to see Daktronics' business booming so robustly that it needs all this extra capacity. It suggests that the company is doing just fine in fighting for market share against competitors Barco and BillBoard Video. Even so, the firm now looks a lot more "capital-intensive" than it appeared back when Tom Gardner originally recommended it to Stock Advisor subscribers, which threatens two central tenets of the original investment thesis: Daktronics' consistent positive free cash flow and strong balance sheet.

Meanwhile, even after yesterday's fall, Daktronics still looks expensive. Backing out expansion capex, it trades for an adjusted price-to-free cash flow ratio of 48, based on last year's results. Between the large FCF multiple and the certain need for hefty cash infusions in the year ahead (which will expand that multiple further), I just don't see Daktronics offering a lot of upside potential here.

What did we expect to see last quarter, and what did we get? Read all about it in:

Get more premium picks from Tom and his brother David each month inMotley Fool Stock Advisor. Their two latest selections, and their entire archive of previous picks, can be yours with a free 30-day trial.

Fool contributor Rich Smith does not own shares of either company named above.

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Rich Smith

I like things that go "boom." Sonic or otherwise, that means I tend to gravitate towards defense and aerospace stocks. But to tell the truth, over the course of a dozen years writing for The Motley Fool, I have covered -- and continue to cover -- everything from retailers to consumer goods stocks, and from tech to banks to insurers as well. Follow me on Twitter or Facebook for the most important developments in defense & aerospace news, and other great stories besides.

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