Innovative Solutions and Support Inc (ISSC) 2010 Q3 法說會逐字稿

Good day and welcome to the Innovative Solutions third-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, Chairman and Chief Executive Officer. Please go ahead, sir.

Good morning. This is Geoff Hedrick and I am Chairman and CEO of Innovative Solutions & Support. I would like to welcome you this morning to our conference call to discuss the third-quarter 2010 results, current business conditions and outlook.

Joining me today in our Exton headquarters are Roman Ptakowski, our President and John Long, our CFO. Before I begin, I would like to ask John to read our Safe Harbor message. John?

Thanks, Geoff and good morning. I would like to remind our listeners that certain matters discussed on the conference call today, including operational 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 worse in 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. Sales and profitability improved compared to both the preceding quarter and the year-ago quarter. Both revenues and profits were up significantly from the second quarter, consistent with our expectations. Compared to the fiscal 2009 third quarter, operating income in the current quarter was up 57% and operating cash flow for the quarter was up over 26%.

New orders this quarter reflect the growing acceptance of our flat-panel display and our data products. We are starting to see some of the roughly $100 million of outstanding proposals converted to firm orders. Despite the challenging conditions in the aerospace industries, we are experiencing growth in our backlog during the third quarter.

Let me turn over the call to John Long for more detail of our financial performance.

Thanks, Geoff and thank you all for joining our call this morning. Revenues in the third quarter were $7.8 million, up $2 million sequentially from the second quarter and up slightly from the year-ago quarter. The sequential increase in revenues is consistent with our expectations that revenues will show improvement this year.

From a product standpoint, flat-panel display revenues in the quarter were approximately $5.8 million while Air Data product shipments in the quarter were about $2 million or approximately 26% of total shipments. Gross margins in the third quarter were 61.5%, illustrating both the leverage in our model as margin improvement was significantly above revenue improvement in the third quarter. Gross margins in the quarter benefited from the sale of product with increased functionality. In future quarters, gross margins are likely to be in the mid-50% range assuming the current quarterly revenue run rate.

Total operating expenses for the quarter were $3.2 million. Of the total, internally funded research and development was approximately $1.3 million in the quarter, up slightly from $1.2 million in the second quarter, reflecting our continued investment in new product development. Internally funded research and development expense was approximately 16% of revenues for both the current and prior-year comparable quarter.

Selling, general and administrative spending in the quarter totaled $1.9 million, flat with the second quarter, although up slightly from a year ago, primarily the result of increased sales and marketing expense. For the quarter, we reported operating income of approximately $1.6 million, which, on a sequential basis, is nearly a $2.5 million improvement from the $851,000 operating loss in the second quarter. Compared to the year-ago quarter, operating income was up 57%. For the third quarter, we reported net income of $1.3 million or $0.08 per fully diluted share, also a meaningful improvement from the second-quarter net loss of $750,000 or $0.04 per share.

In looking at the year-over-year comparisons, we incurred about an approximately $270,000 income tax expense this quarter compared to a $200,000 tax benefit in the year-ago quarter. Absent the tax effect, earnings in the quarter would have shown a significant improvement over the third quarter of fiscal 2009.

Cash flow from operations for the quarter was $2.4 million compared to $1.9 million in the comparable quarter of last year, an increase of approximately $0.5 million. As a result, our balance sheet remains strong with over $38 million in cash and virtually no debt.

I would now like to turn the call over to Roman for some comments on the current market conditions and on business development efforts. Roman?

Thank you, John. The Company's business development efforts are focused on the commercial air transport, military and business and general aviation segments to allow us to better capitalize on the unique opportunities in each of these markets.

Our commercial air transport efforts continue to be centered on delivery of our flat-panel display systems to the major airlines and packaged carriers. We resumed shipping product to existing customers as they completed aircraft retrofits and had a need to replenish their flat-panel display inventory for additional future retrofits. We believe commercial air transport remains a very large market opportunity for IS&S and so we continue to enhance our product through the introduction of additional capabilities and functionality.

On the last call, we discussed functionality such as RNP, required navigation performance, for which we have received FAA approval. RNP enables aircraft to descend from cruise altitude to an airport runway along a shorter, more direct flight path. The aircraft can use less power and thus minimize environmental impact, and less fuel in doing so. RNP provides increased accuracy by using a combination of onboard navigation technology and GPS satellites. It improves safety and reliability in all weather conditions.

We have now introduced the Class 3 electronic flight bag for the Boeing 757, Boeing 767 platforms. The addition of Class 3 EFB functionality demonstrates the ability of the Cockpit/IP to evolve to address future requirements.

The IS&S electronic flight bag presents information to the pilot in his forward field of view. This is known as the Class 3 EFB. The EFB displays electronic charts, electronic checklists, video surveillance and enroute maps, as well as satellite and weather information.

Among the $12 million in quarter three new orders, approximately $6.8 million was military. The military has lately been our strongest market. We still have $60 million of outstanding proposals pending with various military and defense agencies, both domestic and foreign. We have quoted a number of large programs to the major integrators. These have been both new proposals and a refresh of existing ones where requirements have firmed up.

Activity in the general aviation market is slowly beginning to recover. The AdViz system is certified for the Cessna Citation 500, 550, S550 and 560 and is available in two or three 10.4-inch display unit architectures that provide enhanced situational awareness, increased functionality, reduced crew workload and weight savings. Options include electronic charts, XM satellite weather, wide-area augmentation systems, also called WAS and enhanced vision system displays.

In the third quarter, we delivered product with increased functionality to [Eclipse] Aerospace. The product included certified XM satellite weather and electronic chart functionality for the Eclipse [E500] [very] light jet. We are seeing growing interest from installation centers for our Vantage flat-panel display systems. The Vantage is our fully integrated common cockpit display, created specifically for most business aircraft. The Vantage cockpit/IP allows operators to retrofit their aircraft with a new flat-panel display system while leaving existing third-party avionics installed in the aircraft, minimizing the cost of the upgrade.

It also provides the owner the opportunity to upgrade to new radios, transponders, GPS or other third-generation avionics. They can select from the best of breed from all the major vendors. The Vantage product provides service centers with improved logistics. With Vantage, the independent service center operator has only to make a minimal investment in inventory because this single product can be retrofitted into a number of different airframes.

We continue to grow the functionality of our Pilatus PC-12 upgrade by now offering WAS, LTV approaches and RVSM certification. These benefit the operator by further ensuring on-time arrivals, even at secondary airports and the use of optimal in-transit air space.

As mentioned earlier, we announced $12 million of new orders. Within this total, there are a number of contracts in which we include only the value of the program's initial releases. There are options on a number of these orders for future years, which will be reflected in backlog once the options are exercised. Backlog at the end of the third quarter was $39.2 million, up from $35 million last quarter.

There are $60 million of military and $35 million of general aviation and commercial air transport proposals outstanding and a number of new proposals are in preparation in response to customer requests for quotation. Our outlook is for improving performance as deferred shipments start up again, as our business in general aviation programs accelerate and as our offerings to the government and military are increasingly accepted. I would now like to turn the call back to Geoff. Thank you.

Thanks, Roman. As we mentioned, both revenues and order rates were up sequentially in the third quarter. In a very difficult environment, we managed to grow our business both in new orders and produce profits against the existing orders. We have maintained that and generate and continue to generate positive operating cash flow. Operator, would you please open the call for further questions?

(Operator Instructions). [Irwin Goldman].

We didn't have a comment on progress on the stock repurchase program. Could you give us an update on that?

Sure, Mr. Goldman. During the quarter, we did not purchase any shares for the quarter ending June 30 and that will be disclosed in our 10-Q, which we anticipate filing in another week. There were no share repurchases.

No share repurchases.

All right?

All right. Can you give us a picture on the scheduled releases for fourth quarter from your order backlog?

I think what we indicated in the business outlook section of the earnings release is that we do anticipate continued profitability and positive operating cash flow. At this point, we really do not want to establish or set any specific targets because we are, again, working through a somewhat difficult climate. Geoff or Roman, I don't know if you want to provide any color on that, but basically we are driving very hard to and do not anticipate any problem achieving profitability and positive operating cash flow. Other than that, Roman, do you want to shed any additional -- or Geoff?

Our customers are cautious and prudent and we don't want to get ahead of them. (inaudible). Our commitments are such that we will be profitable. We have some upside and we just don't really want to comment on that at this point.

Yes, we prefer to stay conservative and not get ahead. We will deliver -- talk about it after we deliver.

Okay, thank you.

[Kristina Marsh], Thompson Davis.

Hello, good morning. I'm calling in for David Campbell. You touched on this briefly in your prepared comments, but if you could just repeat again what you said about the gross margins? Was there anything unusual in the quarter? Because it was pretty high and I guess you said sustainability going forward would be mid 50% range. Was that correct?

Yes, we've always maintained that our target would be mid 50%s for sustained gross margins. (inaudible) discussed maintaining our competitive posture by keeping our margins at a high, but respectable level.

This past quarter saw both sales expansion of functionality, which yields very high margins. So the increase between the increased volume and product mix as it is, we got very high margins this quarter. As you know, historically, gross margins, depending on product mix, have risen as high as mid to high 60%s.

Okay. Thank you very much.

(Operator Instructions) David Starkey, Smith Barney.

Yes, hi, guys. Great quarter. It looks like you are into -- looks like with the backlog, we should see some more decent numbers going forward there. The long-term debt at the end of the last quarter, I guess at the end of March I guess, according to Standard & Poor's, was about $24 million dollars. Can you tell me the average rate of interest you are paying on that?

Actually, you may want to check the source there. We do not have any long-term debt other than a number of small copier leases, which are de minimis. So you may want to check your data point. Our 10-Q is out there on SEC.gov if you want to have a look at the balance sheet.

Okay, will do. That's a Standard & Poor's report, so maybe they need to be notified.

We better check it, but --

Yes, I'll check it.

We have no long-term debt.

Okay, great. That's not maybe mortgages or leases on your property?

Well, no. We had a small IDA loan, about $4 million that we actually cleared out entirely because it was more expensive to keep than we were getting with interest on our cash. So we have no -- we own the building and equipment free and clear.

Okay, your current ratio then, they are claiming 14 to 1. Was their short-term debt -- maybe that's just misclassified or --?

We appreciate you bringing it to our attention. We will get a hold of them right away.

Okay, great, great. So that $39 million is basically unencumbered other than the day-to-day needs from the cash flow of the Company?

Yes, absolutely (multiple speakers).

That's right. The current ratio is 14. But, yes, there is no debt as Geoff said.

Okay, that's good news to hear. Really that was one of the main questions I had because I was thinking this would be a pretty big positive surprise for you guys. I think the forecast that was out there was a penny loss or somewhere in that neighborhood for the quarter. So that makes things look a lot better for you. With $50 million or $60 million in order potential coming, is that what you said in the text of your comments?

We've got about $100 million of outstanding proposals. We are working on additional ones in request to customers. It's just difficult to forecast the conversion rate. They are being processed.

What about the $60 million?

Yes, $60 million of military --

That was military alone.

Just military, okay, great, great.

I think the thing that has kept us in reasonable shape is we have -- since we started -- focused on keeping all three components, market components active -- military, commercial air transport and business and general aviation. And by keeping all three active -- I don't believe in things that are countercyclical, but they tend to move and it keeps you in reasonable balance so that when one area like GA, which is down acutely now as you are aware, we are able to pick up in the military and some commercial air transport.

Textron has said that things are starting to pick up in their business. Is that a customer of yours?

Yes, actually it is. So we have, as you may know, we have a fair amount of business on the Citation.

Right. The business jet market has been really starting to pick up.

So we are poised to deliver into the market as it gets stronger, so we are pleased -- it has been a useful and successful approach.

Right, right. Okay. And that $39 million in cash, you didn't buy any stock back in the last quarter. Are you comfortable bringing that down? You can't be making any interest on that right now. That's a big chunk of your assets that is earning really nothing for you.

We have a buyout and we bought some stock this --.

Since the end of the last quarter.

Since the end of the last quarter.

Okay, great, great because, yes, it got under $4 there for a little while and it looked pretty cheap there.

(technical difficulty), especially now.

Yes, okay, well, thanks and good luck going forward. It sounds like you are ready for some improving results here the next year to two. So good luck.

And with no further questions in queue, at this time, I would like to turn the call back ever to Mr. Hedrick for any additional or closing remarks.

Thank you. Appreciate your interest. As we said in the call -- and you'll excuse me, I'm losing my voice -- as we said in the call, we see a positive growth in response to our proposals. It is clear that we can make money on the products that we have sold and we see an expanding market as our functionality of our existing markets expand.

Over the next several months, we expect to make a significant number of announcements of new products that will be brought to market and will increase our opportunities further. Thank you for your interest. Thanks for attending the call. Bye-bye.

And that concludes today's conference call. Thank you for your participation.