Innovative Solutions and Support Inc (ISSC) 2011 Q1 法說會逐字稿

Good day and welcome to the Innovative Solutions and Support first-quarter 2011 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. Welcome to the Innovative Solutions and Support first-quarter 2011 earnings conference call. Today's conference call is being recorded. At this time, I'd like to turn over the conference to Ron Albrecht, who will -- our Chief Financial Officer, who will review the Safe Harbor statement.

Thanks, Geoff. Good morning. I would like to remind our listeners that certain matters discussed in the conference today, including operational and financial results for future periods are forward-looking statements and 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 10K, which is on file with the SEC.

I will turn the call back to Geoff now.

Thanks, Ron. Results for the first quarter of our fiscal 2011 were markedly improved from a year ago on both the top and bottom lines. Revenues in the quarter were up 42% from a year ago and we recorded a profit this year, a major improvement over the million-dollar loss from the same period last year.

Of course, a year ago, many in the industry were commenting that we were in the midst of the worst industry slowdown in history. While the markets are rebounding, there is mounting pressure on our industry to deliver increasing value to the customers. Consequently, our performance indicates that we can meet the most demanding requirements in the most challenging of markets. We can trace this success to the strong relationships that we've built over the years in the military, commercial air transport and business aviation markets. In fact, these relationships have enabled us to enter fiscal 2011 with more than a year's worth of revenues in our backlog.

We see the value of a balanced portfolio among the military, commercial air transport and general aviation markets. The general aviation markets were hit hardest by the economic slowdown, but we see encouraging times -- signs of some recovery remaining very guarded in our optimism. We are pleased that we were able to maintain a strong backlog and presence in the commercial air transport market.

Happily, many of our customers see significant increases in load factors and commensurate improvements in revenue and profitability. Military opportunities, we believe, will pursue value solutions where we excel in outstanding performance versus price ratio. We continue to invest heavily in market development, product development. Our investment of over 20% of revenue enables us to address next gen, the next generation air traffic control system, as well as miliary updates for the military. We intend to continue this investment through the year as we see demand growing.

The development of our flight management system for Eclipse is progressing well. The FAA flight test should start next week and we believe we're on track to deliver this equipment this quarter. We focus on productivity and efficiency of our operations, which has enabled us sustain gross margins of better than 50%. The margins this quarter were 55% as well as -- as well, within our gross margin target range. By keeping a tight rein on our expenses while continuing to invest strongly in product research and development, we leveraged our performance into a bottom-line profit while driving $1 million worth of cash flow this quarter.

We are on pace to improve revenues and earnings this year as previously expected. Ron will go through the numbers in more detail in a minute. As the markets evolve, customers are expecting more functionality in their flat panel display and cockpit systems. Core research and development has been maintained at strong level despite these challenging marketing conditions. We rely on our ability to stay close to the market and to quickly and nimbly adapt as conditions change.

In addition, we are -- now have a foothold in the European commercial air transport market. Recently, we achieved certification for our Boeing 757 flat panel display system, and our first customer, Iceland Air, will soon by flying our equipment. The first installation has just been completed and we expect that aircraft to be operational within days.

Certainly, we have hoped that our end markets would have rebounded more robustly by now. Nevertheless, there are reasons to believe that our markets have troughed and will improve. For instance, the defense budget is under scrutiny. With new weapon systems procurement being deferred, defense spending is likely to be increasingly directed at enhancing and modernizing existing aircraft. This spells opportunity for our equipment, such as flat panel display systems and control systems. Roman will provide more detail on recent wins as well as opportunities arising from business development and product development efforts.

Let me turn it over to Ron for a more detailed review of our recent financial performance. Ron?

Thanks, Geoff. Revenues for the first quarter were $6.5 million, a 42% increase from the first quarter last year. From a product standpoint, flat panel display revenues in the quarter were approximately $5.7 million, while air data shipments in the quarter were about $800,000, or an 88% and 12% breakdown of quarterly revenue respectively.

Flat panel revenue represents an increasing percentage of total revenue, up from 80% in this fiscal -- from the fiscal quarter -- same fiscal quarter of last year. Gross margins in the first quarter were 55%, up substantially from a year ago, but down about 8 percentage points sequentially both as a function of somewhat lower volume than the product mix.

As Geoff mentioned, the 55% margin achieved this quarter is within our expected long-term gross margin range. Total operating expenses for the quarter were $3.4 million. Research and development expense in the quarter was approximately $1.4 (technical difficulty) million, roughly flat compared to both the first quarter of a year ago and the fourth quarter of fiscal 2010. For the quarter, research and development spending was about 21% of revenue, consistent with our objective.

Selling, general and administrative spending in the quarter totalled $2.1 million, down slightly from the year-ago quarter. Sequentially, SG&A expense was essentially flat for the fourth quarter. We have been successful in holding down the administrative costs while freeing resources to support sales and marketing efforts.

For the quarter, operating profit was $151,000 and profit before tax was $348,000. Other income of approximately $200,000 included final payment in settlement of patent litigation and interest income. After-tax net income was $285,000 or $0.02 a share. Cash flow from operating activities was approximately $1 million in the quarter.

We have continued efforts to reduce inventory levels with a total reduction of 17% over the last 12 months. Our balance sheet remains strong with $41.9 million in cash and no debt. Along with our revenue and earnings growth objectives for 2011, we expect to continue to generate operating cash flow at a level consistent with profits, although higher fourth-quarter sales may result in higher year-end receivables, which will not be liquidated until early fiscal 2012 quarter, first (technical difficulty) of 2011.

I will now turn the call over to Roman for some comments on the current market conditions and new product and business development. Roman?

Thank you, Ron. We have stated before, the Company pursues business development opportunities in each of the three aerospace segments, commercial air transport, military and business and general aviation. Our commercial air transport efforts are focused on delivery of the flat panel display systems and their data products for the major airlines and package carriers.

As we anticipated, this segment is showing signs of a slight improvement. This gives us confidence that our current customers will continue their upgrade programs, consume stock on hand and release purchase orders to replenish depleted inventories. In the short term, our business activity levels in this segment tend to reflect market confidence levels, which have recently been muted. Nevertheless, over the long term, commercial air transport remains a very large market opportunity. To capitalize on this opportunity, we have focused our research and development efforts towards enhancing product functionality, such as RMP, required navigation performance, and ADSB, automatic dependent surveillance broadcast.

These features enable us to address both the federal Aviation Administration's next gen and the European Aeronautic Services Agency, EASA, Single European Sky initiatives dealing with increased flight volumes and overburdened air space. In addition to improving functionality, we continue to expand the number of platforms for which we are certified and qualified.

This quarter, we began shipments of the flat panel display system upgrade for the Boeing 757 cockpit upgrade to Iceland Air. This provides us with entry into the large European commercial air transport market. Our sales efforts are focused on expanding sales to the European operators, domestic airlines and cargo carriers, as well as to VIP customers that fly Boeing 757 and 767 aircraft.

In the military segment, there has been much discussion regarding anticipated changes in military procurement priorities, precipitated by announced defense budget cuts. Our 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 benefits us. Of course, while the final budget is debated, there is likely to be more of a lull before we begin to see any increase in fleet upgrades.

Based on our growing number of relationships with defense agencies, both domestic and international, integrators and fleet operators, we anticipate that as the focus of spending shifts to existing aircraft, we will see significant growth opportunities. The general aviation market is displaying signs of having bottomed out. Most accounts in the trade publications suggest this segment is unlikely to gain significant momentum until 2012. Consequently, our general and business aviation efforts are focused on enhancing product functionality, capturing new near-term opportunities and preparing for the eventual more broad-based market recovery.

The new flight management system that we announced last quarter is going through the FAA qualification process. The implementation of FMS will give pilots the capability of advanced integrated flight planning and navigation that enhances safety, increases situational awareness and allows access to more airports, even in inclement weather, through the use of coupled autopilot GPS precision approaches and other features.

At the end of the first quarter, we had a backlog of $32 million, essentially unchanged with the level that we have been maintaining. Presently, there are more than $110 million of military general aviation and commercial air transport proposals outstanding. While the proposal pipeline remains robust, many of these opportunities have been going through a variety of rescoping and resizing reviews. In part, we think this reflects the somewhat cautious mood of operators. By the same token, we believe also that the fine edge these operators are putting on these projects is suggestive of their intent to go forward shortly, especially with the projects that have already gone through several iterations of refinement.

In summary, customers are beginning to commit orders for deferred product in our backlog, general aviation and commercial air transport markets appear to have bottomed out and we are anticipating an uptick in maintenance and upgrade spending in the military sector.

I would like, now, to turn the call back to Geoff.

Thanks, Roman. Just a few concluding remarks before I take questions. The first quarter represents significant improvement over the prior year and is a good start to the fiscal 2011. We remain cautiously optimistic going forward. We are succeeding because we are able to provide real value to our customers at a relatively modest price. And this means that value is always in demand, regardless of market conditions. Through innovative and improved product functionality such as FMS, Beta 3, GPS receivers and navigators, we are able to deliver value to our customers. This value then produces new relationships in GA, commercial air transport and military markets. Better products, more customers, create values to our shareholders.

Our outlook for the year has not changed. We expect revenues and earnings and cash flow to increase in fiscal 2011 compared to 2010, improving especially as we approach the end of the fiscal year.

This concludes our management's presentation and we're available to take your questions for the balance of the hour. Operator, will you please open the call for -- open the -- for calls, please?

Yes, sir. Thank you. The question-and-answer session will be conducted electronically. (Operator Instructions). Our first question comes from David Campbell with Thompson Davis & Company.

We knew that.

Good morning everybody.

Good morning. Listen, I was expecting the only people that were calling were plow operators. (Laughter)

Well, this is -- I wish I could give you tons of orders. That's what I need.

Yes, well.

I need -- I need to change jobs and go to work for Delta Airlines or something and get them off their butts.

Yes, well, we're starting to see some broad improvement. And fortunately, we're seeing American Airlines now running four modification lines and we're expecting to see six to eight aircraft a month now start moving. So we're seeing a recovery. That's the good news in that area.

And having this three-pronged approach, the three-legged stool, so to speak, allows us to accommodate this massive impact to the general aviation marketplace, although Eclipse is going strong. They're doing a great job, and we expect to be -- they're waiting for our GPS receivers and flight management system, and as soon as we finish flight-testing with the FAA, we will start delivering them to Eclipse.

Well, I take it American didn't help in the first -- in the December quarter?

Not at all.

Okay.

And it won't -- we won't see American impacting us until -- really the third quarter is when it will start coming along, May, June kind of thing.

Okay.

Remember, they had 50 ship sets in their stores that we delivered and their lines weren't up. Now their lines are starting to use up that backlog. The equipment is working very well, we're happy to say. So it will be May before we start to support the lines with new equipment.

Right. Right. Right. Can you explain a little more about Beta 3 GPS, I haven't heard --

Well --

-- much discussion about that?

Well, Beta 3 is just a performance definition. The normal GPS has got update rates of once a second and has pretty wide accuracies. The Beta 3 has updates of five times a second that will allow you to actually control the aircraft and provide a lot of data about the constellation so that you can monitor integrity. So it's a far more sophisticated version of the GPS receiver, but it uses the same satellite.

And -- and it --

We use it -- and we use it for primary navigation of aircraft including commercial air transport aircraft, military and general aviation.

So it's -- sales are not part of flat panels, but --

No, they're part of --

-- they're a part of --

-- they'll be part of our -- they'll be principally part of our flight management system. In fact, we will be delivering two receivers with every FMS to Eclipse, and they are waiting for them. We have outstanding orders for them right now, so we'll start delivering those, we hope, at the end of this quarter, as soon as we get certification from the FAA, the flight tester starting next week.

End of the March quarter?

Yes.

Right, right, right. Right, right, okay. And you mentioned in your remarks that the backlog exceeds annual revenues and you're implying revenues of $30 million for the year?

No, I'm saying right now they exceeded last year's revenue and our present quarterly revenue times four, so they exceed that. We hope that the backlog increases as we increase our sales. So that's what it means.

Oh, okay, so --

It just -- it's doing the same thing you do, which is annualize a quarter. You do that all the time. And keep raising our target. That's good for us.

Um-hmm. So you're not forecasting revenues in that statement?

No, I'm not forecasting revenues at all. We're -- it's an anecdotal comment, to be honest with you.

Um-hmm, right, right. Right, right. In the 757 in Europe, that could be a big breakthrough but Iceland Air is not exactly a great target, is it?

That's not true. There -- clearly, they had serious economic problems, but, oh, by the way, so does places like Ireland, Spain, Greece. A lot of people have a lot of problems in Europe. Iceland has got the -- their problems under control and they're doing fine, and as Ron commented, is the entree. W

We got, most importantly, EASA, that's the European FAA, certification for our system. That's a major breakthrough. It means that we can deliver -- and interestingly enough, Iceland Air maintains that -- almost a dozen aircraft of other people and are expecting to do installations on them. They're going to be selling them to those people as well. So it's a start and it's a good one.

How many -- so Iceland Air itself has how many 757s?

17.

They have 17?

Yes. It's a good airplane. It's a great airplane.

Well, we know that because FedEx is buying some of the used ones so. I --

They're buying every one they can find.

Right. Right. But despite that, there are still plenty of used ones in Europe, you see the market there as significant?

Well, they made about 800 of them. There's a total fleet of [57s and 67s], as I said, about 1,700 aircraft. And 500 of them are in Europe.

Um-hmm.

It's a good opportunity.

That's a lot.

It's a good opportunity. And we're increasing the package that we're going to make available to this including things like potentially GPS navigation and a few other things.

Um-hmm. Um-hmm. Right, right, right. But your orders so far for the fleet management systems are primarily in general aviation?

The -- it's a flight management system and is -- it is only in GA now. But we're just finishing the product and integrating it into the general aviation for Eclipse, but the basic computer and engine is applicable to all the marketplaces. It's only the human interface, the interface to the flight crew that varies from application to application. It has the capability of navigating to incredibly accurate levels of controlling an aircraft as tight as 600 feet laterally through its maneuvers for approach into the airport, which opens up opportunities for required navigational performance in a -- for aircraft like the Eclipse and the citation retrofits.

Okay. One last question, that is, the commercial airlines in the United States could hardly be making more money, at least in the forecast by analysts in the companies. What's holding them back, I mean in terms of upgrading their equipment?

Well, like everybody, after you've lost money for a while, you tend to take a breather and tend to be a little cautious about your investment. And they're going to be doing that. But look at American, American is growing aggressively and so is FedEx. So we expect to see that growing and we're doing well in the commercial air transport market.

Yes.

Yes.

Okay, thanks, Geoff.

Thank you.

There are no further questions at this time. We'll pause for just a moment.

And we'll now take a follow-up from David Campbell.

Yes, just want to make sure I clarify something, Geoff. The sales of Iceland Air starts in the month of March?

It's -- we've already been shipping to them.

You've already been shipping?

Yes, starting December.

It started in December? Okay.

Yes. Yes.

All right. And then the last -- in the air data -- air data, $0.8 million in the quarter, that's hardly even counting anything, is that seasonal, is that -- I mean, is that a military seasonal decrease?

Oh, no, it's a general -- there's generally not much being procured. General aviation is almost dead and commercial air transport is just coming alive. So you -- the general demand is down and it's going to rebound and we see it. We're prepared to do it, but right now it was to -- almost to be expected.

Right. But a lot of this goes to the Department of Defense and military stuff, doesn't it?

Right. But even as --

(inaudible) ordering stuff.

-- but you -- and you remember that the Department of Defense is relooking to taking -- Gates just -- pulling a billion dollars out of -- $100 billion out of the defense budget so everybody is recalculating what they're going to buy and reprioritizing. So that's delaying some of the procurements in military. And it should be, as you point out, a good sign. It suggests that they're going to be looking for how do I get the most value for the buck, which is a refreshing change, generally.

And there's going to be some pent up demand, of course.

Sure. Pent up demand, as Ron comments.

Right, right. And I think Ron said $110 million of outstanding proposals. Did I get that right?

That was Roman who said that.

Yes. Yes, I did say that.

Yes, Ron -- yes, Roman. Has there been any movement in that; I mean that's roughly what it's been for several quarters?

Well, you would expect that. I mean, we would continue to refresh -- either refresh proposals or come up with new proposals if and when we get awarded. We expect some awards to come up in the near future but a lot of these procurements were delayed and reviewed, especially the military ones, in light of the demands on adjusting the defense budget.

I would think that Icelandia, was a proposal before is now --

That's right.

-- is now in the backlogs.

That's correct.

That's exactly what happened.

Despite that being in the backlogs, the proposals are still up where they were.

That means we got more proposals out.

Yes, that's -- in fact, they're up about 10% from the prior quarter.

Um-hmm. Yes, so, that's a reasonably good sign for the future.

(Multiple speakers).

Yes, we expect the -- they'll start maturing. A lot of them have been recast, but we're optimistic.

Um-hmm. Um-hmm. Right, right. Okay, well, I don't know, I guess that's it for me. Thank you very much. I look forward to seeing you again soon.

I look forward to seeing you. Thanks for calling in. Thanks for those of you who sat through this snowstorm and were able to listen in.

That will conclude our comments for today. Thank you for attending. Bye-bye.

And once again, that does conclude today's call. We thank you for your participation. You may now disconnect.