Good day, ladies and gentlemen, and welcome to the Daktronics Fiscal Year 2017 Second Quarter Earnings Results Conference Call. As a reminder, this conference is being recorded today, Tuesday, November 22, 2016, and is available on the company's website at www.daktronics.com. .

I would now like to turn the conference over to Ms. Sheila Anderson, Chief Financial Officer for Daktronics, for some introductory remarks. Please go ahead, Sheila. .

Thank you, Lianne. Good morning, everyone. Thank you for participating in the second quarter earnings conference call. .

I would like to review our disclosure 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 conditions, changes in the competitive and market landscape, management of growth, timing and magnitude of future contracts, fluctuations of margins, introduction of new products and technologies and other important factors as noted and detailed in our 10-K and 10-Q SEC filings. .

At this time, I would like to introduce Reece Kurtenbach, our Chairman, President and CEO, for a few comments. .

Thank you, Sheila. Good morning, everyone. As highlighted in the press release, we are pleased with our financial performance for the quarter. We had higher sales and lower warranty costs, which contributed to the improved net income as compared to last year. .

We continue to see the digital marketplace expand through technology adoption and replacement cycles. While some uncertainty in global macroeconomics can cause delay in order decisions, we have seen a nice pickup of floating and order bookings in many areas this year. .

Orders have improved on a year-to-date -- over year-to-date basis in Commercial, High School Park and Recreation and International. In the Commercial segment, we have seen a pickup of -- in order bookings in a spectacular niche.

This is the area that focuses on larger projects for prominent areas like Times Square, Las Vegas and other city center or entertainment areas. Commercial also added volume through the acquisition -- due to the acquisition of the ADFLOW organization late in the last fiscal year and increased demand in the on-premise business.

The billboard segment of Commercial is relatively flat for orders on a year-to-date basis. In Q2, we saw a bit of a pickup in multi-display orders as compared to last year. .

High School Park and Recreation continued with strong order bookings through the second quarter. We continue to see schools adapt to larger-video applications and larger-sized transactions for both sporting and communications display systems. .

On an international basis, order bookings have improved over last year's. We are seeing more activity this year compared to last. However, comparisons can be difficult due to the nature of our large project business in which timing can greatly change order outcomes from quarter to quarter..

Orders declined in both Live Events and in Transportation. As you're aware, Live Events order bookings are lumpy due to the timing and dollar sizes of transactions. As we look back to the first 2 quarters of the fiscal year, we have not booked a project over $5 million, and at the same time, we believe we have not lost an order of this size either.

While it is unusual for this market not to have a project of this size during this period, we have recorded a number of multi-million dollar projects for major league sports facilities and we see order opportunities for the remaining year through our broader customer base..

Transportation business is also a project-based business and the timing of projects is the primary reason for quarter-over-quarter and year-over-year difference. We were successful in winning 2 additional state procurement projects this past quarter.

Procurement projects provide for specific sizes of orders of similar displays over a time period that is often more than 12 months. This is nice work for the operational side of our business as we're able to plan for production and to align with our customers' delivery needs over a longer time span than in many of our other markets.

To illustrate the impact of timing, subsequent to the quarter, we were also awarded a multi-million dollar project in Nevada for an active traffic management system..

Sales improved over last year as we had a higher percentage of buildable backlog going into the quarter. Last year, at this time, we had a large project for a new stadium that was in our backlog that was not yet ready for their display system.

Also, last year, we delayed production of some orders to take advantage of a new product design, which was ultimately good for our customers, but lowered sales in last year's second quarter. Last year, profitability was also impacted by a warranty issue, which has had limited impact this year.

We continue to serve our customers on this issue with preventative maintenance and ongoing repair work. .

For more details on the financial results, I will turn it back to Sheila. .

Thank you, Reece. Sales for the second quarter increased approximately 7.8% from $158 million to $170 million. The increase is due to the timing of production of orders in our buildable backlog and customer schedules.

Also, as Reece mentioned, last year, we delayed building certain longer lead time projects in order to take advantage of a new product enhancement in our module design with no such needs this year. Last year's schedule change primarily impacted the timing of sales in the Live Events between quarters.

Demand in the High School Park and Recreation business unit has been very strong this year and contributed $4 million of the sales increase this quarter. Transportation buildable backlog and deliveries were also strong and increased revenue for this unit in the quarter.

Commercial business unit sales were relatively flat with a decrease in billboard niche sales offset by sales related to our ADFLOW business, which we acquired late last fiscal year, and for other on-premise sales..

Gross profit improved to 26.1% for the quarter as compared to 22.5% in the second quarter of fiscal 2016. Gross margin levels were favorably impacted by lower warranty costs as a percentage of sales, lower underlying production costs and the sales mix and volume of business.

During the quarter, we incurred a discrete charge of $0.6 million for an impairment of technological and intellectual property. This had an impact on margins by 0.4 point. .

Total warranty as a percentage of sales was 2.7% for this quarter as compared to 4.2% last year same quarter. We continue to evaluate our reserves for a specific issue we discussed last year and increased estimated cost by $0.5 million this quarter as an adjustment to our estimated cost for the issue.

During the quarter, we continued to serve our customers, as Reece mentioned, and at the end of the quarter, we had $4 million of reserves remaining. .

Operating expenses increased $1.7 million or 5.8% to $31.6 million for the quarter.

Increases in operating expenses this quarter relate to a discrete $0.8 million accounts receivable bad debt allowance charge, $0.7 million for an addition of the ADFLOW organization for the full quarter and a $0.2 million impairment of the customer list intangible asset impairment.

In addition, personnel costs, information technology expenses and professional fee increases were offset by other areas of savings in travel and expense costs and convention expenses on a quarterly comparative basis. .

As we previously discussed, for fiscal 2017, we are working to constrain cost growth to manage our expenses to the order picture and have been able to fold underlying spend taking into account the addition of ADFLOW and the discrete events mentioned.

While our plan is to allocate additional resources for our design and development areas to complete development and enhance our design in our display and control systems, our costs haven't picked up significantly on a year-to-date basis. .

Overall, our effective tax rate was 30.5% as compared to 43.5% last year same quarter. The decrease in effective tax rate is primarily due to the reinstatement of the U.S. research and development tax credit that happened late last year during our third quarter.

We forecasted a forward-looking effective annual tax rate to be approximately 30% to 32% with the R&D credit reinstatement put into place this year -- this past year. However, our tax rate can fluctuate depending on changes in tax legislation and the geographic mix of taxable income. .

Our cash and marketable securities position was $52.2 million at the end of the quarter. We reported positive free cash flow of $10.5 million for the quarter as compared to negative free cash flow last year of $19.4 million.

The cash flow generation was primarily due to improved process for the quarter relating to improvements of timing and working capital, net inflows from projects, cash receipts net of payments for our inventory and other supplier costs and due to our reduced capital spending so far this year. .

We incurred $4.6 million of capital expenditures which compared to $10.5 million last year. We expect our capital usage to be less and be somewhere below $17 million for the fiscal year.

Our use of capital expenses are for manufacturing equipment for new or enhanced production line, demonstration equipment for new products and continued information infrastructure investment. We made no repurchases of stock during this past quarter. .

Looking ahead, our third quarter is historically a lighter quarter for sales and profit due to the seasonality of our business in sports and due to the decline of outdoor construction during the winter months. The third quarter also has 2 major U.S. holidays, reducing the number of work days available.

We are entering in the quarter with $184 million backlog, and based on our project scheduled currently, we expect sales to be similar to slightly down with improved gross profit as compared to last year's third quarter, which had higher warranty costs. However, sales could change pending project bookings and customer changes in schedules..

We expect the majority of this backlog to be realized into sales over the next 12 to 18 months. And we expect, as mentioned, gross profit to improve in the third quarter because of that warranty issue last year.

We anticipate operating expenses in dollars to be up as compared to third quarter of fiscal 2016 for the increase ADFLOW costs and increased design and development costs. .

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

Thanks, Sheila. Our outlook remains similar to previous calls as we look forward into the second half of fiscal 2017 and further out. We continue to see the digital marketplace expanding. We expect Live Events to continue to be similar to last year's level based on anticipated activity within this customer base.

High School Park and Recreation started the year out great and it seems like they could grow at a nice pace. Transportation has room to grow with the demand picture. There appears to be stability in federal funding and we have had success in winning procurement projects and other infrastructure road budget.

While it's more difficult to predict the commercial spectacular segment, there are many opportunities in our pipeline that position us for an increase year-over-year. For Commercial billboard niches, we expect similar volumes based on overall activity we see in the national and third-party advertisers.

In our Commercial on-premise business, we are actively promoting our indoor network solutions and new product lines. Internationally, we see opportunities to grow that can be challenging to predict how the year will shape up as our customers wrestle with different macroeconomic factors. .

For the year, our goal is to grow sales and improve operating margin. To achieve sales growth over the long-term, we plan to accelerate activities in our design groups to complete a variety of developments.

While these efforts will increase development expenses, we believe it necessary to drive forward our ability to competitively compete, continuing to capture global market share and meet the request of our customers. Rollouts of products for our new control solutions are expected through the year..

As the order picture can be cloudy and influenced by many external factors, we remain focused on carefully managing our expenses, allowing for some additional resources to add velocity in our product development area.

We continue to see many opportunities for success in this business and believe that while the path will not always be smooth, we are positioned to generate long-term profitable growth. .

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

[Operator Instructions] And our first question comes from Jim Ricchiuti with Needham & Company. .

Just a question on Live Events, fairly low level of bookings and it sounds like you see some projects in the pipeline.

Reece, I'm just wondering how would you compare the pipeline over the next quarter versus, say, a year ago?.

Yes, that market can have big changes based on new construction and planned renovations. But we're seeing significant activity and we believe that, while the year started out lower for this year, that it will end up similar to last year. And so we're looking with some optimism into the second half on the order picture. .

So these projects in the second half, are these mostly MLB baseball-related projects that you would normally see for the spring? Or are these also indoor projects?.

It's a mix. Some baseball, some other indoor, so it's a mixture this year. .

So would you anticipate -- you mentioned that you have not seen orders, at least for this past quarter, for more than $5 million, which is unusual, I think you said.

Do you have some potential projects in the pipeline that are of higher dollar quantities?.

Yes, there are some significant orders out there, some teams looking at changing their configurations that would be over that mark. .

Okay.

And these would be orders that if you're going to see them for this season, you would more likely book them in the current quarter?.

We would book them in the second half of this year. We might see some sales yet this fiscal year, but some of those sales would go into next fiscal year as well. .

Okay. And Sheila, just a question for you.

Just all else being equal on the warranty issue, is this gross margin that you generated in the quarter at the upper end of what you'd expect at this level of revenues?.

We did have a nice mix of business this quarter that we produced so it is a good margin for us. .

Our next question comes from Morris Ajzenman with Griffin Securities. .

Kind of a follow-up on that question to some extent. But first, your guidance, if I'm correct, I think you said in Q3 a seasonally low quarter.

Correct me if I'm wrong, you guided the top line to be flat to down modestly?.

Correct. .

Okay.

Is there the same number of working days in Q3 this year versus last year? Or is that not the case?.

They are the same. .

They're the same.

So I presume the guidance then is a reflection of the orders that came in this quarter, I guess, being lower and along with future revenues, is that causing a reflection of that guidance?.

That plays into it as well as customer deliveries can change and there are a few bookings that, if they happen, there could be some Q3 revenue as well. .

Okay. Now you did guide to improving gross margins. I mean, clearly last year, I think, your 17.8% impacted by the warranty.

But if I look at previous quarters in the past, when you approach the, let's say, $120 million, $125 million revenue run rate, gross margins were about 22% or so, again depending on mix of business, but is that more of a realistic margin to look at for Q3 versus, with Q2, we had a much higher revenue run rate. Can you give us some sort of... .

You're correct. If you look back historically, our Q3 gross profit is impacted because of the fixed costs that we carried through that quarter. So I would also guide us a bit downward from our Q2 rates as well, gross profit rate. .

Okay. And then getting back to the warranty as a percent of sales this quarter, it was down 150 basis points, but still 2.7%.

I think you've articulated in the past, I forget already, getting on to 2% to 1.5%, is that still a realistic goal? Or am I calling that incorrectly?.

That is still a realistic goal, Morris. We're still working on that quality reliability to get to that level. .

And I'm showing no further questions at this time. I would now like to turn the call back to Reece Kurtenbach for any further remarks. .

We thank everybody for your time today, and we here at Daktronics wish you a Happy Thanksgiving and a joyous holiday season. Have a nice winter. .

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