Joe Bergera - President and CEO Andrew Schmidt - VP, Finance and CFO

Jeff Van Sinderen - B. Riley & Co.

Good afternoon, everyone, and thank you for participating in today's conference call to discuss Iteris' financial results for its fiscal third quarter ended December 31, 2015. Joining us today are Iteris' President and CEO, Mr. Joe Bergera, and the Company's CFO, Mr. Andy Schmidt. Following their remarks, we'll open the call for your questions. Before we continue, we would like to remind all participants that during the course of this call, we may make forward-looking statements regarding future events or the future performance of the Company, which statements are based on current information, are subject to change and are not guarantees of future performance. Iteris is not undertaking an obligation to provide updates to these forward-looking statements in the future. Actual results may differ substantially from what is discussed today and no one should assume that at a later date the Company's comments from today will still be valid. Iteris refers you to the documents that the Company files from time-to-time with the SEC, specifically the Company's most recent forms 10-K, 10-Q and 8-K, which contain and identify important risk factors that could cause actual results to differ materially from those that are contained in any of the forward-looking statements. I would like to remind everyone that a Webcast replay of today's call will be available until February 25, 2016 via the Investors section of the Company's Web-site at www.iteris.com. Now, I would like to turn the call over to Iteris' President and CEO, Mr. Joe Bergera. Please go ahead, sir.

Great. Thank you, Shannon, and good afternoon everyone. As you saw, at the close of market today, we issued a press release announcing the financial results for our fiscal third quarter ended December 31, 2015. In Q3, all three of our business segments made solid progress, notwithstanding the fact we made a conservative decision to record a valuation allowance on the Company's deferred tax assets. In a minute, Andy will discuss this allowance in more detail. During the quarter, Iteris recognized $19 million in total revenue. This represents a very strong 8.4% year-over-year rate of growth. Roadway Sensors continue to grow significantly above market rate, Transportation Systems booked a record level of new orders and Performance Analytics achieved major new milestones in the agriculture analytics market following the release of our ClearAg platform earlier this fiscal year. Of the $19 million in total revenue, Roadway Sensors contributed $9.8 million in sales. This translates to a very strong 21% year-over-year growth rate. The pace of growth is especially noteworthy in light of softness in the energy sector which is impacting the Texas region, one of our largest markets. We believe that this continued strong growth is due to our product superiority, demonstrated commitment to customer success, and frankly excellent sales execution. Within the U.S., our sensors business experienced particularly strong results in Northern California, the Midwest and the Southeast regions. We also made continued progress developing our position in Latin America. On an overall basis, during the period we saw an unusually high percent of sales of third-party products which impacted our gross margins. As we look forward, we expect third-party products to return to a normal range of 8% to 12% of the segment's total revenue. In Q3, our Transportation Systems BU added approximately $24 million in new orders, exiting the quarter at a record $52 million in backlog. This represents an approximate 62% increase relative to our Q3 2015 backlog. In addition to the $24 million in Q3 orders, in January the Virginia Department of Transportation also awarded Iteris a program management and government services contract. This significant new contract has an additional $4 million annual contract value. Under the terms of the PMG contract, Iteris will provide program management services related to the Commonwealth safety service patrol and advanced traffic management system, among other programs. As we'll discuss later, we expect the substantial increase in backlog to accelerate the segment's overall rate of growth through the first half of FY '17. To secure the record level of new orders, in other words the $24 million announced in December and the additional $4 million awarded last month, we allocated a higher proportion of otherwise billable Q3 labor against business development and new customer onboarding activities. Due to the effective reduction in billable Q3 labor, the BU's revenue of $7.8 million was flat to prior year. On balance, we think this was a good trade off. These large new orders will not only contribute to meaningful revenue growth throughout FY '17, but the new revenue is recurring in nature and more predictable than indefinite delivery/indefinite quantity or IDIQ contracts that have made up a large percent of our historic contract portfolio. Our Performance Analytics business unit recognized $1.4 million in revenue. Although revenue slightly declined year-over-year, this segment realized over 60% sequential growth. The sequential growth was due to seasonal increases in ClearPath Weather revenues, some improvement in our transportation analytics business, and of significant strategic importance, continued growth in subscription revenue from our agriculture analytics platform ClearAg which continues to help offset general softness in the transportation analytics market. In December, one of the world's largest crop protection company selected Iteris to be a strategic component of its global strategy. Like all ClearAg agreements, this is a Software-as-a-Service model. The full value of the contract represents recurring annual subscription revenue which we expect to achieve 80% gross margins at scale. Under the terms of the agreement, the new customer will consume ClearAg's weather and soil content in the customer's new digital agricultural platform, which we expect to be used by both the company's sales organization and research and development teams. We expect this new crop protection customer to launch its digital agricultural platform in waves before eventually bringing all of its worldwide geographic territories on line. We're assisting this customer with its planned launch activities and in the future we plan to communicate more information about the launch activities in coordination with the customer's global PR team. In the meantime, we are not able to disclose the identity of this customer. In addition to the new crop protection deal, we continue to secure OEM agreements with a variety of software publishers and other Allied Providers who pay us an annual subscription fee to embed ClearAg in their agriculture solutions. These new OEM customers, which operate in North America, Russia, and Australia and New Zealand, further extend our geographic coverage. At this time, our various OEM agreements give us access to 65 million wholesale acres under management across 14 different countries. As a point of comparison, last quarter we had 50 million wholesale acres under management across 10 different countries. Now I would like to turn the call over to Andy to walk you through our financial results. Andy?

Thank you, Joe. Good afternoon, everyone. First of all, before I go through our fiscal third quarter 2016 financial highlights, I would like to bring to everyone's attention that we will be talking to both GAAP and non-GAAP results today. Staying consistent with our past calls, I will provide a non-GAAP view of our fiscal third quarter 2016 and year-to-date results that adjusts and highlights what management feels are atypical operating expenses to better present the performance of the Company and to provide a more relevant benchmark of operating expenses going forward. Specifically, our non-GAAP results adjusts for audit fee overruns and related costs, financial consulting service fees, costs associated with our CEO transition, and the recording of a valuation allowance on the Company's deferred tax assets. For our fiscal Q3 2016, we posted total revenues of $19 million and a GAAP net loss of $10.4 million or $0.33 per share. The GAAP loss includes a nonrecurring tax asset allowance charge of $10.1 million. This is a non-cash charge that simply results in a conservative balance sheet presentation of our short-term and long-term deferred tax assets. We have taken this charge this period given that we have chosen to invest operating income from our transportation businesses over a significant period of time to develop and launch our precision agriculture business. Reserving the tax asset does not change our ability to utilize our tax NOLs nor does it indicate that management feels that we will not be able to take advantage of our NOLs in the future. At this time, we have approximately 18.5 million in gross federal NOLs that expire in 2022 and 2024. Netting up this nonrecurring tax charge in our current period, our net loss is $378,000, which is fairly consistent with our first two quarters of fiscal 2016. In regard to our atypical expenses, we did not experience audit fee overruns or financial consulting support fees this period as compared to incurring approximately $192,000 of such fees in Q3 of fiscal 2015. In regard to executive management transition costs, we did not experience any cost this period, however recorded $111,000 associated with executive recruiting fees in the same period of fiscal 2015. For the nine-month period ending December 31, 2015, audit fee overruns and quarterly review fee increases totaled $150,000 as compared to $1.1 million in the same nine-month period last year. Costs associated with financial consulting services were $88,000 in our current nine-month period compared to $756,000 in the same nine-month period last year. The change in the Company's CEO or CFO totaled $150,000 for the nine-month period ending December 31, 2015, as compared to $111,000 in the same period last year. Our non-GAAP adjusted net loss for the nine months ended December 31, 2015 was $724,000 or negative $0.02 per share, as compared to net income of $893,000 or $0.03 per share. Today's earnings release and related current report on Form 8-K describes how we calculate these non-GAAP financial measures and provide a detailed explanation of our atypical expenses as well as reconciliation between our non-GAAP financial measures and their most directly comparable GAAP measures. Moving forward, Joe noted Q3 was a great quarter. We posted third quarter revenues of $19 million and total revenues for third quarter of fiscal 2016 increased 8.4% from $17.5 million in the same quarter a year ago. The increase was primarily driven by strong transportation revenues led by a 21% year-over-year increase in our Roadway Sensors segment. Gross margins in the third quarter of fiscal 2016 were solid at 37.9%, down slightly from 39.1% the same quarter a year ago, but within expectations. Changes in our gross margins are essentially product mix related driven across all our business units. Revenue in our Performance Analytics segment was slightly down year-over-year due to timing delays in the deployment of new traffic analytics iPeMS type projects. We continue to make significant progress building our precision agriculture pipeline. As our deal flow improves, we expect to see earned revenues in this area start to make an impact. Non-GAAP operating expenses in the third quarter of 2016 increased to $8.3 million, compared to $7.2 million in the year ago quarter. The increase was primarily due to planned investments in headcount, product development, sales and marketing expenses in our Performance Analytics segment. Non-GAAP net loss in the third quarter was $378,000 or negative $0.01 per share, as compared to non-GAAP net income of $90,000 or $0.00 per share in the prior year quarter. In regard to our year-to-date financial position, we followed up on our record revenues for our fiscal year 2015 with record nine-month revenues for fiscal 2016 of $58 million, an increase of 6.9% from our previous year nine-month period. Non-GAAP loss for the first nine months of fiscal 2016 was negative $0.02 per share, as compared to non-GAAP net income of $0.03 per share for the previous year period, and is considered again to be as expected due to investment in our Performance Analytics initiatives. Gross margin for the current year at 39.2% compares favorably to 38.7% last year, and is a good indicator of the quality of our record year-to-date revenues. Non-GAAP operating expenses for the nine months of fiscal year 2016 increased to $24.5 million, compared to $20 million in the year ago period. Again, the increase was primarily due to planned investments in headcount, product development, sales and marketing expenses in our Performance Analytics segment. Non-GAAP operating loss for the nine months of fiscal 2016 was $1.8 million, as compared to operating income of $921,000 in fiscal 2015. A healthy indicator for our Transportation business is backlog. Total backlog at the end of fiscal Q3 increased to $51.7 million, an increase of 62% year-over-year. Cash and cash equivalents at December 31, 2015 at December 31, 2015 was $18.4 million and compares to $22 million at March 31, 2015. Cash used by operating activities during the nine-month period ended December 31, 2015 was approximately $2.3 million. Capital expenditures during the nine months ended December 31, 2015 were approximately $673,000, and we continue to carry no debt. In terms of housekeeping, we expect to file our 10-Q this week. And this concludes my prepared remarks on the financials. Now I would like to turn the call back to Joe.

Great. Thank you, Andy. So Iteris is in a unique position to capitalize on powerful trends in two massive end markets. After joining the Company last quarter, I have to tell you that I'm extremely impressed with the management team's focus on shareholder value. We continue to execute in a deliberate and disciplined manner to not only accelerate the performance of our Transportation segments, but develop a highly meaningful software-as-a-service model in the agriculture market. As noted last quarter, our Sensors business unit has a demonstrated track record of product innovation. After establishing a leadership position in the market for video-based detection sensors used for intersection detection, we successfully introduced a hybrid video and radar sensor and also a velocity sensor that uses anonymized MAC addresses to track the speed of arterial traffic movement. We continue to pursue a strategy of innovation and intend to introduce significant new product capabilities over the next three quarters. This quarter, in other words Q4 of our fiscal year '16, will introduce software enhancements to our hybrid sensor. In the first half of our fiscal year '17, we'll begin field test for new types of traffic sensors who allow us to enter a new currently undisclosed segment of the sensor market. We believe the planned product enhancements and new product introductions will address near-term market demand, reinforce our position as an innovator and product leader, and further differentiate Iteris as the most complete provider of traffic sensors in North America. In addition to pursuing adjacent product segments, we continue to focus on geographic expansion. The prior investments in our Latin America distribution organization are yielding dividends. We not only exceeded our Q3 revenue plan for the region, but we have built a historically high sales pipeline in the region. We expect to see continued pipeline growth in Latin America. And as we move into the next stage of market development, we will be increasingly focused on regional pipeline conversion. Over the next three quarters, in other words through the first half of our fiscal year '17, we expect the rate of growth in our sensors business to slow somewhat and move more in line with the historical average market growth rate of approximately 7%. We anticipate this slower, albeit still very strong, rate of growth due to softness in some of our primary markets such as Texas which again has a high exposure to the energy sector. And while we intend to introduce new products that we believe represent substantial revenue opportunities for Iteris, it will take time to develop and convert the new product pipeline at a meaningful level. Although transportation infrastructure spending remains constrained, Iteris continues to see a shift in spending toward intelligent transportation systems programs in general and connected vehicle programs in particular. Currently we are experiencing an increase in demand for programs related to vehicle infrastructure integration, actionable traveler information, data analytics and enhanced safety and mobility. Indeed the majority of the $24 million in orders booked in Q3 align with these program areas. Against the backdrop of more favorable market demand, our Transportation Systems business will continue to be strategic about the new business we pursue. In general, we'll focus on opportunities that; one, enhance our franchise as a provider of information based actionable insights in target geographies and market categories; two, enable us to leverage existing platforms and other toolsets; and three, represent sizable multi-year programs with a meaningful level of recurring revenue. Over time, we expect to increase our average project size which should create scale efficiencies, resulting in some EBITDA leverage for the business. As we bring both the Virginia TOC and PMG programs online, we'll start to see a significant acceleration in the rate of revenue growth for our Systems BU. For reference, the BU has realized a 2.4% rate of growth year-to-date. In Q4 FY '16 and through H1 FY '17, we anticipate a greater than 15% year-over-year rate of growth, allowing for some ramp-up period. As a result of this new business, we expect to add an approximate 100 new billable employees to our Sensors business unit through FY '17. The incremental revenue results in a measurable increase in absolute contribution margin dollars. As discussed in prior earnings calls, Iteris has identified the agriculture analytics, but what we may sometimes refer to as agriculture informatics market, as a significant opportunity. Agriculture analytics is the intersection of precision agriculture and big data. More specifically, agriculture analytics involves the collection, aggregation and analysis of big data for purposes of presenting contextually relevant insights to a variety of agribusiness users. Within the agriculture analytics market, Iteris has identified a $1.2 billion plus TAM that includes over 8,000 unique customers in four primary segments, Allied Providers, Ag integrators, the Farm 1000 and crop science companies. We define crop science companies to include crop protection, crop nutrition and biologics companies. To pursue the agriculture analytics market, we've assembled a world-class inter-disciplinary team of about 100 experts in software engineering, data science, meteorology, agronomy, epidemiology and biology. This team has leveraged our extensive existing intellectual property in the field of weather analytics to develop a powerful agriculture analytics platform, which we branded ClearAg. Unlike other captive or limited use applications in this emerging market, ClearAg is open, it's extensible, it's adaptive, it's scalable and it's global. ClearAg is a subscription model. Customers may subscribe to either our ClearAg platform services or our ClearAg advisory services. With the platform subscription, customers can integrate our world-class weather, soil and crop health content as well as our powerful analytics and visualization algorithms into their own systems. With the advisory subscription, customers receive location-specific field-level information and science-based advisories associated with key agricultural production events, from planting to irrigation and nutrition to harvest. Since launching ClearAg in Q1 FY '16, our go-to-market activities are focused only on developing our ClearAg platform services revenue stream. In Q3, we started to formulize our distribution model. Today, we have a dedicated field sales team in North America focused on crop science companies and a channel sales team focused on Allied Providers, Ag integrators, Ag retailers and agronomists. We're in the process of establishing a field sales presence in Europe. In the current quarter, our Q4, we will stand up North American telesales and Web sales team. Already four of the top 10 crop protection companies have completed extensive trials, validated compelling use cases and selected ClearAg for implementation. Such customers deploy ClearAg to enhance the efficacy of their analytics processes, improve product performance in the field and/or improve the return on their sales and marketing activities. For these large multinational corporations, we found that ClearAg can drive millions of dollars in revenue contribution, operating efficiencies and risk mitigation. We believe our value proposition is particularly powerful within the context of current global economic forces and related structural changes in the agribusiness sector. We expect our crop science customers, similar to the scenario we just described at our newest global crop protection customer, to deploy Iteris in stages. Therefore, our field sales team is working to expand ClearAg adoption in our four existing crop protection customers as well as to acquire new crop science customers. As these customer relationships mature, we believe each crop science account should conservatively average more than 1 million in annual subscription revenue. Initially, our channel sales activity is focused on acquiring lighthouse customers and validating our value proposition across five key categories at Allied Providers. Today we have strong reference customers in each of these categories and a proven repeatable commercial model. In our model, we require Allied Providers, which represent OEM customers and value-added resellers, to commit to a minimum platform subscription fee. In addition, we participate in upside above the minimum targets. In Q1 of our fiscal year '17, we'll expand the focus of our go-to-market plan, which again is focused only on crop science companies and Allied Providers to date, and we'll begin promoting our advisory services direct to farmers. Our primary target will be North American farmers with over 10,000 acres. We expect to reach these farmers through a network of agronomists and Ag retailers as well as through our own telesales and Web sales teams. In the past, some of you have asked about our direct-to-grower pricing. Although we're not prepared to disclose pricing at this time, I will say that we intend to introduce a simple pricing model we expect to work well across different crop types and different geographic regions. While we expect to increase our level of investment in sales and marketing through FY '17 to execute against the above activities, we validated our technology platform over the past three quarters and we now believe our product delivery organization has achieved sufficient scale for the near to medium term. As a result, we expect some modest operating leverage in FY '17 which will measure as a ratio between bookings growth, calculated as first year subscription value, to investment. To conclude, in Q3, Iteris continued to realize positive momentum across all lines of business. While we reported a significant GAAP loss due to our decision to record an allowance for the Company's deferred tax assets, the actual non-GAAP operating loss of $378,000 remained within our recent historic range. In Q4, our Systems BU will begin to recognize revenue on the over $28 million in recent new orders. We expect this to drive meaningful sequential and year-over-year enterprise revenue growth. We believe the recent deal we signed with one of the world's largest crop protection companies further validates our Ag analytics strategy and we remain confident about the long-term opportunity for Iteris in agriculture market. Therefore, we plan to continue to invest in our ClearAg business. As we believe our ClearAg engineering capacity has reached sufficient run rate level to the current requirement, we will shift the investment mix for the next several quarters to sales and marketing activities. We expect the incremental contribution margin dollars from our Transportation segment to offset the step-up in our agriculture investment. Therefore, we anticipate our net investment level to remain consistent for the next several quarters as our agriculture analytics business grows to its full potential. On a consolidated basis, this should translate to modest operating losses in Q4 and the first half of fiscal year '17. Now I'd be delighted to respond to your questions and comments. Operator?

[Operator Instructions] We'll go ahead and take our first question from Jeff Van Sinderen with B. Riley.

Congratulations on the growth you showed in the quarter. I wondered if you can give us a little bit more on some of the drivers of Systems and Sensors segments and maybe just touch on what exactly is going into increased backlog there?

So first of all, the backlog figures – I'm hearing a lot of background, operator. Can you help with that?

Yes, sir. Let me try and mute Jeff's line while you speak, okay. Go ahead, sir.

Okay, alright, so let's try again. So first of all, the backlog figures that we reported are strictly for our Systems business, and the drivers for the growth in backlog in Systems in my opinion are associated with the shift in spending in the marketplace. Historically, we've seen a lot of expenditures related to transportation infrastructures go into actually building out the roadway infrastructure itself, and at this point increasingly we're seeing investments in intelligent transportation systems and other technology related to connected vehicles or the expectation of connected vehicles. And so that just plays to Iteris' strength, and therefore we're seeing a larger percent of the total available expenditure. So that's I think the driver with respect to Systems. In the case of Sensors, we continue to grow above average market growth rate. So we're obviously taking market share. And I think that's just due to the fact that we're perceived as the industry leaders. I think the reason that we're the industry leaders, we have the most complete product suite, I think most people believe that we have the strongest products themselves, and then also our sales execution I think is just superior to competition.

Okay, that's helpful. And then maybe you could just talk a little bit about the Sensors outlook, given headwinds in Texas, what you're seeing there?

So Texas is one of our largest markets and we are expecting that there'll be probably some restrained spending in that market due to what's going on in the energy sector. That being said, we have a really strong position in other markets as well. When we look at our growth rate going forward, as I said, we're anticipating that our growth is going to be sort of in the near term over the next three quarters. It's likely to be more in line with the average rate of growth, which is 7%. Part of that is the function of softness in Texas, but the other thing that's going on is just kind of where we are in our product cycle. We are planning to bring some new products to market over the next couple of quarters. It will require some time to execute against our marketing activities and get engaged fully in sales cycles and start to realize the benefit. So again, we're a product innovator, we tend to be ahead of the curve in the market, and we would expect as we bring these new products to market and have some time to develop the market opportunity for those products, our rate of growth will probably move up again above sort of the market average. But at this point, for the next couple of quarters, we're staying conservative. We think it will be closer to the historical average growth rate.

Okay. And then maybe on Ag, I mean it looks like you're making some substantial progress there and I think you spoke to four of the major crop protection companies that you now have onboard, and I'm just wondering are there more to come there, are those in trial, that you think you probably will end up winning over?

So we have identified at least 200 unique entities in the larger crop science market that represent prospective customers for us. As I said, crop science is made up of a number of different types of companies, including crop protection, crop nutrition and agricultural biologics firms. Right now four of the top 10 crop protection companies have already selected Iteris and we're at different stages of implementation with them. So there's substantial revenue opportunity in just increasing our footprint in those accounts. But we do expect to close deals with other crop protection companies as well as close deals with crop nutrition and biologics firms which we've been less focused on to-date.

Okay. And then just one more follow up, if I could squeeze it in. I think you mentioned just sort of general softness in the transportation analytics market. I just wanted to see if you could expand on that a little bit.

I think that the softness is actually sort of relative to expectation, and there has been an expectation at Iteris but across the larger marketplace that there would be a substantial demand for transportation analytics across the various state departments of transportation, which was anticipated because of some federal legislation. And that legislation or the implementations of programs related to that legislation has been somewhat delayed. Some of the specific requirements are yet to be defined. And as a result, it's put some states in essentially sort of a holding pattern. So, the softness is really kind of more relative to expectation. There was some initial purchasing that went on and we probably benefited from that and now that's, again, sort of in more of a holding pattern. We do expect that those regulations will go into effect, and regardless of whether the regulation drives the purchase or not, we think that there's benefit to using our analytics to maximize return on investment for various transportation programs. So we would expect that eventually the state departments of transportation as well as small or large metropolitan transportation authority will eventually start to increase their spending on traffic analytics, and we believe we have the strongest offer in the marketplace.

Alright, good to hear. Thanks for taking my questions and continued success.

Ladies and gentlemen, with no further questions in queue, I'd like to turn the conference back over to Mr. Bergera for closing remarks.

Great. Thank you, Shannon. So anyway, we appreciate everyone's support and thoughtful questions and we look forward to updating you again on our continued progress when we report our results for the fourth quarter of fiscal year 2016.

Ladies and gentlemen, that does conclude today's conference. We do thank you for your participation and you may now disconnect. Have a great rest of your day.