When the Chicago Bears and Indianapolis Colts clashed in the Super Bowl, a third team also suited up for action at Miami's Dolphin Stadium. Daktronics
Those were some of the fun facts revealed in Daktronics' third-quarter conference call, but I'm sure shareholders would really rather know whether the recent gang-tackle to the company's stock, dropping it by more than 20%, was warranted. Is the outlook that bad?
In my analysis, the outlook isn't that bad, but I'm not sure how good it is, either. Not even Daktronics' management seems to know. Confused? You're not alone. To give us a better understanding of the state of this firm's business, let's turn to its conference call for clues.
A clearer picture
Las Vegas made its "odds" for the Super Bowl game, and my colleague Anders Byland shared his version of Wall Street odds when predicting fumble-itus for Daktronics' stock in 2007. His basis for declaring this the worst stock for 2007: valuation. "So will Daktronics drop like a rock in 2007?" he asked rhetorically, adding, "I think the current valuation is simply untenable, and the market will punish it -- hard."
Good call, fellow Fool.
This statement by CEO Jim Morgan in the third-quarter press release triggered the recent sell-off: "As evidenced by our backlog, our ratio of orders to sales was less than expected, which we attribute to lower than expected orders in professional baseball and in the billboard niche." During the conference call, Morgan elaborated further on the state of its business with America's favorite pastime, stating, "It wasn't that we lost orders; there just wasn't quite as much activity at the professional stadium level."
Morgan did indicate that the digital billboard business is a bit trickier, because of regulatory issues. You get the sense that if regulatory hurdles from municipalities were not an issue, the sky would be the limit for digital displays. But Morgan cautions, "There are constraints on the rate of application for the digital billboards;" one of the primary constraints, it seems, is the regulatory environment in certain cities.
In his analysis, Anders also cautioned that competition from a company like General Electric
Based on remarks made in the call, competition doesn't seem to be Daktronics' problem. Instead, the culprit seems to be slower business in certain markets. For instance, Morgan mentioned that the digital billboard biz was down for the quarter, but on the positive side, he doesn't believe the slower quarter indicated a negative trend. For him, the temporary decline reflects the "normal irregularity of the business."
When CFO Bill Retterath followed Morgan, offering his own prepared remarks, I came away with a similar vibe. The problem, in his eyes, isn't that the company was losing orders to the competition. As he states, "There just wasn't the number of projects out there."
Despite weaker third-quarter sales and orders, statements made by both Morgan and Retterath seem to suggest that business should return to normal soon. Retterath indicated that if orders in the fourth quarter perform "as expected," fiscal 2008 should be off to a good start. During the question-and-answer session, he added, "In this quarter [fourth quarter], already for the first two to three weeks, we've seen a nice level of order bookings for that business [digital billboards]." These statements point to brisk business for fiscal 2008, at least at the start.
Management is optimistic partly because the company has made a considerable investment over the past year in expanding its infrastructure, thus increasing its capacity. Capital expenditures for the year have already topped $46 million, and by the close of the fourth quarter, they're anticipated to reach $55 million. Retterath admits that capex is "exceeding expectations." Expanding facilities such as its plant in Sioux Falls might have come at a higher-than-expected cost, but the investment in infrastructure should pay dividends for the company down the road.
At the outset of the call, Morgan reminded investors that the company was previously hindered by inadequate manufacturing capacity to meet demand. To address this problem, over the past three quarters, the company spent considerable funds to expand that capacity.
Now, Morgan reports, "Capacity for digital billboards is not a limiting factor at this time." To support his claim, he pointed out that despite a 50% increase in revenues in third quarter, "This was done with very little overtime."
One might conclude that increased capacity will lead to increased sales, right?
A fuzzy outlook
One of the greatest hurdles to an investment in Daktronics is its unpredictability. Because of the nature of its business and the size of the projects involved, time and time again in this conference call, I heard fuzzy statements like, "Rate of growth is hard to nail down" and "The rate of growth is probably what's hardest to predict." Or how about this one: "The future is never real predictable." It kind of gives you an uneasy feeling, doesn't it?
Yes, order demand seems to be brisk, indicating that FY2008 should get off to a good start. Yes, the company has increased capacity to meet that demand. Yes, one might expect both improvements to profit margins and cash flows as costs and investments become more normalized. Even so, if management can't predict what's going to happen over the next several quarters, it would be awfully presumptuous for investors to claim they can. As such, prospective Foolish investors should heed Anders' warning.
If Daktronics is still a company you want to invest in, demand a solid discount before plopping down hard-earned dollars. Both the stock and the business are too unpredictable to do otherwise.