Innovative Solutions and Support Inc (ISSC) 2003 Q3 法說會逐字稿

Good morning and welcome to the Innovative Solutions and Support third-quarter conference call. At this time, all participants have been placed on a listen only mode and the floor will be opened for questions and comments following the presentation. At this time, it is my pleasure to introduce Geoff Hedrick -- Chairman and CEO. Sir, the floor is yours.

Good morning. This is Geoff Hedrick. Welcome to our third-quarter conference call and in a few minutes I will discuss our third-quarter and year-to-date results for the period ending June 30th, 2003. Joining me on this call are Roman Ptakowski, our President and Jim Reilly, our CFO. But before I get started, I would like Jim to read the conference call Safe Harbor message.

Thank you, Geoff, and thank you all for being on the call this morning. Certain matters discussed in this conference call including operating and financial results for future periods are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially, either better or worst from those discussed including other risks and uncertainties reflected in the company's prospectus and 10 K. on file with the SEC. Geoff, back to you.

As stated in our earnings release, third-quarter sales amounted to $6.5 million with earnings of 1.2 million or 10 cents per fully diluted share. And for the nine months ending June 30th, revenues were 18 1 with net income of about 2.7 million and fully diluted earnings per share of 22 cents. This result was encouraging because I believe that it demonstrates a complete transition completing the transition from a very large significant -- and significant revenue generating program for the KC135 -- it was a successful program and when it stopped or when we completed the contract it represented close to two-thirds of our annual revenues.

We have successfully replaced all of that and now have a backlog that's nearly a record backlog of $25 million released with roughly $45 million in total backlog. The significant part of it is you'll see in the results is that the gross margins and operating margins have stayed consistent with previous years.

The obvious concern when you transition from one product line to another and are producing very high margins as we have been are those margins sustainable with new products? And, indeed, we demonstrated they are. So we're very encouraged in that area. In addition, we look forward to a good fourth-quarter which will produce revenues and profits consistent with street expectations and on a forward look into next year of a strong and even stronger next year with significant growth.

So we're very optimistic and very bullish on the future. Our product line development is working well. We have been booking a significant number of both commercial business and general aviation and military businesses (indiscernible) the new business almost in a balanced way so that we continue to strive toward the third revenue model, which has allowed us to sustain the impacts of things like the 9/11 aftermath and the general industry malaise as a result of a number of macro influences we all are aware of. We have been able to successfully shift and supplement lost revenue from some other areas with military business. And when the military has come back in the past, we have been able to supplement that with commercial and business in general in the aviation business.

Significantly, the Company's RVSM business increased to almost $18 million for the first nine months of fiscal 2003 compared to 8.5 so it is almost about a $9--$9.5 2-million increase in the RVSM business which is not unexpected but it's happily consistent with our expectations and plan although it has slipped somewhat as you are aware.

The additional revenue represents over 110 percent growth in volume and recognition that the Company's position as a key RVSM supplier is now reinforced and highlighted.

I would like to turn the call over to Q&A, following just a couple of other comments which I covered before and that is to reiterate that the backlog is now 25 million -- that's released backlog -- and the total with unreleased business is over 40.

We have a solid balance sheet. You'll see some reduction in stockholders' equity, but that's a result of our buyback program where we bought back over a million shares now over the last year and a half and we put that in Treasury so we actually show an apparent reduction in stockholders' equity. Indeed we have a 50 odd million dollar cash position and a very strong cash generating business.

Let me turn this over to Q&A. Lynn, would you pick this up?

Thank you. The floor is now open for questions and comments. If you do have a question or a comment, please press the numbers 1 followed by 4 on your touchtone phone at this time.

Our first question is coming from Jerry Gallant from Huberman Financial.

Good morning, gentlemen, thank you very much for your presentation. I wanted to ask you about the pace of business. On your last conference call, I believe you indicated that April was the strongest first month in history of a quarter and in history and your revenues of 6.5 million were sequentially down from the second quarter. And when I look at year-over-year if I extract what I believe to be your KC135 business in the same quarter last year -- about 700,000 -- essentially you're flat year-over-year. But your backlog is significantly higher than it was a year ago. So, could you provide some more color on what's happening out in the marketplace?

Potentially, it is program timing -- there are a number of new programs including the A-10 and NASA programs that were timed and deliveries were made or will be made within a month of the quarter, so they slipped over into next quarter. So you're seeing actually a timing, not a lack of business, but a deliverability of timing. And its 30 days type of timing.

Are you saying they slipped from the quarter end in June 30th into the quarter we are in today?

Right.

And you have been -- can you be a bit more concrete about your outlook for this quarter?

Well, I don't want to be because as you know we never provide specific guidance. I can tell you that we made -- we said that we would be flat in our revenue and from year-over-year which is what I am reiterating, that and I believe that the analysts' expectations are consistent with our own internal expectations and that's consistent with our guidance. We don't provide guidance in the traditional sense.

And, secondly, could you discuss where you are with the flat-panel display? Can you just provide some more input on where that stands?

As you know, we have a military program that amount to about almost $20 million worth of backlog. We received another release just recently for three-quarters of one million or $1 million additional equipment and we're in production delivering that equipment. It is performing well. We have an additional addition, the Cockpit IP -- which is the replacement for the traditional instrument panel in a variety of aircraft from military all through commercial and business in general aviation aircraft. That program is proceeding on schedule with a TSO (ph) submittal for the end of December. We just had a program review and it's consistent and on track and we have been notified that our patents covering the system had just been -- the first one has just been allowed and a couple of others that covered the technology that surrounded it have also just been issued. So the program -- development program is moving along strongly. The development of the product has -- we've actually, in the process -- costs have actually gone down and the program is on schedule for the December FAA TSO submittal.

Thank you very much.

Thank you. Next question is from Solomon (indiscernible).

Thank you. Good morning. Two quick questions. First off, you look like you repurchased 500,000 shares during the quarter?

Jim, is that right -- the exact number.

Solomon, we repurchased the 1,109,000 shares and if you're looking for an actual quarter breakout, I can give you that.

We can get you that, Solomon. Q3 was 500,000 shares, Solomon.

That's all I needed. The tax rate went to 24 percent this quarter from I guess roughly you'd been at the 35, 37 percent. Anything going on there?

No, what we did, Solomon, through the quarter we recognized additional R&D tax credits. We also recognized some last year and the 24 percent the tax rate in the quarter was to bring the year-to-date rate to 30 1/2 percent and that's the rate that we will go out of this year with and we will study the impact on what we would expect next year.

So all you're saying is for this year, you'd be at 30 1/2 -- you are not saying that's what you'll be at for the next year. Is that right?

(indiscernible).

Geoff, if you can walk me through -- in the press release you guys talk about a backlog, a release backlog of 22.8 million and then you've got also in there 15 million of follow-on options which I am assuming is the unreleased number?

That's correct and that has actually gone up to 25 'cause we just got another $3 million worth of business. Since the press release. Since the end of the quarter. That is why I said 25 -- sorry, Solomon -- I interrupted you. Go ahead.

So anyway that takes you up to 37.8 total. 15 plus 22 gets you to 37, you said you just got another 3, that takes you north of 40.

Correct.

But earlier you said 45 -- was there something else going on there?

Solomon this is Roman Ptakowski -- (indiscernible) earlier said 45 but later in the remarks corrected that to 40.

So the number's 40. In the RVSM you said you did 18 million on a year-to-date basis compared to 9.5 million.

A little less than 18 million.

Could you just say what you did in Q3 of this year compared to Q3 of last year? Was this business virtually all RVSM this year (indiscernible) ?

That's correct -- yes, yes. And it's actually growing. What's happened, Solomon, is the mandatory date has been put on (indiscernible) for a signature and that is expected momentarily. The words we were told by the FAA is that date is consistent with what it's always been which is a January 2005 mandatory date. And there's no reason to slip it, and I will explain why because the airlines to a large extent -- in fact, almost entirely -- are equipped to comply or a majority of them are. So there is significant pressure from the highest user of the airspace to actually implement the reduced vertical separation and the reason you want to use it is they desperately need the available routes to reduce the congestion. And it provides -- based on the implementation data from North Atlantic -- upwards to 5 percent fuel burn reduction. It's huge.

So there's enormous pressure to implement it. The largest fleet is probably business and general aviation and as you know we have roughly 30 FTCs (ph) or something like that indirectly for applications from everything from (indiscernible) Falcons to Learjets and a broad variety of equipment with our RVSM solution and that we expect to really take off, increase growing, and take off over the next couple of years. It will be a big demand beyond the date of implementation because they're estimating over 2,000 people who will not be able to find resources to install equipment.

In other words, they just can't physically put it in their airplane. (indiscernible)

Let me just jump back to ask one question I forget to ask there. How much of your backlog are you expecting to ship next quarter? For this quarter we are in?

What you are asking -- you want me to tell you what we are going to ship this quarter and, Solomon, all I can tell you is that the projections we made to you, the projections we made to you and what you believe is consistent with what we plan to do.

Let me tell you this and maybe this is your question and I'm not being fair to you. Over 95 percent -- actually 97 percent -- coverage is firm released backlog. I did not understand. That is -- and the answer is 97 percent which is the highest I think we've had in three or four years is firm released for the backlog for the quarter.

Got you.

And we're starting to ship significant amount of it already this last month and this month.

Okay -- as you look at your quarter and your monthly business do you see it improving throughout the quarter then?

Yes. I mean it's good. We're seeing -- it's early to say we are seeing an industry turn but we're clearly seeing a strengthening of our business.

Great. One last question and it relates to the flat-panel display. When you get your TSO what you're talking about in December, is that right sized for certification (indiscernible)?

No that's primary left side and the TSO is -- what the TSO is a certification that the equipment meets all the FAA requirements, environmental, and integrity issues for a primary flight display. In other words, left and right side and what it does is it means that as we put it on each airplane, we do not have to provide a lot of support data to get an STC (ph) on the specific airplane airplane types because the TSO essentially says we're complying and the FAA approval complying to all of these standards. So it accelerates supplemental TSOs I mean STCs. And I would comment that in the process of getting the TSO we will be doing significant amounts of flight testing with the FAA which would be -- the FAA even volunteered. They said with the data that we will test you'll be able to get an STC on any aircraft you do the test on, so you might as well apply for that while you're getting that because you will get it for nothing.

Okay --

Unidentified Corporate Participant This will be what we talk about left side.

Right great but okay, so that begs the next question. How long from your TSO to your first supplemental (indiscernible ) which I am going to guess will put you on a specific airplane do you think?

Two months. That's our schedule right now.

And then that would be the first aircraft you could actually be in? On a commercial basis?

On a commercial revenue aircraft that is correct. Understand, we can still put it on military aircraft anytime (indiscernible)

Without the STC but the nice part about a TSO which was -- which is a little bit of extra effort in the front end but a huge accelerator in the back end and that program is moving along very very well. We got a great team of guys working it.

Herbert Schafer.

Good morning -- good quarter. Quick question. In the past you talked about possible acquisitions. Is this still somewhere on your back burner?

It's actually more than our back burner so you understand we have engaged actually I guess I don't know quite signed yet but close to two merchant banks to actually produce MA&A work research and pursue that. So we've got one and actually two -- we're close to the second one right? I mean, we're waiting for the signatures on the second one. So we're spending lots of money to find acquisition targets, but we are very much focused toward getting a very precise profile (indiscernible) and our President has had a lot of experience in this area and has outlined criteria for the acquisition. We ranged the revenues and profits and management skills etc. in a fairly good profile so that it gives strong guidance to the banks and that is proceeding.

We are terribly conscious that we really don't want the first acquisition we make to be anything but an excellent success. So we're being prudent. Because we have a strong business core. The worst thing we can do is just try to put (indiscernible) it diverts our management, chasing problems in an acquisition. So -- being very careful. (indiscernible)

To complement Geoff's comments, we are obviously a strategic investor not a financial investor so these -- we got to get synergies out of these types of investments that will get the multiplying kind of benefits that you'd expect in a strategic investment. We have identified those criteria, we've gotten them accepted by the merchant bankers and they understand what we're after.

That sounds very good. One further question on the RVSM. You alluded to this, but understand -- this program is going to run into 205, 206 (indiscernible)

It will go down. It will drop off. It will be a peaking but we've always known this and that's why programs like the flat panel in other programs we're working on with the military are going to fill in that area. And that's pretty consistent with any product. In today's technology and -- you're seeing a lot of it with our competitors. In the old days you could run a product for a very long period of time. I can remember with my first business we sold primary flat displays to Boeing --

Today I would suspect that you're not going to sell the same equipment for more than about four years or five years. In other words, the same thing we have seen in PCs and every other technical appliance is now coming more and more into the aviation industry. So the technology -- the demand for performance and expansion of function is going to cause great demand on new product development. And we do that well.

All that sounds good. Thank you.

Richard (indiscernible) of Lockport Partners.

I have a couple of questions if I may. The decline in R&D quarter to quarter. What happened there?

It's a function -- it is a double function. First of all primarily in the timing function and Roman can expand on this, but, primarily, it's outside services has been a significant portion of our R&D. And this quarter we had no demand for outside services. So it reduced that number. And they were associated with certifications specifically in the other quarters and the secondary -- and, secondarily, it's -- we had a significant write-off. We had accrued certification expenses for parts of our flat panel program and we opted to write them off last year, so that we had no capitalized R&D in that entire part of the capitalized R&D for the flat panel program we wrote off.

Okay, but I was really looking at the quarter to quarter.

You're talking about the...

Yeah the quarter to quarter is down.

Program timing issues exactly what is ahead (indiscernible ). (MULTIPLE SPEAKERS)

We continue to spend at our underlying rate of about 13 percent of revenues on R&D. We've continued to spend on the if you will the new core product line of like technology in particular and lesser amounts certainly spent this year and over prior quarters in the RVSM area. Initially, you know we had to expand the product suite there but a lot of that has been accomplished. So if you will the existing product line doesn't require the R&D effort that it required in prior periods.

It is literally -- we discussed earlier, it's a literally program timing issue but the underlying rate is unchanged.

Okay. Then can you talk if there is such a thing as a typical contract, how do these things ramp up in terms of the revenues? Do they start for a quarter or two and build until you get the production line organized and then they're flat for the rest of the life of the contract? Or do they -- or -- just the general contract?

Let me take a stab and answer that for you. One is, there probably are no typical contracts as we all know. Unfortunately, you get to spend more time negotiating the contract than (indiscernible) art shipping products and we all face that. Depending on the complexity of the product and how new the application is, if it's a expansion of a given product line, an extension of something we already have, we would typically see that we would spend the first three months defining the requirements and developing what is a product application specific to the customer's needs and then it would generate revenue on an ongoing basis.

Then you got other longer-term contracts that may involve the military, where they will do proof of concept initially before they out (indiscernible) (indiscernible) as little as three months to us much as a year and these contracts run for a long time. As we hear all the time in the military these platforms are put into business over a seven- to ten-year period. The most recent example being I think that involves our Company is the Boeing 767 tanker leasing program where -- those are planes that we purchased over about a seven-year period. So we will be recognizing revenues from a program like that over many years.

I see. Okay. Then in the last quarter, the last conference call, you were talking about how it was cheaper for the -- to replace the -- with your flat panel than it was to maintain the existing systems. Would that require a retrofit of the cabin or the display panels sitting in front of the pilots?

It would not require -- our equipment requires little if any structural modification. It would essentially a typical retrofit would replace or get rid of something on the order of 23 part numbers and probably 210 pounds or 250 pounds worth of equipment would be replaced by 25 to 30 pounds of our equipment. But there are no real structural modifications. I mean support panels are modified but it's pretty minor.

I see.

If I can I will add a little color to that -- your specific comment there, too. These are discussions that we're having -- our solution's using the commercially available technologies and applying them in this business have allowed us to offer products that are less expensive in terms of an acquisition than to maintain existing O&M budgets, operating maintenance budgets, but, again, in the world of budgeting to get people to move dollars and funding from an O&M budget to a capital budget -- sometimes it takes a little work for them to understand that. I mean intellectually they understand it, but to do that takes the buy in from the different departments that are involved on the customer side.

I have been flying a lot on Comair a lot recently and I noticed they mostly seem to be flying under 29,000 feet and I've asked the pilots if they are RVSM compliant and the answer is no. Are they likely to just stay under 29,000 in the -- after '04?

I don't know what they fly -- sorry, I don't know Comair.

40 or 50 seat -- I think they're Bombardier.

Bombardier -- but are they regional jets.

Yeah, regional jets.

(indiscernible) then, in that case they should continue to fly under 29,000 feet for short hops. The problem is for them is when RVSM is made mandatory roughly 2000 to 3000 aircraft that are now presently using the higher altitudes will be moved down to the altitudes that these CRJs delays are presently using. Which would suggest that they better change their schedules a bit. It's all a matter of space.

There are a lot of aircraft that optimally run in that space. The issue is going to be for several years that -- that space which is normally occupied by some regional jets, short hop which you're only going to go from New York to Boston or Washington or Boston you will very possibly stay under 29,000 feet.

What will happen is that the aircraft that have been flying above that, many of the bizjets that do not get RVSM implemented in time will have to move down to that lower altitude and make it extremely busy. And it will likely inspire people operating there that have the capability to go higher actually move higher. As an example (indiscernible) Airs which are traditionally airplanes that run at 25 -- 28,000 feet that have the capability to go over upwards to 35 or higher, will find themselves moving -- providing -- going into RVSM space simply because there isn't going to be a lot of traffic up there. Two reasons because they double the available space by reducing the vertical separation and the people that haven't gotten their equipment in time are all going to move down to that lower altitude.

Our airplane is an example. It's capable of going go into RVSM space and we've actually we may be going there once because there hasn't been any reason to, but now it will be very desirable to be able to do it because there will be very little traffic up there compared to the space that we normally run which is in the high 20s.

I'd like to come visit your Company. Is that impossible?

Get hold of Jim and see if it's available. I mean on a limited basis we are delighted to have people come by and if we're available to have people chat with you. We will have to (indiscernible) we have to be prudent in what we're capable of discussing.

Of course.

All right?

(indiscernible)

The floor is still open for questions and comments. (Caller Instructions). (indiscernible)

A private investor and shareholder. I wanted to know for RVSM, what is the percent of business in commercial planes that already have met the FAA requirements and what is the percent that still have to add it by the January 05 deadline?

For commercial air transport airlines, in other words?

Yes.

I don't know the precise number but I can give you a rough estimate. I think there's probably three-quarters -- two-thirds to three-quarters are fully equipped. Probably two-thirds. We happen to be involved in delivery of a number of airline programs, including Northwest. So I would say two-thirds to three-quarters. And I would expect -- I mean, remember our regional jet is a commercial jet as well so those -- there may be RJs that are not equipped although I am surprised that many of them come from the factory that way. It's the business and general aviation market that is going to be the strongest now for the next year and a half to two years. The commercial guys have pretty much equipped their fleets.

Okay.

You can still fly short hops New York to Boston kind of thing. It's not a terrible penalty except that I believe that and most people believe that when the mandatory date comes it is going to be extremely busy in that 20 to 30,000 foot range.

Okay. In terms of the business and general aviation, what is the percent of planes that already have met the requirements (indiscernible) (inaudible)

It's under half -- based on the numbers we're getting it is something in the area of 35 to 40 percent. It's a big number left.

Okay. What is the percent of the backlog that is RVSM?

Of the released backlog, it's probably 90 percent RVSM. (indiscernible)

75 percent. (indiscernible) Tax in there is a very small piece.

75 percent of the released backlog is RVSM related.

Because the RVSM equipment is easy to install is it easy for the customers to wait until the last moment to buy?

I'll comment on that. They can buy it at the last-minute but they're going to run out of service centers that can do the installation. That is the -- if you will -- the constraint: how many planes can be done in the last-minute. We certainly can supply them from an equipment standpoint but it is the installation, the certification that then is required aircraft by aircraft, all the paperwork needs to be filed and that is what will cause the constraint at the end as people approach the deadline and why they should really be scheduling that today. Those commercial operators who've run fleets of 100 airplanes and so on have been installing this equipment on a regular basis because they understand you can't do it all at the last-minute.

So once you buy and you get certified it takes maybe 3 to 6 must?

No but these operators will basically do an aircraft like one every two weeks. (indiscernible) installers and so -- that's about one a week I should say and then if you will if every operator or installer could do 4 per month, how many are there? You can just do the math and (indiscernible) Some installers that can do.

More than that parallel 3 and 5 but the constraint is once the equipment can be delivered and installed at the same time, but right now, there's an increasing backlog for the installers to install the equipment. And it will get -- when the mandatory date comes, it will be worse. The reason many people pause and wait is in the past on other programs the FAA has delayed implementation date by a year or so. And many operators say, I don't want install equipment I can't use that has no value to me. So they wait until the mandatory announcement comes out. Unfortunately it seems to be delayed a little bit. The announcement not the date of implementation which is creating this big bubble at the end.

I mean RVSM equipment has very little if any value until you have RVSM airspace. So many people are saying, I am not going to put the stuff in.

Now the commercial operators have no alternative because they cannot operate their aircraft and I understand if they had to operate their aircraft at below 29,000, it would be a disaster. So they can't take the risk whereas the individual operators, that's a judgment call the owner makes.

One or two quick questions I had was what are the percent margins the Company has for RVSM?

On a retrofit basis, we believe we have close to 50 percent on a retro fit. That's not upgrading existing equipment that comes in the aircraft that is changing or recalibrating. We're talking about replacement is probably close to 50 percent.

And, lastly, when does the Company see RVSM demand peaking?

Say that again.

When do you see your RVSM sales peaking?

Next year.

Sometime next year? Middle of next year (MULTIPLE SPEAKERS )

Yes, something like that -- the middle of next year.

Thank you. Solomon Aceuil (ph).

Just a quick follow-up. What's the number of shares outstanding at the end of the quarter?

12 million.

Jerry Gallant.

Just a follow-up on the points you're just making about the FAA deadline. To the best of your knowledge not being extended but this signature being somewhat delayed -- in talking with installers around the country, I'm getting the feedback that customers are -- they don't believe it's real. Not the commercial aviation business jet and they're kind of waiting and waiting and installers are telling me yeah, there's a little more interest but there's not a line around the block yet. And yet everybody who is close to this says, there's no way that everybody can get installed by then because of the limited supplies. Installers that you've alluded to and the test for certification process. So I guess I am just -- what's your read on the FAA? I mean is this going to be signed sometime in the next 30 days and is there going to be kind of a big light goes off at that point because everyone realized I made the analogy that it is sort of a Y2K event but there everybody knew that the clock was going to turn and the calendar was going to change. Here we're kind of waiting for somebody in the government to finally do something and --

Well, the answer is, if you take the commercial airlines which have billions and billions of dollars worth an investment. They have, without exception, committed to meet that date. They all have. In 1998, the same questions occurred on whether the FAA and IKO would make the North Atlantic Corridor mandatory on the date that they had planned it to be. Well the date slipped one month and it became mandatory and a number of people with bizjets found that they couldn't fly across the Atlantic and they ultimately fixed the problem but that was a minor problem because that's the North Atlantic Corridor.

Historically, Europe accelerated and actually implemented three months early. Australia and the Pacific have already grown hot. If people believe this isn't going to happen, I think they all (indiscernible) if it's done I can still fly my airplane. If it were me, personally, I would have the equipment when it was -- when everybody said it was mandatory. Do I believe they're going to slip the date. No.

Does anybody that is in the industry that knows the details believe it is going to slip? No.

Tim Hall.

Wanted to know the percent of your backlog that is business and regional jet RVSM?

It's again the only number we will give out is that our backlog is about 75 percent RVSM. We don't give a further split. But we have in addition to business jet and so on, we do certainly have commercial airlines, freighters which also are covered by RVSM. And those are in those numbers.

We will take more question and we will conclude the conference call.

There are no more questions at this time, sir.

Thank you for everyone's participation and interest. We will talk to you at the next investor conference call.

Thank you. This does conclude today's teleconference. Please disconnect your lines at this time and have a great day.

(CONFERENCE CALL CONCLUDED)