Tel-Instrument Electronics Corp (NYSEMKT:TIK)
Q3 2016 Earnings Conference Call
February 16, 2016 09:00 AM ET
Jeff O'Hara - President and CEO
Joe Macaluso - Principle Accounting Officer
John Harold - Harold & Associates
Dennis Tondalo - Luparin Partners
Greetings, and welcome to the Tel-Instrument Electronics Corp Third Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder this conference is being recorded.
It is now my pleasure to introduce your host, Katie Smith [ph], Investor Relations. Please go ahead.
Unidentified Company Representative
Good morning and welcome to our conference call to discuss Tel-Instrument's financial results for the 2016 third quarter ending December 31, 2015. On the call today, we have Jeff O'Hara, TIK's Chief Executive Officer who will review the results of the company's business operations, and Joe Macaluso, who will review the company's financial results; Michael Schirmer, TIK's Chief Operating Officer will also be in the call and available to answer questions; following their prepared remarks we will take questions from our call participants.
I'll take a moment now to read the Safe Harbor statement. This call may include statements that are not historical in nature and maybe characterized as forward-looking statements, including those related to statements concerning the company's outlook, pricing trend and forces within the industry, the completion dates of capital projects, expected sales growth, cost reduction strategies and their results, long-term goals of the company and other statements of expectations, beliefs, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts.
All predictions as to future results contain a measure of uncertainty and accordingly actual results could differ materially. Among the factors which could cause a difference are changes in the general economy, changes in demand of the company's products or in the cost and availability of its raw materials, the actions of its competitors, the success of its competitors, the uncertainty of government contracts, technological change, changes in employee relations, government regulations, litigation including its inherent uncertainty, difficulties and plan operations and materials, transportation, environmental matters and other unforeseen circumstances.
A number of these factors are discussed in the company's previous filings with the Securities and Exchange Commission. The company disclaims any intention or obligation to update any forward-looking statements as a result of developments occurring after the date of this call.
With that we'll now turn the call over Jeff O'Hara.
Thanks, Katie. Good morning and thank you for joining us we issued our third quarter press release earlier this morning and I hope you had a chance to review it. I am pleased to report that the third quarter of fiscal year 2016 continues our trend of increasing revenues and profitability. Compared to the third quarter last year revenues increased 19% to just under $6 million and operating income increased $725,000 roughly $500,000 improvement versus year ago levels.
We expect to see continued progress going forward as we continued production on our major programs as well as begin full rate volume production of the TS-4530A Army test sets, which started in volume in January of 2016. As a reminder, we currently have three major government programs and produce another 15 products that are sold at lower volume levels. The three major government programs are the CRAFT product affordable pre-flight multi-purpose testing solution for the U.S. Navy and Coast Guard, the TS-4530A affordable pre-flight IFF testing solution for the U.S. Army and Air Force, and the ITATS bench test set, which is the maintenance shaft testing product for the U.S. Navy.
The company is also actively working on its next generation commercial and military test set family that will be smaller and provide greater capabilities at lower cost of production. It is expected that the first product of this new family of test sets will be released within the next 12 months. We are confident that this new family of test sets will substantially broaden our existing avionic product line and allow for expansion into the much larger radio test set market segment.
I now like to provide a more detailed update of our three large government programs, first let me discuss CRAFT. The third quarter saw continued full rate production for the CRAFT program. The CRAFT product replaces seven absolute Navy test sets that collectively cost over $300,000 making the CRAFT test set an excellent value to the government. As of December 31, 2015, the company had open orders of 113 CRAFT test sets with a booked backlog of around of $3 million. This does not include the $1.43 million 40 piece CRAFT order from Lockheed Martin that was received in early January.
The remaining Navy orders are almost all the higher priced follow on orders and we also expect additional orders from the Navy and the follow on $9.5 million IDIQ contract, which only has about $750,000 of availability left. The navy has indicated that any additional CRAFT orders would likely be placed on the government GSA procurement system. As an excellent value to the government the CRAFT program has significant potential for sales into the balance of the U.S. military, NATO and other friendly countries.
This product has been rid into the F-35 Joint Strike Fighter program and we have received orders to-date of $4.4 million from Lockheed Martin. We expect ongoing CRAFT orders as Lockheed Martin moves from limited rate initial production into full rate production with total F-35 aircraft deliveries projected at around 2,500 aircraft. We do not know the ratio of test sets to aircraft as this will be determined based on how and where these aircrafts are deployed. It is also important to note that Lockheed Martin recently completed the acquisition of Sikorsky, which manufactures large helicopters for the U.S. Military. We have been informed that Lockheed is recommending the CRAFT test set and this could result in additional units to the U.S. Army. We are also meeting with each of our CRAFT customers to determine what additional next gen functionality could be added to the CRAFT unit, which could result in additional sales.
With respect to international orders the drop-dead date for decertifying Mode 4 IFF worldwide is January 1, 2020. Many of the NATO countries are struggling to meet this deadline so we anticipate the bulk of the overseas orders to take place in the 2017 to 2020 timeframe.
Tel has currently sold small quantities Mod 5 test sets to 18 different foreign countries. So we are in a good position to capture a significant amount of this large overseas market. The FA has also mandated that company called ADS-B, the next generation GPS navigation system be installed in all U.S. Aircraft by the same date. We are in the process of adding full ADS-B test capability to the CRAFT test set, which could also drive additional sales volume over the next several years.
Second our TS-4530A product, as of December 31, 2015 we had a backlog of 640 TS-4530A sets with a contract value of about $7.3 million and a backlog of 224 kits with a value of $1.1 million. We have recently been informed by the U.S. Army that they will likely need another 200 or so TS-4530A sets over the next few years. In January we received our first follow on purchase order from the Army for 10 units at a value of over $200,000.
We are also adding an additional test capability to the TS-4530A and we are working to upsell this software enhancement to both existing and new customers as part of this efforts we have terminated our previous outside marking reps for the U.S. Army and Air Force and replaced them with internal marketing resources in order to drive future business with these two key customers.
In summary, we believe that TS-4530A product will have significant potential for add on sales domestically and should do very well in the large international markets with volume purchases expected in the 2017 calendar year of pipeline.
The third program is ITATS we continued Full Rate Production on the new ITATS product and have remaining book backlog of 26 units at a value of $1.5 million. We continue to market this unit to other domestic international customers. Finally with respect to the Aeroflex Litigation we have completed our follow-up depositions of Aeroflex Management Personnel in the December-January timeframe and we believe these depositions went extremely well from our perspective. Adjusted the current Aeroflex contention is more fully stated in the pleadings is that TIK used Aeroflex trade secret or confidential information to win the Army 4530A award. Due to the fact that we had two former Aeroflex employees who were familiar with the Aeroflex product working at our company.
Management does not believe these claims have any merit and we are vigorously defending our position. The trial is currently scheduled for October 2016 although this date could slip.
I will now turn the call over to Joe to review the financials. Joe?
Thanks, Jeff, and good morning, everybody. As Jeff mentioned at the beginning of the call, we recorded revenues of approximately $6 million in the third quarter, a 90% increase from the same period last year.
Gross profit increased to $2 million, a $499,000 improvement from the year ago quarter. Gross margin as a percentage of sales increased to 34% as compared to 31% for the same quarter last year due to the different product mix and manufacturing efficiencies. The gross margin percentage still remains much lower than historical levels this year due to an increase in the TS-4530A and ITATS programs which were competitively bid.
SG&A for the quarter decreased by $57,000 as compared to the prior year period. The decrease was due impart to the determination of our U.S. Army and U.S. Air Force sales representatives and slightly but still high litigation expenses offset by higher profit share accruals, salaries and related payroll expenses, commission expenses and professional fees.
R&D cost increased slightly in the second quarter to $542,000 compared to $494,000 in the year ago period. This R&D is now primarily being spent on new products as oppose to product support as has been the case the last few years. As a percentage of sales, R&D cost declined to 9.1% of sales in the current quarter compared to 9.80% a year ago. As is expected that engineering expenditures will increase to approximately 10% of sales going forward as we work to bring these new products to market.
Operating profit was $725,000 for the third quarter compared to $226,000 in the same quarter last year. Income before taxes for the quarter was impacted by a $247,000 increase in our warrant liability for the period as our trailing 12 months EBITDA continues to increase to over $3 million. As detailed in our 10-Q these warrants are priced at the higher of market value or a multiple 5 times of trailing EBITDA.
Net income for the third quarter $227,000 or $0.07 per basic and diluted share compared to a net loss of $21,000 or $0.01 per basic and diluted share in the third quarter last year. Adjusted EBITDA for the quarter was $774,000 or $0.24 per share as compared to $280,000 or $0.09 per share in the third quarter last year.
Turning to our balance sheet we make great strides this year in improving our cash position with cash balances over $600,000. This was done in conjunction with working down our accounts payable balances and paying down long-term debt. Net working capital improved $1.6 million to $4.2 million as of December 31, 2015 as compared to March 31, 2015, for the nine month period ending December 31, 2015 operating cash flow inclusive $978,000.
I'll turn the call back to Jeff now.
Thanks, Joe. This quarter we continue to make excellent progress and achieve a 5th consecutive quarter of improved operating results. We have done a nice job in keeping cost inline despite sharply higher revenues and are generating positive operating cash flow that has allowed us to build up our working capital and cash balances to more comfortable levels.
With our backlog of around $15 million now down to more typical levels for the company, we are working diligently and business development. This includes maximizing sales from our existing customers, operating software product upgrades on certain key products and actively working potential large military opportunities with our major customers. We are also working diligently to capture the lion share of the untapped Mod 5 domestic and export market and we are focused on the Mode 5 export market in particular as we need to capture the lion share of this business to preserve our profitability growth as the Navy programs wind down.
We remain committed to investing meaningfully in product development with the goal of planning Aeroflex's a market leader in commercial avionics testing. As we have accomplished in our core IFF testing market the TR-36 Navigation Communication test set, which we discussed last quarter represents a significant opportunity to re-enter and capitalize in the large commercial market with a highly competitive product.
We are also very pleasured about our new family of light weight commercial and military test sets under development, which we believe will significantly broaden our product line outside our traditional avionics test set market and help the company achieve its long-term objective of returning to its traditional 50% gross margin performance levels. The development on this new test set remains on schedule and we anticipate releasing the first of these new products by this time next year.
Thank you for your continued support and we look forward to updating you next quarter. Operator we'll now turn the call over for questions.
Thank you. At this time we'll be conducting a question-and-answer session. [Operator Instructions] Our first question today is coming from the line of John Harold from Harold & Associates. Please proceed with your question.
Good morning. First of all, what are you guys expecting in Q4 revenue and EPS wise versus last year? I didn't see any guidance. And why do you guys still reporting non-GAAP EBITDA instead of EPS seeking out there is already reporting this morning earnings per share of $0.07 for the quarter instead of the realistic $0.24? And what are you guys doing about shareholder value going forward; just investment seems to be so far in the past couple of years nothing short of a disaster with or without improvement in earnings.
John that's cheating that's about six questions.
Well, if I can recall I will try to.
Let's go with the first one, let's talk about guidance Q4 earnings per share revenue versus last year.
Well, I think it's the same you're going to get every time. We have established a pretty -- you've seen what our performance was over the last four quarters and you can probably I'm not saying anything different is going to happen. So, we have been fairly consistent, I expect to be fairly consistent at least for the next few quarters.
And let's switch over to the EBITDA issue, why you guys reporting non-GAAP EBITDA to EPS, it just seems to turn a lot of people off. They don't understand the [indiscernible] you guys still have.
Yeah, we have this question a couple of times and I think Joe would say is that the EBITDA is the easiest to understand, I think you could take depreciation out of it and interest and make a non-GAAP EPS, but that's just a little bit more complicated. And Joe, do you have any comments on that?
No, it's just what we've done in the past and we do report both numbers, so we try to make it comparable and again that's more of a cash flow number too, and if you look at our operating income you see that kind of reflects that number.
Yeah, it just kind of creates problem and on look are seeking out there is already reporting earnings per share of $0. 07 and when you look at $0.07 and your overall scheme of things that's not impressive that doesn't get me interested in the stock books rather now for actually $0.24 was a head line instead of $0.07 that makes a huge difference.
It's just seems like we keep spinning our wheels quarter-after-quarter and here the price is in the $3 range now. I mean what you guys doing to increase shareholder value and why are you even public at this point why not just a private?
We have gone out and done some presentations we're very solidly profitable, we've got some new products and potential with our gross margin improving to continue improving profitability and I think from management's perspective we're trying to drive revenues and drive profitability and I think at some point the market is going to recognize that we are undervalued and that we're a great company and we've got a big upside. But right now the market is pretty ugly I don't think anyone is going to get any positive feedback from the market down to 15%.
Final question and I will get back in the queue, regarding to the upcoming litigation, why are you letting your lawyers continue to let this thing just drag on out forever things like with Aeroflex's litigation seems like if I may I had a taste that was rock solid I wasn't going to lose I want this in court to finish possible rather than agreeing to these once continuing after another and now we are looking at October and later this year and you know that rolls around and what happens when you guys agree to another continues into 2017 that does nothing for shareholder value it's time to bring that thing to a conclusion.
Yeah, I think we will if I just time by this time next quarter we will have an update for you. I don't really want to discuss what we are doing this quarter in terms of any legal strategy. I think we will probably have a more meaningful update at the end of the next quarter.
It's just a great investment value down here insiders, Board of Directors buying any stock down here, the company buying back any shares?
Well, I know in the last couple of years I have put in a couple of $100,000 into it personally with three kids in college. So I'm -- and if you look at the other side in management and the insiders haven't sold one share. So we think it's a very good value.
Okay, I appreciate your answering all the questions, good luck.
Thank you, John.
Thank you. Our next question today is coming from Bill Massana [ph] from [indiscernible] Capital Management. Please proceed with your question.
Yes, good morning, I was hoping you could just speak to how big the radio test set market is?
You got to be more specific on that answer, we consider the rate of test set market to be military secure communications, [indiscernible] homeland radios and that's the market that we haven't played with at all. Our new handheld product is specifically going to cover those frequencies and we think it's significantly larger than the current avionic test set market that we're in now. So this is a new market for us and it's significant, we know Aeroflex is focusing significantly on it and that's one of our areas of growth.
[Operator Instructions] Our next question is coming from Dennis Tondalo from Luparin Partners.
Please proceed with your question.
Hey, good morning guys. Congratulations on the new quarter. I guess, you guys have been very open, honest about your contracts so putting some numbers together, I know you pressed for some guidance, but it looks like your fourth quarter should be up 10% sequentially over this past quarter and if the F-35 work that you guys have only procured your first and second quarter should break the $7 million mark do you disagree with that my numbers are very [indiscernible]?
Yeah. I am not really going to project revenues Dennis the really the key process to get some of the contracts that are out there and I know you know that there is an army contract for 47 ends out there that the army is looking at. I think our focus now is we just need to go out there and capture the business we have and the revenues in the next three years are going to be little bit harder to predict because the backlog isn't quite as large on the other hand the gross profit on these additional sales are going to be kind of 50% relative compared to 30% on some of the big government contract. So it's a little bit of trade-off. But we're not really going to project revenues; we're looking at a good year for this year and the good year for next year. With the new products coming out we think it could be significant going forward.
And in the previous call I understand what you are trying to say again as far as using adjusted EPS versus EBITDA, I mean you guys will have almost $15 million in net operating loss carry forwards, so you won't be paying an income tax six, seven years, eight years. So you have no income tax, you have just warrant liability that brings our GAAP number down to some ridiculous number $0.07 is ridiculous I mean in will honestly you guys made $0.24 this quarter. So I can understand where it's coming from hope that you guys maybe would be open to maybe using adjusted EPS versus EBITDA as well that could be more shareholder friendly?
Yeah. We'll get with IMS on that and we've been talking about that with you for the last couple of quarters, but we'll review that. The other item in terms of the warrant liability is, it's really had a negative impact on our EPS this year because we were replacing last quarters with very strongly profitable quarters, it's not going to be as significant going forward in terms of our numbers.
And I guess that these non-cash items drag down your GAAP number to ridiculously low levels and I hate to say but the markets headline driven and the headlines show such a low number where in fact that's not the case. I think the more honest number would be your non-GAAP EPS, which I wish you guys would utilize. Anyway, congratulations on another nice quarter and look forward to heading hearing you at your fourth quarter.
All right. And Dennis we did kind of take your advice and put it right off the top. But I guess we agree with you the fundamentals of the company are $0.24 a share.
Thank you. We've reached end of our question-and-answer session. Now, I like to turn the floor back over to management for any further closing comments.
We consider the company we're doing very well I think, Michael Schirmer is doing a tremendous job in the manufacturing, our R&D is going to be tremendously important, our market infinity is tremendously important. We've taken some steps to upgrade our market in particularly to some of our military customers and we're very excited about the next couple of years and it's fun coming out with new products. And we appreciate the support and we look forward to talking to you in a couple of months.
Thank you. This does conclude today's teleconference. You may connect your lines at this time and have a wonderful day. We thank you for your participation today.
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