Innovative Solutions and Support Inc (ISSC) 2011 Q2 法說會逐字稿

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

Good morning. This is Geoff Hedrick. I would like to welcome you to our morning conference call to discuss the second-quarter 2011 results, current business conditions and our outlook.

Joining me this morning 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?

Thank you, 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 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 10-K, which is on file with the SEC.

I will turn the call back to Geoff.

Thanks, Ron. The second quarter of our fiscal 2011 marked our fourth consecutive quarter of improved year-over-year financial performance. Net revenues were up 26% from the second quarter of last year. We reported fiscal 2011 second-quarter net income of $499,000 or $0.03 per diluted share, which is up from a loss of almost $750,000 or $0.04 a share for the second quarter of last year.

Margins for the quarter reached 57%, up compared to both a year ago and the most recent quarter due to improved productivity and product mix. The quarter's earnings growth was achieved while increasing our investment in new product research and development to the highest level in two years, $1.6 million or approximately 24% of revenue. The Company generated $600,000 of positive cash flow from operating activities in the second quarter, helping us to maintain our strong financial position.

In a minute, Ron will go through the numbers in more detail. While we are pleased with our second-quarter financial performance considering the uncertainty in our markets, what is most notable was the progress achieved in strengthening our competitive positioning for long-term growth. In what can reasonably be described as a major accomplishment with positive implications for long-term success, we received FAA Supplemental Type Certificate, STC, for the Flight Management System and the global positioning system receiver, the Eclipse twin-engine jet, in the second quarter.

For the Eclipse FMS, or Flight Management System, we were providing a more comprehensive and powerful package of COCKPIT/IP, and it combines our flat-panel display system with the Flight Management System and GPS that greatly improves safety, reliability and reduces fuel consumptions and carbon emissions. This is one of the most advanced fully featured FMS systems in general aviation.

We are pleased to add new functionality to our products and add new air frames to a long list for which we are certified. We can now offer OEMs a turnkey cockpit solution. These certifications are clear indications that we are achieving our objectives of offering the industry's best available value and preparing us well for long-term success.

In the near term, there has been a pause in the market, rising oil prices and uncertainty related to federal budget debate, have caused delays in awards on outstanding proposals, especially in the military and other government markets. As a result, while the value of outstanding proposals is continuing to increase, backlog has fallen somewhat.

While the federal budget impasse has impacted the release of military contracts, subsequent to the end of the fiscal year, we have been awarded a strategically significant multimillion dollar contract from the Air Force's new aerial refueling tanker, the KC46A. Winning this prestigious and highly visible contract is another important milestone in our strategy to penetrate military markets.

Since April 14 when the budget impasse was resolved, we are starting to see increased procurement activity from previously delayed military and other government programs. Further, we are advancing identified opportunities in commercial markets, although it appears that a strong recovery in general aviation activity may not occur until 2012.

With our [adder] functionality and related new certifications, our addressable market is now greater than any time in the Company's history. With an increasing number of platforms on which we are qualified and the additional functionality broadening the appeal of our technology, we are now poised for new growth.

While the pause in the market has influenced our expectations for the second half of this year, we believe that various product development successes have increased our prospects for the long-term.

Let me now turn over the call to Ron Albrecht for a more detailed view of our quarterly financial performance. Ron?

Thank you, Geoff. Revenues in the second quarter were $6.7 million, which is subsequently compared to the first-quarter 2011 revenues of $6.5 million and up 26% year over year compared to $5.4 million in the second quarter of fiscal 2010. This quarter's result represents our fourth consecutive quarter of year-over-year revenue growth.

From a product standpoint, flat-panel display revenues in the quarter were approximately $5 million, and Air Data product shipments in the quarter were approximately $1.7 million or 25% of total quarterly sales. Gross margins in the second quarter were a very strong 57.4% because of a favorable product mix, productivity enhancements and the inherent operating leverage in our business. In comparison, gross margins were 45.2% a year ago and 55.1% in this year's first quarter.

To balance our growth and profitability objectives over time, we believe that gross margins should be in the range of 50%.

Total operating expenses for the quarter were $3.4 million, up less than 4% from the second quarter of fiscal 2010. Virtually all of the year-over-year increase was in research and development expense, which increased to approximately $1.6 million in the quarter compared to $1.4 million in both the first fiscal quarter and the year ago quarter. At $1.6 million, research and development investment in the quarter was the highest in absolute dollars in two years and reflects our commitment to invest in product enhancements and new product development.

Sales, general and administrative spending in the quarter totaled $1.8 million, basically flat with the year ago quarter, but down over $200,000 sequentially from this year's first quarter.

For the quarter, we recorded net income of $499,000 or $0.03 per diluted share, up significantly from a loss of $746,000 or $0.04 per diluted share in the second quarter of last year. Second-quarter earnings were also up sequentially from $484,000 or $0.02 per diluted share in the first quarter this year.

Cash flow from operating activities was approximately $600,000 positive in the quarter. Our balance sheet remains strong at $42.5 million in cash and no long-term debt. Cash at quarter-end is up about $1.6 million this fiscal year.

After a challenging first half of last year, we now have a solid four consecutive quarters of year-over-year revenue growth and profitability as a result of our concerted efforts to continue to invest wisely and build our market opportunities. We believe that this strategy is effective in creating value over the long term.

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

Roman?

Thank you, Ron, and good morning. As you know, the Company pursues business development opportunities in three aerospace segments -- commercial air transport, military and business and general aviation. Our commercial air transport efforts are focused on delivery of flat-panel display systems to the major airlines and package carriers. While rising fuel costs and the profitability discipline of the major airlines are strongly influencing the timing and nature of fleet spending decisions in the near term, our growth strategy in this segment is long-term oriented and focused on enhancing our product functionality and expanding the aircraft platforms for which our technology portfolio is qualified.

For example, earlier this calendar year our flat-panel display system (inaudible) upgrade received EASA certification. This is the European equivalent of the FAA. This increased our addressable market by the approximately 500 Boeing 757/767 aircraft operated by carriers throughout Europe and the Middle East.

We have already completed our first installations with Icelandair, which is placed aircraft retrofitted with the IS&S COCKPIT/IP into revenue service. This important milestone builds capability in Europe and serves as a strong platform to create additional growth opportunities.

In the general aviation segment, as Geoff mentioned, we announced that the Federal Aviation Administration issued the supplemental type certificate for the Flight Management System for the Eclipse aerospace twin-engine jet. The IS&S developed FMS and dual WAAS, SBAS, Beta-3 GPS receivers are approved at TSO-C146c and TSO-C145c respectively.

Eclipse twin-engine jet operators are now able to upgrade their aircraft with an integrated Flight Management System through Eclipse Aerospace. The Avio IFMS avionics suite is one of the most advanced cockpits available for any aircraft. The 13 microprocessors in the IS&S displays control all major aircraft systems. Improvements to the E-Chart mapping and satellite weather functionality, along with FMS precision navigation, give the Eclipse twin-jet unrivaled performance.

Among other features, the Flight Management System provides coupled WAAS LPV approaches, performance-based top of descent, required navigation precision to 0.1 nautical miles, coupled in-route GPS navigation, coupled approaches and procedures, and automated airway entry as examples.

The E-Chart feature has been enhanced to allow selection from a list of applicable charts based on the flight plan and to view nearest airports. Charts may be overlaid on the moving map to improve situational awareness. XM satellite weather data display has been expanded with additional functionality.

This rollout of a proprietary Flight Management System is the latest in our long line of product innovations and functionality improvements since the introduction of our first flat-panel displays. This history of product innovation continues to distinguish IS&S as offering the best value for the operator's investment in the industry.

We continue to believe that the military market represents a large opportunity. We have made significant strategic progress with a variety of federal agencies, as well as international defense agencies, that we believe are keys to developing this market for future growth. As Geoff mentioned earlier, we have received an award from Boeing for the KC46A tanker.

Outstanding proposal value has increased to over $140 million, the highest level of proposal activity in the Company's history for the majority of the opportunities centered in the military and government segment. Unquestionably the increasing functionality and additional platform certifications of our technology are having a very positive impact on our market opportunities and is contributing to this increased proposal activity.

In the short term, however, closing of these proposals has been slowed by the lengthy delays in the award process, which we believe is the pressing backlog temporarily. Backlog has decreased to $25 million since March 31, 2011.

As has been our practice in vigilantly assessing our contracts, backlog also reflects an approximate $4 million of de-bookings. These de-bookings pertain to orders for certain aging aircraft that are being removed from the fleet or will not be modified by the current operators. We do believe these same aircraft offer ongoing market potential as they become acquired by other operators.

Over the past several years, we have also experienced the marked increase in the proportion of revenue generated by intra-quarter book and ship business, which is another indication of the cautious nature of the operators. Although our markets have paused, the need to improve the efficiency, safety and reliability of aging aircraft is increasing.

At the same time, the legacy avionics are becoming increasingly unsupportable. This is a situation which creates growth opportunities for companies such as IS&S with the ability to quickly develop and implement key upgrades that improve aircraft. We pride ourselves on our track record of consistently delivering critical improvements to our COCKPIT/IP. These address not only current requirements, but simultaneously provide operators with a flexible path to future upgrades and enhancements. We believe that this aspect of our product strategy is critical to creating value for customers and is an important market discriminator. Our strategy is to increase our position in all three of the market segments, grow sales and generate cash that will enable us to earn superior returns for our shareholders.

Now I would like to turn the call back to Geoff. Thank you.

Thank you, Roman. We have produced a marked improvement in virtually all key financial performance metrics over the first half of fiscal 2011. At the same time, we have maintained strong financial position. We have made significant strides improving the functionality and broadening our addressed markets. This critical performance cannot easily be measured in financial terms at which we feel is the most important current measure of the Company's progress. We are gaining recognition within the industry for our ability to deliver the greatest value for the investment over the long term.

And I would like to now turn over the call to our questions.

(Operator Instructions). David Campbell, Thompson Davis & Co.

I've got a couple of questions. Roman, you said that the military had awarded you the contract for, is it the KC10 tankers?

KC46A. This is that long ongoing tanker competition between Boeing and Airbus. Boeing received the award from the Air Force, and in turn, we are a supplier to Boeing, and Boeing has placed the contract with us.

So you have -- well, this is an original equipment order, right?

That is correct, David.

It is for about 179 --

179 aircraft, yes.

767 tankers.

So then production of those starts in the next fiscal year?

No.

Two years out that they go into low rate production, and then in the third year, they move into production.

And they continue on for almost 15 years.

Yes, and possibly longer as our fleet's age is out there existing, they will keep buying more of these tankers.

So this would be in your fiscal year 2013?

Yes, that is production. But, in the meantime, we have a multimillion dollar contract initially here to support the initial aircraft. So this will have an impact in the current fiscal year, the next fiscal year and so on. It is a good contract for us.

Right, right, right. And it was not in the March 31 backlog, is that right?

Correct. It was not in the March 31 backlog. (multiple speakers) But that is significant increase in backlog. And initial funding is several millions of dollars for the --

Engineering developments phase, as well as first prototype aircraft, etc.

It starts immediately.

So you said that since it is March 31, you have got about a $25 million increase in the backlog, is that what you said?

No, no, no.

Our backlog was $25 million at the end of the quarter. We are now beginning to see increases in that backlog already in April.

In a couple of programs that have come in since the end of the quarter.

Okay. Okay. Despite this contract and the overall enthusiasm, though, you are talking about -- it sounds like you are talking about revenues that will be about the same as they were in the first six months for the next six months. Is that correct?

Right now that is what it looks like. (multiple speakers) We are optimistic things are changing, so we're not changing our numbers at this point.

Well, right. It is sort of difficult to figure out what is going to happen.

Well, it is hard for us to understand. I mean, first of all, the struggle over the budget delayed a whole bunch of military programs that would have not only increased our backlog significantly, but would have given us revenue now which we anticipated and expected. So that is impacting us. And the doubling of oil and the cost of jet fuel literally doubling in the year has obviously had an initial impact.

Now the fact that we can save fuel with our equipment is a positive, but it certainly brought pause to an awful lot of air carriers that are trying to operate aircraft and finding their costs going up. So both of those have an impact, and we are just trying to be cautious in our predictions. That is all.

But the Department of Defense, what it looks like now is that those revenues will be down from what you had planned six months ago?

The timing of them, but overall we still anticipate the same awards. Just everything kind of slowed to the right.

We are seeing a couple of things are positive. Some of the programs that were delayed in award are being accelerated in delivery, so that's a positive aspect. But it is too soon to really let you know.

Right. Well, it must be a little discouraging to be spending all of this money in R&D and not seeing it in revenues. What about the 737s? You mentioned those a couple of years ago that you are working on retrofits there, and it looks to me like a lot of airlines are grounding their older 737s instead of refurbishing them, re-equipping them. How do you see the 737s program? Is there any news on STCs there?

Well, two things. First of all, addressing the ones that are being put on the ground, they are about, as I understand, 170-odd aircraft that are directly affected by this recent skin failure on a 737. But there are still about 1800 that are unaffected and still flying.

We have just been notified that we will be a receiving substantial equipage order for a very large system on a number of -- a relatively small number of 737s aircraft, and we expect to be supplying a complete cockpit, including some very sophisticated equipment supplied by other manufacturers, and we will serve as full systems integrator on those aircraft. It will be a substantial order in dollar terms and most importantly substantial and positioning us in a market that is an additional 1800 aircraft. And we are able to take the technology we have developed for the 757/767 and move it into the 737 at a fraction of an original development cost. So we will be able to respond quickly to this new contract.

I mean this is a big change. I mean you are now acting as the principal installation of a new cockpit. And that is just -- (multiple speakers)

Absolutely correct, and the significance is two things. For the first time, we can actually provide -- offer an OEM a complete cockpit from autopilot through radios. And most significantly, our solution is quite different than some of our competitors in that we provide them -- the OEMs flexibility in the long term to be able to purchase things like radios through us from multiple sources. So we can get -- we can capture the most advanced technology that is available and the best value available at any point in the production over its lifespan of 15 to 20 years. So it is a real breakthrough for us, and a systems integrator on a large complex program like we have just described is also significant. So it has really moved us up a big rank into a different league, and we are very excited about that.

I mean the percentage of the cockpit that you had manufactured is relatively small compared to what you would be buying from other manufacturers, isn't it?

Well, but what is increasingly -- we are increasingly adding features. I mean we do module flight management. We do -- obviously we always did Air Data. We do the complete display systems, and now we are in full control. We do the radio management units and a broad range of control systems. As an example, we are in control of the electronic circuit breakers in the Eclipse. There are only a few aircraft flying that have electronic circuit breakers in them.

Well, I mean Honeywell would have gotten this contract a year ago. So you are really taking business away from what Honeywell would have gotten.

I don't know if Honeywell would or would not have, but I'm happy we did. You know, somebody might have, but we are happy we did. So this is a good step in the right direction, and now we just have to put a few more together and we are guardedly optimistic. You know (multiple speakers) a lot has changed in the last several years, and the biggest change in me is that I just have been a little bit more circumspect in my enthusiasm.

But will you have more to say publicly about this in a press release or something when --?

Yes, when we get the actual contract in hand, etc., we will have a release and describe exactly what we're doing, and that is a couple of weeks away probably.

So what have you got so far is some kind of verbal agreement with the airline that is doing this?

That is correct.

Well, that is huge, huge, huge change.

It will be -- it is definitely a big change, and we are optimistic about the future.

And these are 300s or 200s? What kind of 737s are they?

They are just classics. They are in the same group in the 300, 400, 500 group of 737s.

It sounds like Southwest Airlines to me, but obviously you can't say.

I can't say.

Which is a company you have had trouble getting through to before.

You will know next week or week after. How is that?

Okay. Okay.

Thank you.

I just can't imagine. This is a huge change.

Well, good. I hope it is a positive one in your mind.

Well, I mean you are going to go from, I guess, not much revenues to significant revenues in the next fiscal year.

Well, let's see. We will find out. We are going to put one foot in front of the other and try to make sure that we generate cash, generate a profit and increase the -- (multiple speakers)

Right.

All right?

And what about Eclipse? This -- can you update us on Eclipse? Because I understood they had a lot of unsold aircraft that they had to sell, and they had a lot of unsold flat panels from you that they had to use. What is the status of all that?

Well, they are actually upgrading and selling aircraft. They are working closely, as you know, with Sikorsky, and that has strongly improved the situation with Eclipse. They are in strong shape supporting their existing customer base of 250-odd aircraft, and they are looking forward to returning to production in about 15 months. So that is very good news, and their tight linkage with Sikorsky provides them a certainty of performance that is welcomed by the existing owners and the future owners.

So --

And we are happily delivering well over $1 million worth of equipment a quarter for the last seven odd quarters.

Okay. Thanks very much.

Thank you. Good talking to you.

(Operator Instructions). There are no further questions at this time. I will turn the call back over to the speakers for any additional or closing remarks.

Well, thank you. Thank you for joining us today. The concern about higher fuel prices and the federal government stalemate all impacted in the short-term the business, but the future is very promising. As we described, recent certifications and orders have improved our confidence looking forward. We continue to invest in the fundamental technologies that have gotten us where we are today and have been the reason why we have gotten some recent orders. Our long-term view is a strong commitment to research and development, continued innovation and fiscal responsibility that are going to enable us to build real value to the shareholders by broadening our product offerings, expanding the number of aircraft we can improve safety, reliability and performance.

Thank you very much.

And that will conclude today's call. We thank you for your participation.