Tel-Instrument Electronics Corp. (NYSEMKT:TIK)
Q4 2017 Earnings Conference Call
July 17, 2017, 09:00 AM ET
Jen Belodeau - Investor Relations, IMS
Jeff O'Hara - Chief Executive Officer
Joe Macaluso - Principle Accounting Officer
Greetings, and welcome to the Tel-Instrument Electronics Corp. Fourth Quarter and Year-End 2017 Earnings 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.
I would now like to turn the conference over to your host, Ms. Jen Belodeau with IMS. Thank you. You may begin.
Good morning, and welcome to our conference call to discuss Tel-Instrument's financial results for the 2017 fiscal year ending March 31, 2017. 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. 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 may be characterized as forward-looking statements, including those related to statements concerning the Company's outlook, pricing trends, 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 general economy; changes in demand for the Company's products or in the cost and availability of its raw materials; the actions of its competitors; the success of our customers; the uncertainty of government contracts; technological change; changes in employee relations; government regulations; litigation, including its inherent uncertainty; difficulties in plant 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, let me turn the call over to Jeff. Go ahead, Jeff.
Thank you, Jen. Good morning and thank you for joining us. We have issued our audited 10-K report on Friday, after the market closed, and the press release earlier this morning. I hope you’ve had a chance to review it. We had filed an extension in the hopes of having a final damages amount related to the Aeroflex litigation, but the judge has not yet issued his ruling on that matter.
With respect to the 2017 year-end results, the results were heavily impacted by the $2.8 million Aeroflex jury award and possible additional punitive damages, which resulted in our auditors issuing a going concern opinion. Absent the Aeroflex litigation, the Company would have recorded an operating profit of $1.67 million and sales of $18.7 million, if the $1.24 million of Aeroflex litigation cost and the $2.8 million damages accrual were excluded from the results. After the six weeks trial, we believe we presented a very strong case, and we are very disappointed that the Kansas jury awarded the $2.8 million in damages with the potential for additional punitive damages to be assessed. I will discuss the lawsuit in detail after a quick review of the business.
TIK has an excellent position in Mode 5 and TACAN test sets representing an internal development cost in excess of $20 million. As I’ve mentioned before, fiscal year 2018 revenues are predicted to decline from 2017 levels, but we are still forecasting a modest operating profit, as expected reduction in sales should be partially offset by an increase in our gross margin percentage due to the completion of the large government contracts as well as managing our expenses.
We are also forecasting increase in revenues and profitability in fiscal year 2019 when the international and F35 Mode 5 sales are expected in volume, as well as higher projected sales of our new hand-held products that will be released later this year. This new test set will be half the size of competitive test sets and should do extremely well in the marketplace. The 2018 and 2019 projections are, of course, entirely depending on our ability to raise sufficient financing to support the appeal process or pay the final damages award.
With respect to international activity, the drop-down date for decertifying Mode 4 IFF worldwide is January 01, 2020. TIK currently has five Mode 5 test sets, including the CRAFT 708, CRAFT 719, TR-420, TS-4530A and our new T-47/M5. The major competitor in this market is Cobham/Aeroflex with their 424 V2 product, which has a similar form factor to TIK’s TS-4530A test set. The good news is that we’ve been seeing increasing interest in certain European and Far East countries for TIK’s Mode 5 test sets, with particular interest in our new T-47/M5 product, which has now been sold in three countries, with a volume order expected this quarter. This product was designed as a low-cost upgrade to TIK’s old Mode 4 IFF test sets, which we’ve probably sold over 2,000 in the last 20 years.
This product is expected to begin shipping in the third quarter, and we expect it to do very well. Each of the major four markets represents a multimillion-dollar midterm opportunity. We currently have sold five test sets -- we have currently sold Mode 5 test sets into 18 different countries, so we feel we have a strong competitive position. We continue to actively market to each of the key markets and have meetings this week in Asia with key customers. We anticipate volume orders for international Mode 5 test sets to commence staring this summer and continue to grow through the 2020 timeframe.
TIK also continues to sell its products to domestic customers, with the major revenue contributors being the TS-4530A in the CRAFT test set. The CRAFT 708 has been ridden into the F35 Joint Strike Fighter program, and we have received orders to-date of approximately $4.7 million. We expect annual ongoing CRAFT 708 orders as Lockheed Martin moves from limited-rate initial production into full-rate production with total F35 deliveries projected around 2,500 aircraft. We are excited to see the F35 receive IOC operational approval last summer, and is reportedly negotiating a multiyear order for several hundred aircraft that could result in additional CRAFT 708 test set sales.
We do not know the ratio of test sets to aircraft as this will be determined based on how and when these aircraft are deployed. We have also been informed that Sikorsky is riding in the CRAFT test set into its maintenance procedures, and this could be another source of recurring revenue for this product.
Turning to new products. New products are the life blood of our business, and I am pleased to provide an update on our new hand-held product. We have completed the mechanical design work for our next-generation commercial and military hand-held test set and are now working on the software for our initial products. This will be 50% lighter than any avionics test set currently in the market and will provide greater capabilities over a wider frequency range at a lower-cost of production. It is expected that the first avionics-related product from this new family of modular test sets will be released later this calendar year with new functions to be added every three to six months.
We believe that this new family of test sets will substantially broaden our existing avionic product line and allow for expansion to other markets, such as large secure radio test set market. Aeroflex has estimated this market at approximately $300 million annually. The radio test set market will be a challenge as it will be faced with the increased competition from other large competitors, and we will be selling into a new market with a diverse customer base. Nonetheless, we believe we have an excellent and market-leading design that should do very well in a very competitive marketplace.
Turning to litigation. All this being said, the Aeroflex litigation has been a major distraction for the business and has put considerable financial strain in our small company. The Kansas jury found that TIK did not use any Aeroflex trade secrets in winning the army TS-4530A contract, but did find that we interfered with their business expectancy with the army and assessed $1.3 million in damages. This $1.3 million is the amount of the Aeroflex Mode 5 development contract that TIK protested to the Government Accountability Office in 2006 that eventually resulted in the competitive solicitation that had been issued in 2008.
The jury also assessed damages of $525,000 to the 2X Aeroflex employees for alleged violations to their Aeroflex confidentiality agreement, and the jury then assessed damages to TIK in the amount of $1.5 million for the same alleged violations of the Aeroflex confidentiality agreement. Damages against TIK were $2.8 million in total. These damages were assessed, despite the fact that no evidence was presented during the trial that the disclosure of the alleged confidential information had any bearing on TIK winning the 2009 army contract. Finally, the jury authorized a judge to assess punitive damages.
TIK does not believe the jury verdict was justified and filed two motions with the court to reduce the amount of the $2.8 million judgment. The first argument is that the Aeroflex claimed damages were based exclusively on lost profits from the 2009 army production contract and no damages were requested for the loss of the $1.3 million sole sourced contract in 2006, since these claims would have been barred under the Kansas statutory limitations. The second issue we raised that the $1.5 million assessed against TIK for the alleged violations of the Aeroflex confidentiality agreements cannot be higher than the $525,000 assessed to the two Aeroflex employees. The jury instruction indicated the corporations and individuals had to be treated equally, but the jury did not follow these instructions in awarding the $1.5 million of damages against TIK.
TIK had a hearing in Wichita last Monday and Tuesday, where we presented these two motions to the Kansas court and also argued against the Aeroflex’s request for $5 million of punitive damages, which is the maximum statutory amount allowed in Kansas. Prior to awarding punitive damages, the judge can make his own determination whether TIK's conduct warranted punitive damages. TIK believes that its conduct represented a lawful competition against a company that had protested prior TIK contracts and had hired TIK employees.
In deciding on the amount of any punitive damages, one of the factors that is considered is TIK's financial condition. The legal guidance in Kansas is that punitive damages are meant to sting and not kill. TIK presented detailed financial results and projections to the court. It is expected that the judge will provide a ruling on these motions and enter into a final judgment amount over the next few weeks. TIK would then have 30 days to file an appeal or a request to new trial, if necessary. TIK is actively working to arrange financing to cover the cost of the expected appeal and/or pay the final damages award depending on the amount of the final award. The appeal process would entail posting a bond, which is expected to be in excess of $1 million with the actual amount based on the amount of the final word. TIK believes that it has excellent grounds for appeal based on both the merits of our case and other standing issues that were rejected in pre-trial motions. The timing of any appeal could take several years to complete.
I will now turn the call over to Joe to review the financials. Joe?
Thanks Jeff, and good morning, everyone. For the year ended March 31, 2017, sales decreased $6.1 million or 24.4% to $18.7 million as compared to the $24.8 million for the year ended March 31, 2016. This decrease in sales is mostly attributed to the decrease in shipment of the U.S. Army TS-4530A kits, CRAFT and ITATS units associated with the Navy programs, for which contracts have now been completed. This decrease was partially offset by the shipment of the TS-4530A sets and CRAFT units sold to Lockheed for the Joint Strike Fighter program and to other customers.
Commercials sales increased $420,000 or 23% to $2.2 million for the year ended March 31, 2017 as compared to only $1.8 million for the year ended March 31, 2016. This increase is attributed to the sales of our recently introduced TR-36 NAV/COMM test set, as well as an increase in the sales of our TR-220 and our T-30D.
Gross margin decreased $1.3 million or 16% to $6.7 million for the year ended March 31, 2017 as compared to $8 million for the year ended March 31, 2016. This decrease is mostly attributed to the lower volume, offset partially by improved gross margins, resulting from the completion of the low-margin government contracts. The gross margin percentage for the year ended March 31, 2017 was 35.7% as compared to the 32.2% for the year ended March 31, 2016.
Given the magnitude of the Aeroflex litigation expense, we split these costs out into the two years for the financial disclosures. Selling and general administrative expenses decreased $338,000 or 11.6% to $2.6 million for the year ended March 31, 2017. This decrease was primarily attributed to lower bonus compensation, salaries and related expenses, partially offset by higher commission fees.
Litigation expenses increased $796,000 to $1.24 million for the year ended March 31, 2017 as compared to only $448,000 for the year ended March 31, 2016 as a result of the deposition, the export witnesses and the trial preparation related of the Aeroflex litigation. Legal damages of $2.8 million were also recorded for the year ended March 31, 2017 as a result of this Aeroflex litigation. This amount will be adjusted in our next financial statements, based upon the final decision by the judge.
Engineering, research and development expenses increased $392,000 or 19.2% to $2.4 million for the year ended March 31, 2017 as compared to $2 million for the year ended March 31, 2016. The Company continues to invest in new products by taking advantage of our CRAFT and TS-4530A technology to develop the small hand held products, which will broaden our product line for commercial and military applications.
We also introduced a new Nav/Comm test set earlier this calendar year. This is a large and important market segment for the Company, and we are optimistic that this new product will help us regain market share in this segment. We have added additional personnel to research and development to accelerate our time to market.
As a result of the above, the Company recorded a loss from operations in the amount of $2.37 million for the year ended March 31, 2017 as compared to income from operations of $2.6 million for the previous year. For the year ended March 31, 2017, total other income was $257,000 as compared to other expense of $724,000 for the year ended March 31, 2016. This change is primarily due to the loss of $617,000 on the change in the valuation of the common stock warrants for the last year as compared to a gain of $321,000 in the valuation this year. Interest expense declined as a result of the lower interest rates on the new loan and the lower outstanding balance.
For the year ended March 31, 2017, the Company recorded an income tax expense of $2.6 million as compared to an income tax expense of $852,000 for the year ended March 31, 2016. This increase in provision for taxes for the year ended March 31, 2017 is due to the valuation allowance against our deferred tax assets as a result of the ongoing concern opinion, which is now included in our 10-K from our orders. It should also be emphasized that $3.5 million deferred tax assets could be reinstated in the future, if we can secure sufficient financing to eliminate the going concern opinion and continue profitable operations.
As a result of the above, the Company recorded a net loss of $4.8 million for the year ended March 31, 2017 as compared to net income in the amount of $1 million for the year ended last year, 2016. At March 31, 2017, the Company’s sales order backlog was $3.2 million versus $11.6 million last year. For the fiscal year 2017, the Company had new bookings in the amount of $11.2 million. International Mode 5 sales represent only a small portion of these bookings.
At March 31, 2017, the Company had net working capital of $215,000 as compared to $3.5 million at March 31, 2016. This change is primarily a result of the increase in the current liabilities as a result of the $2.8 million accrued legal damages and lower cash and inventory. If the Company appeals this award, it’s possible that these liabilities will be moved to long term, which would substantially improve our working capital position. Cash was down from the prior year, mainly due to pay-down of the BCA liability.
I’ll now turn the call back over Jeff.
Thanks, Joe. We really have a solid market position in our core markets of IFF and TACAN, and we are very excited about our new hand-held products that will be get hit in the market later this year. This has been a very challenging time for the Company, and we are working hard to get the Aeroflex litigation behind us and move forward as a Company. We will provide an update as soon as we learn more about the final Aeroflex damages.
Thank you for your continued support. And we’re opening the call for questions.
Thank you. At this time, we’ll be conducting a question-and-answer session [Operator Instructions]. Thank you. There are no questions at this time. I’ll turn the floor back to Mr. O'Hara for any final comments.
We appreciate everyone’s interest in the Company. The Company has been around since 1947, where we think we have excellent prospects here and the best success as becoming the dominant player in both commercial and avionics test equipment, and that’s our plan. Thank you so much.
Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.
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