Innovative Solutions and Support Inc (ISSC) 2004 Q1 法說會逐字稿

Good morning and welcome to the first quarter conference call for Innovative Solutions and Support. At this time all participants have been placed on a listen-only mode and the floor will be open (Operator Instructions). At this time, it is my pleasure to introduce Geoffrey Hedrick, Chairman and Chief Executive. Mr. Headrick, you may begin.

Thank you, good morning. This is Geoff Hedrick. And as she said, I'm Chairman and Chief Executive of Innovative Solutions and Support. I welcome you to this first quarter conference call. Where in a few minutes we will discuss the results for the period ending December 31, 2003.

Joining me on the call are our corporate -- and our corporate office is Pennsylvania -- is our President, Roman Ptakowski; our CFO, Jim Reilly and our controller Jeff Bonum (ph). But before we get started, I would like Jim to read our Safe Harbor message. Go ahead.

Thanks, Geoff, and good morning everyone. Certain matters discussed in this conference call, including operational and financial results of the future periods, are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially, either better or worse, 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.

Thanks, Jim. I'll be talking to you in some detail about our quarterly results, but I would like to address a recent problem we had with the premature release of our 10-Q filing. We had planned that 10-Q filing for February 4th, and put out an announcement last week as most of you I think know. For unknown reason, our local printing firm, Donnelly, who does generally a very fine job, apologetically released it Friday prematurely and it came out on the street yesterday. It has sadly created some uncertainty and disruption.

I would like to announce that there is no uncertainty and there's no disruption. In the discussions today, I think you'll find that the company is stronger today than yesterday, and stronger than I think in anytime in our history.

We had a great first quarter. It was at or above plant. We did substantially better than last year, although you know last year was a problem. It was -- on the numbers -- it was double last, year, roughly. But, practically, it was exactly what we had planned -- slightly above and we maintained our margins at almost 60 percent.

Net income was obviously significantly higher and it came in at just as exactly what we had planned for this quarter, to support our goal of satisfying our projections from the analysts for this year. It is consistent with an upward growth slope, as most of you who have followed us in the past, recognize that our quarters tend to progressively get larger as we mature through the year. And that's natural for a Company that is anticipating the kind of gross we're talking about. I appreciate that the analysts have us doubling this year. I mean that's -- even for me, I think, that's pretty aggressive. But we are comforted and comfortable that we can achieve that kind of performance. We have a record backlog. Record backlog of -- is now 26 million, and that's significantly ahead of last year's at this time. It's substantially commercial, but we expect it to have a fair amount of additional military business.

In addition, we have about 17 million in unreleased backlog, bringing the combined total for about 43 million. We're looking at a backlog and equipment shipped of roughly $40 million. So that would say that we're already locked in with orders -- released orders for the fiscal year, and are almost 50 percent ahead of last year. So it's a very positive and strong future and we believe that in addition that our engineering developments have been moving along incredibly well. So I'm very comfortable there.

The balance sheet is strong. We have 52 million in cash, that's $4.42 of the stock repurchase program was successful. We stopped it early so that we would maintain a reasonable liquidity in the marketplace. We believe that going forward there will be increased liquidity as some of early investors that may release some of their stock -- we're happy to see that.

We're very pleased to also note that recently in the last three months that the stock has been trading at much more -- much higher volumes, which I think is good for all of our investors. Our assets are 72 million, and after subtracting 10.6 million for treasury stock, our stockholders equity is 63 million, but -- and the cash from operations in the quarter were almost 3.1 million. So we continue to generate cash, we maintain a strong cash balance sheet. And our future looking forward looks like we will maintain that standard going forward. What I would like to do is open it up for questions. Operator are you there?

Thank you. (Operator Instructions). Chris Versace, FBR.

I just had two real questions for you. The first would have been, I know you guys had very strong backlog coming out of the December quarter and I was a little surprised to see the degree of seasonality still exists in the business. Can you talk about that? And talk about how the level of comfort you have with the back level you have this year, and any kind of robust growth prospects we have? In part because there is -- is there a healthy piece coming from our RVSM in North America in terms of your backlog?

First of all, it's really not seasonal, although if you project -- if you look at a business in a strong growth area, you would expect that the end of -- at the end of a year, it's always going to be stronger than the beginning of the year. Because if you are even to maintain a general upward slope, the end of the year is also always much stronger than the beginning of the year. So, it's not seasonality but it's clearly -- we're looking into a very strong and aggressive growth.

If you go back and you take a look at last year at 28 million, that says on a quarterly basis -- that's 7 million. Notably, this quarter was 8.5 over the average of 7.5 for last year. So it really is in an upward trend it is just that we were, last year the recovery happened near the end of the year, and we filled it in at the end of the year. So, it's pretty consistent with what we've seen in the past.

Backlog it's terrific, Chris. I mean, the backlog is almost $41 million, that is released for the year. We've never had a backlog even remotely close to that and we feel very strong. Plus, we see almost eight months to go and we're still going to be booking in orders, we book in orders almost daily for RVSM and other equipment.

And remember, RVSM will continue on for several years. Because, we will be able to -- based on the numbers we're looking, at they won't be able to satisfy but about 40 percent of the actual demand because there's not adequate installation. So, we see it continuing on through 2005 and onward. In addition, the product we call RVSM is air data systems and there are tens of thousands of them that are 20 and 30-year-old technology that are not RVSM applicable, but will need a support and replacement, because the components in them are obsolete. So we continue to see a strong product area in our air data product line.

So in summary, yes, we see the RVSM business maturing very much as expected. It's strong. Our backlog is strong. And the first quarter is basically what we expected. We actually expected slightly less.

Okay and then just two other quick questions.

Just to interject one term -- the backlog numbers about the released and an unreleased number. Just to be clear on that -- we don't want to misstate -- change some of these expectations.

When we talk about backlog, we talk about released and unreleased. But the 40 million that I'm talking about includes the 8.5 million that we already shipped. So when I talk about a $40 million so-called backlog for the year, that includes the 8 million and we shipped.

Okay, okay.

And if we continue to book on that, at this point, we would expect to do 40 to 41 million, which again there is almost 50 percent over last year. I might also add as you well know that once you get over the break even point, the gross margins tend to drop directly to the bottom-line. So that almost 50 percent of revenue drops to the net after-tax profit line.

Okay. And just two other quick questions. One, given the recent share repurchases, can you just tell us what was the -- and this is for Jim -- the actual shares outstanding at the end of quarter?

The actual shares first we published in the 10, (indiscernible) 11 million, 486.

And then one last one. It's been a little bit -- and I don't want to distract detract from RVSM -- but can you guys give us a brief update on the flat-panel product and what's going on there?

Flat-panel product is moving along extremely well. As you know, we are continuing to ship flat panels on a number of programs very successfully. In addition, we are in negotiation on a couple of significant programs, which I prefer not to discuss. But they are flat-panel related. And I -- you will be hearing increasingly more information on the progress of the flat-panel over the next several months.

Okay and just to that point, Geoff, you said you did ship some in the quarter. It sounds like any sense -- less than 10 percent of revenue, less than 5 percent of revenue for the quarter?

It's still definitely less than 10 percent. It's about probably 5. But we expect that to move up. We could not -- I won't say that we are overly taxed but you know our plan has always been for that to slide in and continue the growth of the business as RVSM leveled off. So it's following that trend and we're very optimistic. The product is stronger, then it -- it continues to improve from performance as it goes through -- or goes into the production cycle we're seeing significant cost reductions and improvements in its ability to produce-ability. So, all the indications are very positive. We're very optimistic. We continue to be very optimistic with the product.

And just -- let me just steal one last one. I'll let someone else in. You mentioned a number of programs. Without telling us what they are, are they all for the same original application, in terms of the cockpits? Or are there other applications?

They are airborne. That's probably the best thing. They are airborne -- a variety, from cockpit to other applications that are airborne.

Okay, thank you.

Okay, please understand that I have to be a little circumspect about discussions because we're in the middle of negotiation on a couple of programs, and it would be imprudent for me to discuss them.

No, thank you, sir.

Selman Akyol, Stifel Nicolaus.

A couple of quick questions. First of all, I'm a little confused on the backlog numbers here. Your 26 million at the end of the quarter, plus another 17 on top of that, that would take you to 42 million in total backlog, regardless of the 8 million that you shipped this quarter. Is that not a correct understanding?

Yes, Selman, maybe I can qualify this a little bit for you. The backlog that we talk about -- the official backlog at the end of the quarter is 26 million. Released. On top of that, we have 17 million of unreleased backlog that gets us to 43 million. But the number that Geoff was talking about was a combination of what we shipped in the first quarter, plus what is now in backlog that will ship out this year. That's about $40 million, exactly.

We ground substantially in January -- there's essentially -- the differences are. Plus we shipped product in January, also.

Now, Jim that was very helpful. But then -- so I just have an understanding of the Company -- you would still expect to receive orders this year that you will ship this year?

Oh, absolutely.

Okay.

Yes, and we've done that and we would expect significant orders in this year. But, (multiple speakers)

Do you want to quantify significant?

No. I don't know what it is. But I know it's good.

Okay. Then, just going back to the backlog for a minute -- can you split it out between military and commercial, please?

Yes, the backlog, Selman, as we sit here right now, is about 90 percent commercial. However, when we add the unreleased backlog, that shifts from 90 percent commercial to about 46 percent or 50 percent commercial and 40 percent military. And a lot of the new business that is coming in, that we are alluding to, is leaning towards the commercial side as opposed to the military side. But it's going to be pretty balanced.

Got you. Okay. Let me, if I may, turn to the flat-panel, Geoff, and I will be honest with you, I was sort of expecting an understanding that you guys would have been looking for a date to submit for your TSO.

We got people at the FDA (ph) this morning. I-I -- look it's -- until I have specifics, I would prefer not to discuss it at this point. It's a sensitive time. But I will guarantee you that within the next three or four weeks we will come out with an announcement. But I can tell you that we feel comfortable and the update in three or four weeks, we will give you an update on the progress on that program.

Okay so I should expect to have more of my questions answered within the next several weeks.

Right -- the program continues to move. We have not lost any business on this program. In some cases, some of the anticipated business or the business we had hoped for may have moved to the right. No body else has gotten the business. There are majors changes occurring in the industry, as you are aware. We're looking at partnering with people -- and there are a number of other developments. That's going to take some time to mature. It would be -- we would only be able to give you a very small part of the picture. I continue to be optimistic with the flat-panel program.

Okay. Let me add -- (multiple speakers)

I can tell you that there are, at this point in the game for sure, there are no technical problems. No issues in front of us that are putting the program at risk.

Got you. Now, can you -- again not talking about your flat-panel, but as you take a look out there on the horizon for competition and what they're doing -- are you hearing of anything -- is anyone close out there to doing what you're doing?

I think there are a number of people that are making a variety of flat-panel switches, consistent with what we suggested three years ago, that that would be the direction it's going. But there have been no -- there have been no major changes in profile in the commercial or military product areas. In the general aviation lower end of markets. There are, as an example -- Garmon (ph) is producing a panel for the Mustang. But they don't have a product, they don't have -- to my knowledge, they don't have a product yet for certification. And they provide in the package. On the Mustang.

We never targeted that as a product area that we were going after, so that we never -- we don't see that as an issue. We continue to believe that our product -- and we've been told that our product -- is strongly a better performer and the cost line, as we move it into production, continues to improve. That is, significantly less -- which means our competitive position retains. We would like to have the TSO's issued at this point? Yes. But we're not there yet, and it's probably imprudent for me to discuss the details of that and the other things at this point.

Right. One last question I will let go. Just so I have an understanding, though -- you apply for your TSO first and then you're STCs (ph) after that?

The only reason you get TSO's is that it eliminates the requirement of, essentially, eliminates the requirement of providing the support data -- the package -- that normally gets associated with a supplemental tax certificate. And that is -- all of the environmental testing of all the equipment. We will do that in the front end, and that is non-airplane specific. It's still an STC, but it's significantly facilitated by the TSO. And we're going in those directions and there is a -- that program is moving along well.

Okay, thanks.

Jerry Galant, Huberman Financial.

I wonder if you could walk us through the sequence of events between -- that occurs from receiving an order and it going into backlog? And then shipments actually being made and revenue obviously being booked at that point? Just give us -- because obviously -- you don't seem to have a lot in inventory, so maybe could just walk us through a normal or average sequence of events?

Well I mean -- unfortunately, I don't know that there is a normal event. I mean, it varies anywhere from -- orders that will come in are -- literally can be shipped within four weeks or three weeks. And then there are situations where you'll have an order that is for delivery two years from now. So there is a rather broad variation of that.

But typically, if you end up with a firm, fresh order, without a specific prepurchase or planning, (indiscernible) you receive the order in, theoretical cycle for procurement is around three months to bring in new material to support that. And then from there, the cycle time and production is less than 30 days. So on a -- without a lot of pressure -- about four months on the average.

But a fair amount of our equipment, like RVSM equipment, is fairly uniform. And from airplane to airplane is a tremendous number of common parts. So in many cases we can accelerate deliveries. The issue we would run into as we increase the volume, it is more and more difficult to push a new order through without putting pressure on the production (indiscernible) floor. But we do that routinely. That's sort of planned in as required. So, we would like to turn our inventories -- and we have a plan in-place and increase our inventories significantly -- turns of our inventory.

As you know, the material costs are a relatively small portion of our sell price. You can see that in our gross margins. So, that and the fact that our direct labor content is significantly less than 3 percent on the average product, we are able to turn the product quickly by design. We control virtually the entire process in-house. We do our own circuit boards etc. We don't mold plastic parts but we keep those inventoried. So we have a good control on the supply chain.

Geoff, if I may, this is Roman Ptakowski. Jerry, one other comments and maybe this is behind a question a little. We have the capacity to support the increases in demand that we foresee in the marketplace. So that -- both from a production standpoint and material procurements standpoint -- we can meet the demand the marketplace.

Yes you are right, that was going to be my next question. Was capacity and I think you've alluded to that a little bit, because you've got a fairly new manufacturing plant and so okay --

We had actually talked to that before. I think we -- in our last release we talked about the fact that we were capable of handling almost three times the previous volume. So, out of this plant we could manage our expectations for this year, with a probably a 50 percent or 75 percent reserve. We work single shifts and we're able to meet our commitments.

Right. Okay. So that's not an issue.

I mean it's getting -- it's a -- the more business we get in the better. The only issues you have is you are prudent the way you produce the product. Because, the quality of the product that we feel is really rather remarkable. Our warranty reserve -- our warranty expenses -- our warranty expenses -- as a function of revenue. It's about half of 1 percent. That's four or five times better than the industry average. And that speaks very highly to the product. One of the reasons we do it that way is so we (indiscernible) and we also know that when you push things out the door, that you always risk having a problem. By the way, we continue to produce products 100 percent environmental stress free. Everything we can make has 18 hours of thermal cycling, and three axes random vibration before shipments. 100 percent of our product.

Let me ask you -- change the subject a little bit. Airbus -- last year they shipped more new planes than Boeing and now it appears they are making some entry into the military marketplace. What kind of business -- have you done any business with Airbus before? Or provided equipment that goes into Airbus aircraft?

Indirectly, on RVSM, but we do not do business directly with Airbus. Although we are in discussions with Airbus. As you know, we have focused most of our business not on the OEM, but on retro fit. Because even in a good year, the quantity of new airplanes produced is 2 or 300, whereas we'll support probably close to 1,000 aircraft this year.

Okay. I presume you have shown them your designs for flat-panel?

We have and they have shown some very good interest. And I would expect -- and we've made a number of trips to talk with them. It is a -- especially in Europe -- it is a long-term have them get to know us kind of relationship. And we started that effort about 1.5 or 2 years ago. So we're moving well, we have a good rapport, and I think some real interest in our product. And we are in discussions on opportunities there.

Great. Thank you very much.

I think I should really say that we are -- we see them as a -- an important opportunity. We are aggressively pursuing that marketplace is really the proper answer. The specifics I cannot go into. But we see that as a strong customer.

Great, thank you.

Jim Leonard (ph), Highwood partners.

You guys generate an amazing amount of cash flow. You generated about 2.75 million free cash flow in the December quarter alone. Since you have apparently pulled back, at least for the time being, on your stock buyback, can we assume that you're still keeping your powder dry for a potential acquisition?

Very much so. We have an aggressive program. We are very interested in making the right acquisition and we are accumulating our stock -- our cash with that in mind. It is imperative that we get the right acquisition. And it is difficult to find the right match. We have been cautious that we want to preserve -- we not only want to preserve the business model, but we want to be able to find an acquisition that's truly synergistic. Everyone talks about synergy. But in our case, it's absolutely imperative that we pick the right one. And as you can expect, if we pick the wrong one, the street will punish us. For failing in our first one. We're very conscious of that.

But more importantly, we don't want to get something too small, because it takes an enormous amount of management effort to look after it. Disproportionately high. So we're relatively range limited and we want to find a very good Company. And very good Companies tend not to want to be acquired. So, we have happily a couple of opportunities we continue to pursue. We're very, very interested in making more than one key acquisitions to grow the business. And we hope to do that this year.

But as you point, out we're keeping our powder dry. We don't anticipate buying back any of our stock anymore. Because we want to keep adequate liquidity out there. I think a buyback could have a sufficiently negative effect on liquidity, as to not help us -- the value -- the stockholders' value.

Speaking of liquidity, you're talking about the liquidity of the stock in the trading volume?

Exactly. I don't mean financial liquidity. Happily, we have good financial liquidity.

Right. Thank you very much.

At this time, there are no further questions.

I hope that's good news. Again, I will reiterate. We feel that we have a very strong forward look. We're only through the first quarter and we have a very significant amount of business on the books and ready to ship. We think we will have a strong year and we feel confident that we are going to be able to make our analysts' estimates this year. The business is strong over the next -- in the next three or four weeks, we will be able to continue to give you additional information on progress -- hopefully in our flat-panel program and how that's doing -- without compromising the business that we're pursuing. Thank you for attending our conference call. Goodbye.

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