Innovative Solutions and Support Inc (ISSC) 2010 Q4 法說會逐字稿

Good day and welcome to the Innovative Solutions and Support Fourth Quarter and Fiscal Year-End 2010 Earnings Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Mr. Geoffrey S. M. Hedrick. Please go ahead, sir.

Good morning. This is Geoffrey Hedrick, Chairman and CEO of Innovation Solutions and Support. I would like to welcome you this morning to our conference call to discuss the results of the fourth quarter and fiscal year, ended September 30, 2010, current business conditions, and outlooks. Joining me today in the Exton headquarters are Roman Ptakowski, our President, and Ron Albrecht, our CFO.

Before I begin, I would like to ask Ron to read our safe harbor message. Ron?

Thanks, Geoff. Good morning.

I like to remind our listeners a certain matters discussed in this 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, from those discussed, including other risks and uncertainties reflected in our Company's 10K, which will be filed with the SEC.

It is now my pleasure to turn the call over to Geoffrey Hedrick, Executive Chairman and Chief Executive Officer.

Thanks, Ron.

On the strength of our significant year-over-year improvement in the fourth-quarter performance, I am pleased to report we achieved our second consecutive year of profitability while increasing already reasonable cash flows by another 6% over 2009. As anticipated, the second half of the year was much stronger than the first half and a top line by 50% in the second half compared to the first half. Gross margins in the fourth quarter was 63.4%, which boosted our margins for the year to 51.3%. We are very comfortable with sustainable margins in the 50% range, although the mix and other variables may occasionally cause spikes in the margins like we saw in the fourth quarter.

We achieved both profitability and increased cash flow for a year despite lower revenues. We continue to invest in new product research and development. For the year we invested $5.2 million in R&D, or nearly 21% of revenue, compared to $5.3 million or 14.5% in 2009. We believe we must retain our engineering resources even in lean times to stimulate the Company's growth. To our research and development, we continue to improve functionality of flat panel display systems. Just recently, we announced the introduction of the integrated flight management system for the eclipse twin jet. Our new FMS delivers a measurable improvement in performance with demonstrable fuel savings and ease of navigation. As Roman will explain later, we are in the process of leveraging this new functionality to develop flight management systems for our entire general aviation product line including the Cessna AdViz and advantage platforms. With competition for flat panel orders focused on enhanced functionality, the FMS offers measurable operating costs improvements and illustrates our ability to be resilient and resourceful in responding quickly to market opportunities.

The introduction of this new technology comes at a time when we are starting to see signs of improvement in the aviation markets. Cessna and Gulfstream general aviation bellwethers have both communicated relatively upbeat expectations for the coming year. Commercial air transport passenger traffic is increasing, which is causing airlines to return aircraft in service and operators are rushing to complete deferred maintenance. In military markets, the defense department is entering a period of budget restraint which will increase the proportion of spending directed towards retrofit programs. Currently, we have approximately $100 million in total proposal outstanding, and we have worked this past year to extend and broaden our relationships throughout the general aviation commercial air transport and military markets.

We begin the new year with an extremely strong balance sheet. Over the past year, we added $5 million to our cash position and presently have over $40 million of cash on hand. The momentum of the second half of the fiscal 2010 is continuing. The first quarter looks promising with revenues up 50% from the first quarter of last year ,which should lead to a profitable quarter compared to the loss of last year's first quarter. Our outlook for the first quarter should provide a solid base upon which to improve cash flow over the fiscal 2010.

And now, I'd like turn it over to Ron Albrecht to go through the results for the quarter and the year in more detail. Ron?

Thank you, Geoff.

We reported fourth quarter net income of $1.3 million or $0.07 per diluted share, substantially consistent with the third-quarter put up significantly compared to the fourth quarter of the previous year. Revenues were $7.5 million, down marginally from both the third quarter of this year as well as the fourth quarter a year ago. For the quarter, flat panel display system revenues were approximately $4.3 million, while IR data product shipments were approximately $3.2 million. Gross margins for the fourth quarter were 63.4%, reflecting efficiency improvements, a broader sales based for fixed overhead absorption and a favorable product mix for the quarter. As Geoff mentioned, while we are pleased with this performance, sustained margins are more likely to be the 50% plus range and may fluctuate from quarter to quarter depending on mix, volume, and other variables.

Total operating expenses for the quarter were $3.5 million, of which $1.4 million was invested in research and development. We would hope to maintain R&D at around 20% of revenues which should allow us to achieve attractive returns while making a significant commitment to new product development to fuel growth. Selling, general and administrative expenses in the quarter were $2.1 million, which is somewhat less, but broadly consistent with previous quarters. Pretax income was $1.3 million and for the quarter, we recorded a modest tax benefit. We would expect the effective tax rate would be in the range of 20% to 30% over the next year. Our cash flow and financial position remains strong. Cash flow from operating activities in the fourth quarter was $2.9 million, and at September 30, 2010, we had $40.9 million of cash on hand, an increase of more than $5 million over the last 12 months.

Now, I'd like turn the call over to Roman.

Thank you, Ron.

The Company pursues business development opportunities in each of the major aerospace segments, commercial air transport, military business, and general aviation. Our commercial air transport efforts are focused on delivery of the flat panel display systems to the major airlines and package carriers. Based on the reported improvements in their in markets, we anticipate our customers will accelerate their retrofit programs and replenished depleted inventories. Despite the market weakness of the past few years commercial air transport remains a very large market opportunity. To capitalize on this, we have directed our research and development efforts towards enhancing product functionality such as RNP, required navigation performance, and a ADSB, automatic dependent surveillance broadcast. These features enable us to address both the Federal Aviation Administration's NextGen and the single European Sky Initiatives dealing with increased flight volumes and overburdened air space.

We have also introduced the Class Iii Electronic Flight Bag, which displays electronic checklists, satellite weather and electronic charts and maps, and the pilot's forward field of view. This quarter, we won a C757 cockpit upgrade contract with Iceland Air. This provides us with entry into the European market. We are making continual progress in the military market. Presently, we have approximately $56 million of outstanding proposals pending with various military and defense agencies, both domestic and international. Experience suggests that as Department of Defense budgets tighten an increasing proportion of military spending gets directed to upgrades and retrofits of existing aircraft, a situation which should benefit us.

The general aviation market is displaying signs of modest recovery. At the October 2010 MBAA tradeshow, Cessna forecast an improvement in demand for new aircraft and separately, Gulfstream announced the addition of 1,000 new employees. These developments suggest a recovery, modest perhaps, across the entire general aviation market. The new Eclipse Aerospace, successor to Eclipse Aviation is in the process of upgrading the approximately 250 aircraft in service with our hardware and software. At the October 2010 MBAA tradeshow, we announced the development of two new products. One, an integrated flight management system, or FMS, and two, advanced GPS receivers for general aviation and air transport. The FMS will be the standard on all total Eclipse twin jets beginning in our fiscal second quarter, subject to FAA certification, which is underway. Every pilot will now have access to advanced integrated flight planning and navigation that enhances safety, increases situational awareness, and allows access to more airports even in inclement weather through use of coupled auto pilot GPS precision approaches and other features. We are developing a complete portfolio of FMS systems for our entire general aviation platform, including AdViz for Cessna and our universal vantage general aviation flat panel display system. Also at the MBAA tradeshow, Eclipse announced an investment by Sikorsky, a United Technologies company, which may indicate a future return to new aircraft production.

At the end of the fourth quarter, we had a backlog of $32 million, essentially in line with the level we have maintained throughout the year. There are $57 million of military and $40 million of general aviation and commercial air transport proposals outstanding. In summary, there are early indications that previously deferred shipments will resume, that business and general aviation and commercial air transport markets are recovering and that our efforts to penetrate the government and US and foreign military markets are succeeding.

I like to now turn the call back to Geoff.

Thanks, Roman.

Just a few concluding remarks before I take questions.

As you heard this morning, despite the significant market disruption, fiscal 2010, which led to a very slow start in the year, we managed to make major mid-course corrections and achieve profit and positive cash flow for the year. Due to our constantly changing customer delivery schedules and volatility of customer capital commitments, our quarters may vary making our annual results a much better representation of our performance. We believe that we are creating value through innovative and improved product functionality, such as FMS and advanced Beta 3 GPS receivers to our new relationships in general aviation, commercial air transport, and military markets.

Operating margins are sound. Expenses are now at levels consistent with revenues and the balance sheet is solid with ample cash and no debt. That cash provides our customers the reassurance that we are in it for the long haul and will support our products throughout their expected life. Our long-term objective is to create shareholder value by growing revenues, earnings, and cash flow. We expect revenues earnings and cash flow to increase in fiscal 2011 compared to fiscal 2010, improving especially as we approach the end of the fiscal year. This concludes Management's presentation, and we are now available to take your questions for the balance of the hour.

Operator, we please open the call for questions?

Yes, sir. Ladies and gentlemen, the question-and-answer session will be conducted electronically.

(Operator Instructions)

We'll pause for just a moment. Our first question today will come from David Campbell with Thompson Davis & Company.

Good morning, everybody.

Good morning, David.

I wanted to ask a few questions one about the cash flow the fourth quarter. What was it that enabled you to get that much cash flow in the quarter?

There were two factors. One was the profit, needless to say, and the second was a reduction in receivables. The receivables days decreased and that allowed us to enjoy that improvement in cash flow.

And you are very optimistic about cash flow in fiscal 2011. Is that, obviously the earnings, though, is probably the major reason for that, so that shouldn't be too surprising.

I would agree with that.

As far as the receivables, you're not going to get any more benefit from that in fiscal year 2011.

I would agree with that.

Right.

Now, this first quarter, you are talking about revenues that are almost as much as a September quarter. That's surprising, usually there is a big slump in the fourth quarter of every year. Calendar year. Is anything, to what do you attribute that better growth?

Hard work.

It is the drive. We would love to find a consistent smooth upward growth, and as you know, our first quarter is typically lower than the final quarter of the fiscal year for a whole bunch of reasons that are consistent in the industry.

We are hoping to continue the upward growth and we feel confident that we can get reasonable revenues in the first quarter. Every day we go out and battle; we are seeing some promising signs of demand recovery, and we are hopeful that some of our long-term contracts that are in place will start back up again and support our revenue plan.

But they did all support it in the September quarter, did they not, all your long-term contracts?

American Airlines, specifically, did not. We had no revenue at all from a very large backlog. Right?

Right.

I didn't -- yes.

We are hopeful that we will see some of that coming back and listen, just get out there and -- we have increased our sales staff and that is actually working out well, and some of our new products are getting a real interest in the marketplace.

We've had good support on our 757 product line in the fourth quarter.

That has come alive again as well.

Does American have any inventories of equipment or have they used it all up?

They have pretty much used to that. They are getting pretty close to starting to accept new hardware again. It has taken them time to get retrofit lines set up. They have three operating and they're trying to set up more as we speak. They've got a big fleet to modify and they're trying to do it as quickly as they can.

Just to clarify, as we have said before, they are doing more than just upgrading the cockpit with their equipment and those are the long lead time items.

Flight management system installation and winglets. It is a big mod.

Sounds like you are doing better than Cornell, which is really good to see.

I needed that.

Sorry about that Cornell-Penn game, but anyway -- SG&A at $1.2 million. Anything unusual and there? That's pretty much sustainable for the next fiscal year?

My view would be it will be a little bit more than that on a quarterly basis. There was a modest one off in there for the quarter.

As we grow the business, that will obviously go with it because sales staff will grow with that, so SG&A will grow proportionately with revenues and, obviously, the total expense and engineering will be -- we hope to maintain a fixed percentage which would suggest that the absolute value will grow as we grow revenues.

Right. Now, the FMS systems, the flight management system, do you have any new manufacturers involved in that or is it still just Eclipse and Cessna, no new manufacturers? Is that right?

Not anybody yet. We are working on it, as you can imagine. We just came out with the product, but as you know, going back about three or four years ago, we picked up the Eclipse program when the existing manufacture of the cockpit failed to get certification after an eight-year effort. We managed to design and develop and certify a complete new cockpit in 11 months. We've stayed true to our commitment to the airplane and to the owners of the aircraft and have developed over the last, especially last year, about four or five significant operating features for that equipment and those features will be made available on our citation cockpit and our Vantage system, which is now being certified on a Lear 31.

Lear would be a new market for you, wouldn't it?

By the way. We are not doing the SGC; an FBO, Stevens Aviation is doing the SGC. When we developed the Vantage system, we developed a universal system that can be applied in any business jet and the FBOs can take that equipment and put into virtually any business jet to upgrade the cockpit, and they will obtain their own SGC because we have made adaptation of this equipment to be different flight decks very, very easy.

This is -- quite frankly, you are right. It is a new, an exciting new direction that we've taken for the product line. This will be the first to completely on your own SGC done by Stevens Aviation.

Right.

My last question is 250 aircraft, Eclipse aircraft. I did not realize there were that many operating, 250 operating. The upgrades -- it is not up to eclipse, that is up to whoever is operating them. Is that correct?

Those are the people that -- everybody will want to do it because it now fulfills the promise of the original aircraft and gives it more than an additional functionality, it actually gives it essential functionality and virtually every operator has been enthusiastically supportive. We have the head of the Owners Association thanked us personally for our efforts. We are delighted to be part of the team.

Thank you very much. I'll turn it over to somebody else.

Thank you.

Thank you, David.

Thanks, David.

(Operator Instructions)

With no questions remaining, I would like to turn the call back over to Management for any additional or closing comments.

Thank you.

Thank you for listening in today. We are pleased to answer any questions you might have. Give Ron a call and we are glad to talk to you one-on-one. Thanks again for attending the conference call today. 'Bye, 'bye.

Ladies and gentlemen, that concludes today's conference call. We thank you for your participation.