Innovative Solutions and Support Inc (ISSC) 2008 Q3 法說會逐字稿

Good morning, ladies and gentlemen. My name is Janelle, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Innovative Solutions and Support third quarter 2008 earnings call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (OPERATOR INSTRUCTIONS).

It is now my pleasure to turn the floor over to your host, John Long, CFO. Sir, you may begin.

Morning. Certain matters discussed in this conference call today, including operational and financial results for the future periods, are forward-looking statements that are subject to the 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 our Company's 10-K, which is on file with the SEC.

It is now my pleasure to turn the call over to Mr. Ray Wilson, Chief Executive Officer. Ray?

Thank you, John. Good morning. Contrary to what Janelle said, John is not the host, I am. It's Ray Wilson, CEO. I welcome you to our conference call this morning where, in a few minutes, we'll discuss the results of the third quarter and the first nine months of fiscal 2008, ending on June the 30th, 2008. In addition, we will discuss the current business climate and outlook.

Joining me today from our corporate office in Exton, Pennsylvania, is Roman Ptakowski, our President, and, as you've heard already, John Long, our CFO.

Results from the third quarter show continued progress against our long-term objectives, with revenues rising on a sequential basis for the second consecutive quarter and losses moderating consistent with our objective to achieve quarterly profits by the fourth quarter of this year. We have achieved significant progress in the last few quarters and feel that we are executing the plan as we have shared with the investment community. Over the long term, we believe this is the best strategy to build significant value for shareholders.

This morning, John will go through the results in the a bit more detail, and Roman will provide an update on our backlog and new business activities. I will return for a few concluding remarks before we take your questions. I will now hand over to John Long.

Thanks, Ray, and thank you all for being on the call with us this morning. Let's get right into the numbers.

Revenues in the third quarter were $8.8 million, up 50% from a year ago and up approximately 29% sequentially for the second quarter, when revenues were $6.8 million. This is our second consecutive quarter of sequential revenue growth, indicative of a ramp in the number of programs moving out of our backlog and into production.

Of the total revenues in the quarter, approximately $4.9 million was for flat-panel systems. Continuing shipments under our five-year OEM agreement with Eclipse were the largest contributor, but only account for about one-third of quarterly revenues.

We experienced significant flat panel revenues in the quarter from our FedEx and American contracts, as well as from a growing variety of other, smaller commercial, military and business aircraft contracts.

Air Data product shipments in the quarter were approximately $2.3 million. This quarter, we also recognized approximately $1.6 million in engineering, modification and development revenue from billings associated with change-in-scope provisions in our contracts, as well as from reimbursable costs incurred for customer-specified modifications.

Gross margins were 47.8% in the quarter, compared to 44.4% in the second quarter, an improvement of about 300 basis points, up from 37.7% in the year-ago period. Product gross margins were 46.4% in the third quarter as compared to 40.3% in the second quarter.

With production rates rising, we are achieving better absorption of our fixed manufacturing overhead and, consequently, seeing improvements in our product margins. We continue to drive to the 50+% gross margins as we leverage fixed manufacturing overheads for additional volume.

R&D expenses in the quarter were about $3.2 million, comparable to $2.8 million in the second quarter. In a minute, Roman will discuss the improvements to our Pilatus product and the progress on other programs that are a result of our research and development investment.

SG&A spending totaled $3.3 million in the quarter, compared to $4.7 million in the second quarter. SG&A spending in the third quarter of '07 was $4.2 million. Selling, general and administrative expenses in the quarter were consistent with the roughly $3 million to $3.3 million run rate that we had previously forecast, and were held to that level inclusive of $500,000 in legal expense.

As you may have recently read, the court has now issued a judgment in favor of IS&S for over $23 million in the aggregate. We expect that legal expenses for the fourth quarter will be in the $300,000 range that we had indicated on our last call.

In the third quarter, we took a $2.5 million non-cash impairment charge related to acquired engineering software. Our current product development road map does not include the use of this software, and that was the basis for that non-cash impairment charge under FAS-144.

Net interest and other income was $250,000 in the third quarter, down $450,000 from $700,000 in the second quarter, when we had a large non-recurring gain. Lower cash balances as well as a lower interest rate environment have, and more likely than not will continue to, reduce interest income over the balance of this fiscal year.

For the third quarter, the net loss was $4.3 million, or $0.25 per diluted share, down from the $7.1 million, or $0.42 per fully diluted share, loss in the second quarter. A year ago, the loss was $1.4 million, or $0.08 per fully diluted share, and benefited from a $1 million tax credit.

The Company didn't repurchase any shares during the third quarter under the previously announced share repurchase program. Decisions as to the timing and amount of any share repurchases are approved by a committee of our Board of Directors that gives consideration to alternate investment opportunities, the current economic environment, as well as the Company's financial position. Any activity that does occur under the plan is subject to the trading window restrictions as outlined in our insider trading policy document.

Our financial position remains strong. At June 30, 2008, we had $41.1 million in cash, virtually no debt, and shareholder equity of approximately $57 million. We have not recognized in the financials at this point any of the previously mentioned $23 million favorable jury verdict in our financials.

We anticipate finishing the fourth quarter of our fiscal year with approximately $14 million of annual revenue and a year-end total of about $35 million.

For the fourth quarter, we anticipate our gross margin to be slightly above 50%. R&D and SG&A will be roughly in line with our third quarter levels. And the effective tax rate for the fourth quarter will be 0% as a result of the previously established valuation allowance.

We do anticipate providing annual earnings guidance for fiscal 2009 in our fourth quarter earnings release.

In closing, our balance sheet positions us with a great deal of financial flexibility to effectively leverage and manage the increasing production levels that we have been experiencing and intend to drive into the future.

I'd now like to turn the call over to Roman. Roman?

Thank you, John. As we have reported before, your Company has structured its business development efforts into commercial, air transport, military, and business and general aviation to allow us to better capitalize on the unique opportunities in each of these market segments.

During the third quarter, we were heavily engaged in flight and ground testing over a broad range of programs and platforms in each of the markets. In fact, our engineering investment was supporting certification efforts on eight different programs in parallel.

In the commercial segment, our flat-panel display systems were installed in both American Airlines and FedEx Express Boeing 757 aircraft. Feedback is that the "overall system functionality is outstanding. Every pilot that sees the system loves it and can't wait to fly it."

IS&S received a number of amended STCs for the Boeing 757/767 platform from the FAA, adding increased functionality to the cockpit IP flat-panel display system. As we stated previously, these flagship programs have created interest in the use of the Company's products by other Boeing 757/767 fleet operators. They realize that the IS&S cockpit IP system offers the best solution to meet their needs in the areas of presenting additional information to flight crews, complying with current and future regulatory requirements such as ADSP, improving dispatch reliability, and reducing the cost of aging equipment maintenance, repair and obsolescence.

The FPDS system is also viewed as helping with the commercial airline sectors' green efforts. The carbon footprint of the aircraft is reduced through the savings in weight and the ability to fly more fuel-efficient routes. As the FAA certifies additional precise navigation routes, also known as RMP, operators of aircraft equipped with the IS&S FPDS will be immediately able to take advantage. They will reduce emissions while improving flight safety and increasing utilization of airspace capacity.

In the military segment, the Company's cockpit IP solutions were in tests both domestically and internationally for the C-130 and KDC-10 military air transports. Feedback excerpts are "all testing was performed successfully. Crew workload has been significantly reduced. The performance of the display system was outstanding."

The Company successfully concluded all testing of its newly introduced large format mission displays for military aircraft, and will commence shipment in the fourth quarter of fiscal year 2008.

In the general aviation segment, we recently announced enhanced features to our Pilatus PC-12 product. These include a single-sided cockpit solution, offering customers a low-cost entry point for retrofit, with the option of completing the full avionics suite at a later date. Wide-area augmentation system, or WAS, capability, allowing operators to fly precision approaches at smaller airports. And reduced vertical separation minimum, RVSM, certification will be available for the IS&S cockpit configurations for the PC-12, providing pilots access to the more fuel-efficient RVSM airspace.

We also announced that our PC-12 program has formed a new partnership with Finnoff Aviation. Finnoff Aviation is led by Chris Finnoff, the former president of Pilatus Business Aircraft Limited. As our newest independent sales agent, Finnoff Aviation will use its over 50 years of industry expertise to expand flat-panel display system sales for the Pilatus PC-12 on a worldwide basis.

Continuing with general aviation, Eclipse Aviation has initiated flight testing of software release 1.5, which adds additional flight management and planning capabilities to the already impressive functionality of the E-500.

We are well under way with the Cessna STC effort for legacy Citation aircraft. Ground and flight testing is to take place in this quarter. Submission for FAA certification will take place at the conclusion of ground and flight testing.

The substantial development of field engineering efforts and supporting these diverse programs are paying off, and will continue to pay off in revenue growth for the Company.

Now, let's briefly discuss backlog. Backlog at the end of the third quarter was $71.4 million. This is essentially the same level we have maintained throughout the year. New orders are generally equivalent to outgoing revenues.

As we have mentioned on previous calls, we only carry eight weeks of Eclipse requirements and backlog. This represents their firm needs.

Despite the airline industry struggles making headlines recently, there have been no material changes to our commercial airline agreements. Backlog and the previously described certification efforts support our expectations of increasing revenues in the fourth quarter.

I'd now like to turn the call back to Ray.

Thank you, John and Roman. Just a few brief concluding remarks before we take your questions. I am very encouraged with the significant sequential improvements in revenues and results achieved this quarter. And I believe we will see further improvement in the fourth quarter, consistent with our goal to achieve profitability as quickly as possible.

Let me quickly add to John's comments on the recent ruling by the United States District Court for the Western District of Tennessee. We have now been awarded damages, interest and fees aggregating more than $23 million. The court also entered an order granting our request for injunctive relief.

We are obviously pleased with the decisions both of the jury and the judge in this matter, and intend to pursue collection of the judgment and enforce the injunctive relief. I apologize in advance, but due to advice from our corporate counsel, we will not be taking any questions relative to the Court's decision today.

I believe we have built a very sound foundation for the future. This necessitated very high levels of R&D spend this year in proportion to our sales revenues. As we move forward, these will reduce in proportion to sales while [sustaining] a strong technology base to ensure our future product offerings continue to give us a competitive edge.

We understand our ultimate goal, and we are committed to achieving consistent growth of both revenues and earnings over the long term. We thank you for your support.

We will now be able to take your questions for the balance of the hour we set aside.

Thank you. (OPERATOR INSTRUCTIONS). We'll pause for just a moment to compile the Q&A roster. Thank you. Our first question is coming from Steve Denault of Northland Securities.

Good morning, everyone.

Hi, Steve.

Good morning.

In regards to the fourth quarter guidance of approximately $14 million, how should we think about Air Data's contribution and engineering modification development contribution?

Steve, the Air Data is approximately--at this point, we estimate it to be about $1.4 million. Flat panel is going to be basically the lion's share. There is going to be a good portion of NRE in the quarter. I can get you a number here in a second, but--yes, $11.7 million in flat panel is roughly what we're anticipating in the fourth quarter, and the balance would be NRE. So, $1.4 million Data, $11.7 million flat panel, the difference NRE.

And the bulk of the growth in flat panel sequentially, is there any one or two programs you can point to? Expected growth, I should say.

We expect growth from each of the sectors, so the customers who have got shipments against the different programs and continuing addition to them. We've mentioned our customer base diversifications increasing. One of the notables that hasn't been mentioned that will be contributing revenues in fourth quarter is Marshall Aerospace of Cambridge, in the UK.

Okay.

And the others we talked about--Eclipse, FedEx, American Airlines and so on.

At this point in time, it sounds like you're effectively withdrawing next year's guidance, waiting 90 days or so until you report the fourth quarter. What, if anything, gives you pause at this point in time?

I wouldn't say we're withdrawing the guidance. Where we're at as a Company--and I think I've spoken to some analysts about this--we are in the process of finalizing our 2009 plan and basically all the details that go into a plan, as many of you--I'm sure all of you can appreciate. So really, at this point we're not walking away from anything. We're basically saying we want to come back with some more granular detail in the next earnings release in the fourth quarter. I believe the analysts have us down in the mid-50s somewhere already, even though we had said 60. So at this point, it's really, I'll just say, a holding pattern more than withdrawing anything.

Okay, perfect. Thanks.

Okay.

Thank you. Our next question is coming from Tyler Hojo of Sidoti & Company.

Okay, good morning, guys.

Morning, Tyler.

Hello, Tyler.

I guess my one question that I have for you guys is just based on the backlog. I understand that it's relatively consistent with the levels we've seen for the prior quarters in this fiscal year, but if memory serves, I think I remember Roman indicating last conference call that we'd likely see kind of an up-tick in the backlog just based on some of the favorable trends that you guys talked about in your prepared remarks, I guess we'll say. So I guess what I'm wondering is what kind of changed this quarter to see the sequential dip that we saw as opposed to maybe the greater level of bookings, if anything at all?

I just think it's a historic pattern in our industry, that, if you will, the summer doldrums are hitting us. We still feel very encouraged by what we see. The backlog is solid. There's been no movement in it from our customers. It's up to us to deliver against it at the conclusion of certification efforts.

Perhaps I could just add that we did have an expectation by now to have signed up just one other airline, to be quite honest, for 75 or 76. We've got a lot of people that we're talking to right now. But, of course, airlines are in a little turmoil. It's not that that anyone's going away; I just think they're taking longer to come to conclusions. And hopefully over the next quarter we'll find that something will come to conclusion.

Okay, fantastic. And just one follow up from me, just in regards to the timing surrounding the STC for the 737. Is that still on track for this calendar year, or has that been pushed just with the--in light of some of the groundings we keep reading about?

I think we said last time that we had that on hold, to be quite honest. We certainly made the decision around the time of the last conference call that we would put it on hold. Because we've seen so many people announce groundings of their 737 classic fleets that we wanted to see some stability in that before we started spending money, because we were on the cusp of starting to put engineers on the job. As of now, we've still got that on hold.

I see. Okay.

There's no current forecast date for a 737 STC because we're not, at this stage, convinced there's a return to be had until we understand what's left in the marketplace.

Interesting. And I guess one could assume that when you provided kind of that $60 million range for your out year, attaining that STC was one of the puts and takes that you had in there. Is that fair?

Certainly. We certainly had assumed that by that time we'd get some 737 revenues, and one of the things we're looking at is what fills that.

I see. Okay, fantastic. Well, I'll let somebody else ask.

Thanks, Tyler.

Thank you. Our next question is coming from Alex Hamilton of Jesup & Lamont.

Good morning, everyone.

Morning, Alex.

I applaud the improvement in visibility. You're certainly providing a lot more details on the model. I am eagerly waiting when we get even more details next quarter. I guess my question there is what has changed on the margin in terms of the business? Obviously I think a lot of it is due to John's efforts and the new management team. Is there anything of the business itself that's changed, that's getting you a little more comfortable with providing visibility?

I think that--well, anybody who (inaudible) comes to a business, they get surprises, and it's not that there's anything wrong with the business necessarily. It's just that it wasn't in their anticipated view. And as we remove the surprises and understand more of how the business operates, we feel a little bit more comfortable about--.

Great.

(Inaudible) future.

And then lastly, the Eclipse. Is there any acceleration in the pace of work you're seeing there?

They keep telling us that's going to be the case, but it's always another month away, so we're not making any brave assumptions about the rate. We think we'll stabilize on one a day, we think. They've been on that and off it in the last six weeks, to be honest, but we think they'll stabilize around one a day. We're waiting to hear what the new acting CEO has to say about his program. We listened to him earlier this week, and he wanted a few days to consolidate the position, but didn't give any indication there would be any drop in the numbers that they had previously forecast. So we are assuming for the next few months that it will be fairly stable, and we'll wait and see what happens with what they forecast for next calendar year.

Fantastic. Thank you.

Okay.

Thank you. Our next question is coming from [Jeff Harvey] of Janney Montgomery Scott.

Good morning. I wonder if you could comment on when you think you might expect to get the money from that settlement. And if you get it, and assuming it's around that amount, do you have any plans or are you looking at any possible acquisitions? Do you think you'll increase your buyback program? Have you given any thought to that?

I can't really comment on the money side. I said earlier that we wouldn't comment on the case. We are always keeping our eye on what there is to do with our money. If there's opportunities to expand the business through acquisitions and it will be a real good fit, that's what we'll do.

Okay, thank you.

Thank you. Our next question is coming from Michael Ciarmoli of Boenning & Scattergood.

Hey, guys. Thanks for taking my call.

Sure.

I guess, John, just to follow up on Tyler's questioning on the backlog, you have--out that $71.4 million, how much is shippable in the next 12 months?

About 50%.

Yes, 50%.

Okay.

Yes, American is the primary part of that that goes out front (inaudible).

(Inaudible).

Okay. And then--.

Just over 50%.

Okay. And then, in terms of--I know you were talking about, I guess, Ray, the marketplace with the American carriers. Are you trying to attract business from any of the international carriers? I mean, we continue to see strength from those markets. Is there any activity percolating there or any potential business that gives you confidence maybe for 2009 that you could win some new business?

We have got a lot of activity in Europe. I mean, we've just come back from Farnborough Airshow. We had a number of airlines visit us there. I think we're talking currently to eight or nine airlines [in Europe.] And as I said before, we're planning to start generating some interest in the Far East in the coming months.

Okay.

The international business is very much on the cards.

Okay. And then, if I can, just getting back to the STCs. The 737 was clarified. What's the status with the 747? And also, if you can give us an update on the Cessna program.

Roman?

Yes. On 747, we have engaged the services of a [DER] to help push that through to conclusion. So we can't predict what that is, but certainly in the near term we would expect to see some movement on that STC.

Okay.

We've concluded our efforts. We've just got to make the submissions.

Okay.

And then, on the Cessna, our last quarter they did--I shouldn't say just last quarter, but through this point year to date they've been doing ground testing, plug and play, evaluations in labs and on aircraft. The next step is start flying that aircraft. We've done a number of things that we've--I'm going to say are competition sensitive in terms of improvements to the offering. So that has to be submitted at the FAA as flight plans, and then we'll commence flight testing this quarter, this quarter being the fourth quarter.

Uh-huh.

Then we would expect that by the end of the year, we certainly would expect that the FAA would issue STCs. But again, we can't predict what they would do.

Okay. So that seems more like a fiscal '09 revenue event, potentially?

We have been counting on Cessna to be basically a fiscal '09 revenue.

Yes.

Right.

Okay.

(Inaudible)

Okay. And then, just if you can elaborate a little bit, the buyback--the share price has been depressed. You guys haven't dipped your toe in the water and bought any shares. Can you give me more of a rationale around why you're not actively purchasing stock right now at these prices?

Mike, I'll just refer back to what I said in the--when I spoke earlier. The timing and amount of any share repurchases are driven by a committee of our Board of Directors. That was basicallyfrom the inception of the plan. And they do give consideration, I'll just reiterate again, the alternative investment opportunities--I won't go any further--the current economic environment, and the Company's financial position. Those three things are thought about pretty deeply, and we do have to abide by trading windows and so forth. But that's pretty much where I think I'm going to leave it. There's not much more to say there.

Okay, fair enough. Thanks, guys.

Yep.

Thank you.

Thank you. (OPERATOR INSTRUCTIONS). We have no further questions at this time.

Okay. Well, if there are no more questions, then we'll wrap up. Thanks very much. Thank you, gentlemen.

Thank you. This does conclude today's Innovative Solutions and Support conference call. You may disconnect your lines, and have a wonderful day.