Innovative Solutions and Support Inc (ISSC) 2010 Q1 法說會逐字稿

Good day and welcome to the Innovative Solutions and Support first quarter 2010 earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Geoffrey Hedrick. Please go ahead, sir.

Good morning. This is Geoff Hedrick, Chairman and CEO of Innovative Solutions and Support. I would like to welcome you this morning to our conference call to discuss the first quarter 2010 results, current business conditions and outlook. Joining me today at our Exton headquarters are Roman Ptakowski, our President, and John Long, our CFO.

Before I begin, I'd like to ask John to read or Safe Harbor message. John?

Thanks, Geoff. Good morning. I would like to remind our listeners that certain matters discussed in the conference call today, including operational and financial results for 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 than those discussed, including other risks and uncertainties reflected in our Company's 10-K, which is on file with the SEC. I will now turn the call back over to Geoff.

Thanks John. Results for the first quarter of our fiscal 2010 were consistent with our previous expectations. Revenues in the quarter reflect the lagging effect of a slowdown in orders and customer initiated scheduling changes last year that coincided with one of the worst aviation markets in recent memory. In addition, production on several of our new programs such as Cessna are just beginning to ramp-up, so their contribution in the near-term has been limited.

As many in the industry have commented, this is the worst slowdown in history. The uncertainty this economic slowdown created has affected the up-tick in the aviation retrofit demand historically associated with the slowing of new aircraft production. We are fortunate to have relationships with our customers and a solid order book and the financial strength to weather the unprecedented storm. Throughout 2009 we implemented several significant cost controls and efficiency improvements. We structured our organization to achieve high levels of productivity and this has resulted with gross margins averaging better than 50%.

In the near-term, the strategy does entail some short-term pain since delivery requirements ramp-up over the next few quarters; it is prudent over the long-term to avoid volatile fluctuation in production and engineering capacity. We have managed to maintain the business to prepare us for a time such as we are now experiencing. John will go through the numbers in more detail in a minute.

Heading into the quarter, we recognized the slowdown in bookings last year and the financial difficulties throughout the aviation market were going to pose a challenge in 2010, especially the first half of the year. We have used this lull in activity to refine our marketing and enhance our products and prepare for the inevitable market recovery. We hired an experience Vice President of BRGA Sales and have doubled our overall business development efforts. We're adding new features and functionality that add value to both our products and the customers' equipment. We have developed several upgrades that improve the utility of the Air [Card]. We offer the satellite weather display system and Electronic Flight Bag on all our BRGA Cockpit IP products, including Vantage, Cessna AdViz and the new Falcon 2000 cockpit systems.

In the quarter, research and development spending was maintained at previous levels of investment. This investment is critical to prepare for equipment delivery in the second half of this fiscal year and capture new opportunities as the industry recovers.

Booking and backlogs are not entirely indicative of our long-term revenue opportunities. An additional measure of our opportunity is the revenue potential of various platforms for which we are qualified. With the Falcon 2000 we will now have product qualified on approximately 25 different platforms. We continue to grow in the number of platforms we have served as we have adapted the 767 Air Transport flat panel display system to several markets in military and in BRGA; that's business, regional and general aviation.

From the initial successes of each of these markets we have grown our product offering so that we now have tested, proven product that addresses the needs of a market valued at over $2 billion. The Defense market is equally strong and expanding. Major programs with Homeland Security and the Navy P-3 and C-130 aircraft show real growth in demand. The economic pressure on the Defense budget will tend to affect new weapons systems and necessitate upgrade of existing aircraft. Roman will provide a more detailed description of our opportunities which are more indicative of our long-term potential.

Let me turn the call over to John Long for a more detailed review of the financial performance.

Thanks Geoff, and thank you for joining our call this morning. Revenues in the first quarter were $4.6 million compared to $10.6 million in the first quarter of fiscal 2009. You'll recall that when we reported our results in December, we did suggest that the weakness in the market would probably have its biggest impact on our first and second quarters of the year. As Geoff just mentioned, a commercial air transport client modified their delivery schedule last year when they started to feel the effects of the economic slowdown. Unfortunately the effects of the slowdown and the reschedules happened to fall in this quarter. Our careful monitoring and close relationships with these customers reinforces our confidence that there may be another couple of months of modest shipments, but that the pace of delivery should return to levels contemplated in the original agreements. These delivery requirements were instrumental to the quarterly revenues of $10 million that we realized last year.

From a product standpoint, flat panel display related revenues in the quarter were approximately $3.7 million while Air Data product shipments in the quarter were about $1 million or around 22% of the quarter's total.

Gross margins in the first quarter about 38.4% clearly some deleveraging as a result of our lower production volume in the quarter, however, as Geoff indicated, we did make substantial reductions last year but are committed to sustaining a minimum underlying infrastructure to protect and preserve the efficient workforce and processes that we've been developing over the last year. We do not believe it makes sense to reduce costs when we really anticipate increasing production volumes in the near future. Consequently, we have not decided to further reduce our fixed cost base at this point in time.

Total operating expenses for the quarter were $3.3 million; of that, research and development expense was approximately $1.2 million and R&D was $1.3 million a year ago and $1.1 million in the fourth quarter of 2009, so again, very similar sequential numbers.

Again, we have taken a disciplined long-term view toward our research and development investment and have maintained a fairly consistent investment over this past year. We are committed to sustaining R&D as this supports new product and enhanced initiatives such as the added functionality Geoff mentioned and Roman will speak about that makes our product more competitive.

Sales, general and administrative spending in the quarter totaled $2.2 million compared to $2.4 million in the year ago quarter, again, little change from the quarter and essentially about the same level as the past year. For the quarter we incurred an operating loss of about $1.5 million and we recorded a tax benefit in the quarter of about $328,000 and our net loss was $1.1 million or $0.07 per share.

After four successive quarters of profitability in fiscal year 2009, this was our first quarterly loss in over a year. Our balance sheet remains strong with over $36 million in cash and no debt. Cash flow from operating activities was approximately $1 million positive in the quarter. This was a result of reductions in both inventory and accounts receivable as we continue to manage our working capital prudently and they were the primary drivers of converting that loss to a positive operating cash flow and we do expect to continue to work very hard to generate positive operating cash flow consistent with our profitability as we go through the balance of this year.

Now I'd like to turn the call over to Roman for some comments on the current market conditions and new product and business developments. Roman?

Thank you John. Our company continues to implement its strategy to offer industry-leading technology to three markets; commercial air transport, military and business, regional, general aviation. The market continues to evolve and we are capitalizing on our advantages; mainly experience, agility and resourcefulness to remain competitive. We are leveraging our existing product lines to more rapidly expand into additional aircraft platforms where we believe we have the greatest opportunity to succeed. We continue to broaden our product offering and develop new areas for growth as we expand the functionality of the Vantage Cockpit IP, the cockpit information portal. We have been able to add new features and functionality to our products to meet the needs of the market. The availability of new technologies has allowed us to offer products with increased versatility.

We are increasing our channels of distribution to market these new offerings. We have added seasoned, experienced business development professionals in the commercial air transport and business, regional, general aviation segments. We are further expanding our market reach by broadening our independent service center relationships. This wider representation will provide more localized sales and support to the aircraft owners and operators.

Resources are also being applied to further develop existing opportunities such as Cessna. Product is fully certified and available at a growing number of Cessna service centers. Cessna has made a substantial commitment to market what they call their AdViz platform and we are helping the service centers pull through sales to the aircraft owners. We are engaged with Eclipse on modifications to the entire fleet of operational aircraft. We are demonstrating our ability to quickly develop and implement key upgrades that improve the value of the aircraft. These upgrades build on the IS&S glass cockpit to add new capabilities that increase the utility of the aircraft.

You already heard that our commercial air transport customers modified their delivery requirements last year; they have made their inventory adjustments and now their delivery requirements ramp-up during the balance of the year. There are now more than 50 Boeing 757 and Boeing 767 aircraft in full revenue service with our flat panel display systems and the numbers keep growing.

The military segment continues to provide a fertile market opportunity. We have over $147 million in outstanding proposals with $79 million of these in the military segment. These opportunities encompass the Department of Homeland Security, the Department of Defense and foreign military services. The industry has begun to exhibit an increase in the number of flight hours. This drives the need for maintenance and upgrading of equipment. With this turn in the market, our outlook is to be able to sustain higher volumes, make profits, generate cash and increase our footprint in all three of our market segments.

I'd like now to turn the call back to Geoff. Thank you.

Thank you Roman. We focused on adding sales and marketing resources and developing additional revenues to distribute our product. By preserving our product development resource and efficient manufacturing infrastructure we are prepared for the increase in demand that is driven by our customers' planned delivery schedule. We are also using our resources to develop additional platforms and enhance our product functionality to accelerate the expansion of our immediately addressable market. We are making significant strides in improving our competitive position through continual innovation and rapidly adapting to evolving market demands.

Operator, will you please open the call for questions? Thank you.

(Operator instructions) Our first question is from David Campbell with Thompson, Davis & Company.

Roman, you mentioned that you had $79 million in military proposals, I think I heard, and then I missed the total numbers. It sounds like you got more proposals out than you did in the last conference call. I think the last call -- I don't have the notes in front of me, but maybe $110 million and I think you said something like $130 million this quarter?

$147 million with (inaudible) outstanding proposals and so that is up over $30 million from the last quarter.

And where would you describe the increase coming in; what type of business?

Across all three market segments.

Well, in the military in particular, the Department of Defense.

And Homeland Security.

Right. So really hard to tell when they'll decide to push the buttons but presumably this is for retrofitting older aircraft, so it's certainly going to be a favorable way of completing their budgets; is that the way of looking at it?

David, especially the last [end year], the discussions about maintaining the Defense budget and the Defense budget is constantly under attack, the fact is that when the Defense budget is reduced or if it is reduced, it's always in the new weapons systems programs and you've heard a lot of discussion about that. That inevitably expands the requirement for maintenance and upgrade of existing aircraft and most importantly, puts pressure on the Department of Defense to find very cost effective solutions to these upgrades. When you have a lot of money you tend to focus on just getting the job done. Now it's conserving resources and making sure that you're making a wise decision and we think we're especially strong in that area. So, we feel confident that we'll see expansion in the military.

Okay. I'm not in my office and my final question would be, where do you think the commercial programs will lead you on some of the proposals there in the commercial area or in the small business aircraft area?

We're addressing all three areas and we're staffing all three segments of our market in business development as we've noted that we're expanding our business development rapidly now. We've added several people on to the general aviation market and the military as well and we continue; we just hired two more people for military. So, we actually see opportunities in all three segments and we've got strong proposals out in all three segments. And that's traditionally what we do so we're not hanging on our fingernails for one specific contract to come out.

And finally, do you have any comments about the March quarter or what might happen for the whole fiscal year?

David, I think you'll recall the last conference call, prior conference call, we did say that we are using the fiscal year 2009 as a baseline for fiscal 2010. Naturally our goal would be to exceed but that is our baseline, fiscal 2009, and again, we don't want to get into trying to predict the quarters and so forth. So that's our baseline and again, the hope is to continue to move north here from this point.

Your next question is from Michael Ciarmoli with Boenning & Scattergood.

John, just to elaborate I guess on the kind of outlook for 2010 and the base line of 2009; obviously you're going to have a bit of a backend ramp here to get back to the $36 million level. What proposals or what projects need to happen to help you guys meet those results or are you comfortable enough with some of the outstanding proposals that will hit? Do you need a more dramatic turn in the overall economic conditions to spark the increase in aftermarket activity here, or help me understand what gets you back to that level?

I'll ask Roman and Geoff to chime in here; I'm going to do my best from the forecast perspective. We've clearly identified; you heard the proposal number that's out there and clearly Cessna and programs like that as we develop our architecture and so forth, the proposal base we have out there along with that architecture is going to allow us to more than fill or have an adequate base from which to work. It's a question of timing and when these proposals will translate into an order. Roman, can you or Geoff maybe provide a little more color on it?

Michael, a couple of things are going to happen; first of all, as you know, the delay in our air transport, 757, 767 will be over and the demand will come back in hand. So we see that; that was a significant impact last year, as you know. In addition, we are now in discussions for delivery of equipment to Eclipse, so we expect a significant amount of business to maintain the existing aircraft out in the field with significant functional upgrades. So that business will start as early as the tail end of this quarter, certainly in next quarter, and we have a large program with Homeland Security which is going to start up as well in the second half. So it's not waiting on a whole bunch of proposals to come in; we have a significant amount of business that is now going to restart in the second half and it's really about a two quarter hiatus that we're bridging right now.

Okay. How much of your backlog ships over the next year?

What we believe in there, based on the confirmed schedules we have, that's about 60%. Without being more specific than that, we're sitting in the 60 to 65% range of the backlog.

And there's a number of programs, significant programs that we've been waiting literally any moment to get announced a couple of pieces of military business that we expect to come in shortly and some of which will actually be in the second half of this year as well; stuff beyond backlog. So you know, it's hard to be overly confident in this economic environment but we feel comfortable that we're seeing a lot of existing backlog business that had been delayed, starting to regenerate right now.

(Operator instructions) Your next question is from Sam Bergman with Bayberry Asset Management.

A couple of questions; regarding the business restart in the second and third quarter, is any of that currently in your backlog?

Yes. Specifically, as you may be aware, we started up and we were in production on a large air transport order, retrofit of the 757, 767 fleet and that was delayed as they restructured their retrofit lines and those retrofit lines are now back up and they're now planning to restart the delivery demand in our second fiscal half.

I see. And the contract or announcement you made with this Dassault Falcon order for the flat panels, is that already in progress or is that starting sometime in the second quarter?

Not second quarter; first deliveries of that would be actually in the fourth quarter. That is a nice, long-term program, but deliveries start in the fourth quarter of our fiscal year; that would be the quarter that ends our year, in September.

And can you tell me how many aircraft are being retrofitted for the fourth quarter?

No, because that will be initial demands. Remember, we're going through design qualification now and the certification should be complete near the third to fourth calendar quarter of 2010.

I see. If you look at that particular flat panel that's going to be installed in the Falcon, what other competitors -- was Garmin a competitor in that particular program or what other--?

No, Garmin, to my knowledge, has no equipment certified for air transport application.

Who's your closest competitor on that?

There was no competitor; we created a product that created the market. What happened is Falcon saw our equipment being applied on Cessna and Pilatus and on various other aircraft and saw that as an opportunity for them to deal with their 2000 and we came up with applying our open architecture system to the Falcon 2000.

Okay. Going to the pipeline that you mentioned and ROPs that are out there, do you have a win rate on those from the past that you keep records of or not?

We have a win rate, but from product to product and year to year, we're not sure that win rate actually means much, other than it makes us feel good. Using that to look forward statistically, we've never done and probably wouldn't want to do. We've been very fortunate to date, but that's absolutely no indication of future, as the disclaimer usually goes. But in general, we don't write proposals on programs that we don't feel relatively confident we're going to win, because it would be an enormous waste of resource to do that, so our win rate traditionally is significantly above 50%.

Would you say the military work that's out there, are you sole source or is the specifications that you have written into those programs because of the technology?

It depends on the program. In some cases we have a unique product or a so-called sole-source product. In [Altimeter] Data, and that was a program that we developed many years ago, but traditionally our products, it is a program that is awarded and defined to us. In other words, successive years it's not going to be open to competition with an identical product; once the product is installed they tend to stay with that same product and they do that with our competitors as well.

Everybody that's in the industry, the military wants a consistent product throughout a given fleet of aircraft and for logistics reasons there's a desire to do that. So once you're on the program and qualified, you tend to stay on it and that's true with our competitors as well. So if new opportunities open up and we get them, if we do our job and do it well, we have a relatively high confidence of maintaining and keeping that business.

How would you consider your score in terms of customer service on the existing accounts right now?

I think it's pretty good. Our warranty costs are very low, our failure rates are exceptionally low. As you may recall, every product we make is tested in environmental stress screening to the most stringent standards of military requirements; even equipment that expects no environmental stress screening. In general aviation and even air transport, everything we build is stress screened for 18 hours and vibrated on all three axis at 6-Gs, so our failure rates are exceptionally low.

And we have a very active Six Sigma program. Our Vice President of Manufacturing and Vice President of Quality, both are Six Sigma black belts - -master black belts.

And the last question; perhaps you can elaborate or even correct me on this; I believe several months ago there was a news release pertaining to financing that you think you're going to need in the near future and that you are looking for some type of bank financing to expand the company. Was that a news release that came out from the company?

I don't think it was a news release.

Was it an 8-K?

The only news release that would be the National Enquirer. We have no debt. We've had no debt for a long time; for 10 years or more and we have $37 million in cash. We generated about $7 million in free cash last year and in fact, paid off the only loan we had, which was a loan on a building through the Industrial Development Authority and that was at a reduced interest rate, because the fees were higher than we wanted them, so we paid it off in cash and we still have more cash than we started with.

So perhaps that was the National Enquirer--.

If anybody wants cash, let us know. If you need financing we're available.

There are no further questions. Mr. Hedrick, I'd like to turn the call back to you for closing remarks.

Okay thank you. The company has positioned itself to respond to the demand that we see in the second half of this year. We've chosen to keep stability within the company and we have a strong, efficient team with a lot of business opportunities in the future. We're focused on continuing to improve the internal structure and developing new products. We're optimistic for the future and I continue to be optimistic for the future and I thank you for your interest today.

That concludes today's conference call. We thank you for your participation.