Innovative Solutions and Support Inc (ISSC) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to today's Innovative Solutions & Support third-quarter 2011 earnings conference call. Please note today's conference is being recorded.

At this time, I will turn the conference over to Mr. Geoffrey S.M. Hedrick, Chairman and Executive Officer. Please go ahead, sir.

Good morning. This is Geoff Hedrick, Chairman and CEO of Innovative Solutions & Support. I would like to welcome you this morning to our conference call to discuss third-quarter 2011 results and our current business conditions and outlook. Joining me today in our Exton headquarters are Roman Ptakowski, our President, and Ron Albrecht, our CFO.

Before I begin, I would like Ron to read our Safe Harbor message. Ron, will you do that?

Thank you, Geoff, and 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, Ron. In last evening's release. we reported third-quarter revenues of $6 million, on which we generated a gross margin of 52%. Compared to the previous quarter, research and development and general and administrative expenses were substantially the same. With a continued high level of investment in product development, we have reported a small operating loss, but positive operating cash flow for the quarter.

While the third-quarter performance was down from a year ago, year-to-date revenues, margins and earnings and cash flow remain above last year. With our investment into future opportunities, we are growing this business, not just financially, but more importantly, strengthening our overall competitive position in the marketplace.

Yesterday, the National Nuclear Security Administration awarded us a contract for the systems integration and performance upgrade of the Boeing 737 Classic, with first deliveries in October of 2011. This strategically important win is a culmination of several years of investment in strengthening our capability and our efforts on smaller systems integration programs.

This win and its resulting STC opens the market for 737 Classic upgrades with a worldwide fleet of over 1000 aircraft. It further establishes our experience as a systems integrator on future larger programs.

This initial order for a retrofit of two 737-400 aircraft will provide NNSA full CNS/ATMS communication, navigation and surveillance capabilities, and similar efficiency and performance to the next-generation 737 at a small fraction of the cost. The integration effort eliminates legacy and CRT displays in avionics and provides a platform for future upgrades.

Included in the effort are more than 14 new systems, including advanced FMS, TCAS, EGPWS, Mode S transponders, NexRad and SatComs from eight different vendors, including Collins, Honeywell and ACSS.

Eclipse Aviation is installing our new integrated flight management system on its existing fleet of twin-engine jets. As a result of the enthusiastic owner reception for our system, Eclipse has announced that they are sold out for this Avio IFMS completion program through March of 2012. The successful completion of this FMS now establishes the Eclipse flightdeck as one of the most advanced and comprehensive of any aircraft in the industry.

Boeing has awarded IS&S a contract for aerial refueling operating control and display units for the KC-46 tanker. Initially, this contract covers the engineering, manufacturing and development stage. This aircraft is the backbone of the Air Force's refueling strategy for the foreseeable future, with a plan of over 170 aircraft.

EASA, the European Aviation Safety Agency, issued an STC, Supplemental Tech Certificate, for our cockpit IP flat panel systems for the Boeing 757-200 and -300 aircraft, opening a large new market opportunity in Europe. Not surprising, this quarter, revenues suffered from the delay in orders resulting from past spring's Department of Defense budget impasse.

However, it appears that the dam is starting to break and we are seeing many opportunities opening up. For now, DoD issues have seem to be resolved and in the third quarter we saw some roughly $180 million of outstanding proposals, and have converted a substantial number of those into actual firm orders for over $7 million worth of contracts.

Covering of the order intake, the introduction of new products and the opening of new markets over the past few months have all strengthened our overall competitive position and expanded our immediate market opportunities. We are confident that we are making substantial progress to build value for our stockholders over the long term.

Let me turn it over to Ron Albrecht for a more detailed discussion of our financial performance.

Thank you, Geoff, and thank you all for joining this call this morning. Revenues for the third quarter were $6 million compared to $7.8 million for the second quarter a year ago. From a product standpoint, flat panel display revenues in the quarter were approximately $5.2 million and air data product shipments in the quarter were about $0.8 million, approximately 87% and 13% of total shipments respectively. As Geoff mentioned, revenues in the quarter suffered from delays in orders from the military stemming from the Department of Defense budget impasse this past spring.

Gross profits in the third quarter were $3.2 million, or 52.9% gross margin. We maintained margins within our long-term target range despite the drag created by the fixed costs on lower-than-expected revenues.

Total operating expenses for the quarter were $3.4 million. Of the total, internally funded research and development was approximately $1.4 million, up slightly from $1.3 million in the third quarter a year ago. Internally funded research and development expense was roughly 23.6% of revenues for the quarter. Our commitment to R&D has created opportunities leading to new products, such as the integrated flight management system for Eclipse and to new airframes, such as the Boeing 737.

Selling, general and administrative spending in the quarter totaled $1.9 million, flat with both the year ago and the last quarter.

For the quarter, we reported an operating loss of approximately $105,000, following an operating profit in each of the four prior consecutive quarters. However, we generated positive cash flow from operations of $226,000. For the third quarter, we reported a net loss of $66,000, or less than $0.01 per fully-diluted share.

Our balance sheet remains strong with $42.6 million in cash and virtually no debt. Looking to the year to date, for the first three quarters of fiscal 2011, our financial results are ahead of last year, with revenues up 8% and net income of $718,000, or $0.04 per share, versus a loss of $553,000, or $0.03 a share, for the first three quarters of last year. We anticipate that results for this full fiscal year will exceed those of last year.

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

Thank you, Ron. As we have said previously, the Company's business development efforts are focused on the commercial air transport, military and business and general aviation segments to allow us to capitalize on the opportunities in each of those markets. We believe commercial air transport remains a very large market opportunity for IS&S, so we continue to enhance the product through the introduction of additional capabilities and functionality.

As mentioned earlier, we received an order for the complete systems integration and cockpit avionics upgrade of NNSA's Boeing 737-400 classic aircraft. This upgrade allows NNSA to achieve CNS/ATM mandate compliance; fleet standardization of their flightdeck; increased operational flexibility, while enhancing safety and efficiency; improved dispatch availability and component reliability; significantly improved aircrew situational awareness and reduce workload.

This program complements the IS&S flat panel display system contracted for more than 400 Boeing 757 and 767 aircraft, with more than 100 aircraft already in revenue service. The upgrade for the Boeing 737-300, -400 and -500 series aircraft, as well as for the Boeing 757/767, is a platform for compliance with the FAA's next-gen and Europe's SESAR, or single European sky requirements.

It is CPDLC, RNP, ADS-B and In-Trail capable. It provides power and weight savings, and it reduces fuel consumption and CO2 emissions. The cockpit/IP for the Boeing 737 is an open architecture, flat panel display system that allows operators to upgrade to a glass flightdeck while leaving third-party avionics installed in the aircraft. This design approach allows the operator to select the best of breed new equipment and minimizes the cost and downtime of the upgrade. We estimate the available market for this product to be more than 1000 B737 aircraft worldwide.

Our Boeing 757/767 commercial air transport efforts continue to be centered on delivery of the flat panel display systems to the major airlines and package carriers. We have expanded our product offering for this fleet type to offer an engine-indicating and crew-alert system. This not only gives improved functionality to the flight crew, but provides further logistic savings by removing the last of the CRT displays in the cockpit. The operators can now avoid the rising costs they face in supporting these technologically obsolete components.

The European Aviation Safety Agency issued a Supplemental Type Certificate for the 757-200, -300 aircraft. This opens the door to more than 400 aircraft that are certified to EASA standards.

We have won several important military contracts. As mentioned earlier, we were awarded a contract by Boeing for the aerial refueling, operator control and display units for the KC-46A tanker. The Air Force has awarded Boeing to a contract to deliver 179 KC-46A aircraft, which will increase the size of our contract. And we continued to deliver flat panel display products for the C-130 aircraft. IS&S equipment is now used by seven fleet operators, both domestically and internationally.

In the general aviation market, our integrated flight management system is in service on the Eclipse Aerospace twin-engine jet. Eclipse has announced that over 100 customers have placed firm, nonrefundable deposits to participate in the IFMS completion program, and that the program is sold out through March of 2012.

This program installs the fully-integrated IS&S flight management system in Eclipse jet, completing the most advanced glass cockpit in general aviation. More than a dozen aircraft have already been updated with the integrated flight management system, which includes dynamically calculated top of descent guidance, coupled LPV WAAS GPS approaches, jet and victor airways and RNP. The opportunities for new orders to complete the Eclipse cockpit update total over $10 million.

Eclipse has said they are not yet announcing productions restart, but that they, quote, are sending some strong signals to the market, unquote, of their intentions. Leveraging the success of the integrated flight management system at Eclipse Aerospace, we are introducing the FMS product in the general aviation market over a broad number of aircraft platforms.

Backlog at the end of the third quarter is approximately $27 million, up from $25 million last quarter. Proposal activity remains strong. We have $184 million of outstanding proposals pending with various military and defense agencies, both domestic and foreign, commercial and general aviation customers. We have quoted a number of large programs to the major integrators.

Our outlook is for improving performance as our new product offerings reach the market and as we broaden the number of aircraft platforms we serve. Thank you. I would now like to turn the call back to Geoff.

Thanks, Roman. I would like to conclude by noting that we have made significant progress toward preparing innovative solutions that supports growth with new products and new geographic and new end markets. We continue to produce high-quality products, priced very competitively, and achieve attractive gross margins even at low volumes.

We are experiencing order improvement in both commercial and military markets; however, the general aviation market still remains strained. The ongoing pressure on the US Department of Defense budget will likely benefit our focused lower-cost retrofit approach.

Given our ability to move between commercial air transport, military and general aviation markets -- notably we manufacture all products under the same standards that the military requires -- we believe that we are well-positioned to participate in the global expansion for the air traffic system and next-gen.

As we look toward the current fiscal year, I am optimistic that revenue and profit will exceed the results of next year. Operator, I would like to turn it over for questions.

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

Yes, Geoff, Roman and Ray, thank you very much. I appreciate the opportunity to ask some questions.

I wanted to get some sort of explanation of the capital expenditures, to begin with. The capital expenditures in the third quarters seemed higher than normal, (inaudible). Is that research and development that wasn't charged off to anyone in particular?

No, our capital expenditure this year has been, I think, overall relatively low. We do replace particular equipment as we need to, and I don't see anything particularly unusual. We do have a stock of modern -- of equipment of fairly recent purchase, and our sales are a bit lower this year than they were several years prior. So we do have a good opportunity to grow with our existing stock of equipment.

So I think what you see is a short -- just a blip in the particular quarter, but I wouldn't say significant in relation to the year.

We got a new surface mount oven; it was about $100,000. So I mean, we have a very low CapEx. And we got a new advanced surface mount oven which was to replace a 10-year-old oven.

Okay, thanks. It looks like there is a lot of momentum. I am not sure -- in business, but it doesn't seem to be coming through on the revenue line, which isn't too unusual; we have seen that before in recent years.

The $184 million of outstanding proposals seems to be up from $110 million in the -- roughly in the last conference call. What is that increase? Does that reflect the Boeing tanker business and the -- what does that exactly include?

The Boeing tanker business is already booked. That is off the backlog. It reflects a number of programs, both in the commercial air transport and some in the general aviation marketplace and some opportunities in the military. It's generally distributed over all of them. But it is -- net, it is all a lot of new opportunities that we are, quite frankly, pretty optimistic about.

It looks like the 737 -- enhancement of the 737 business that you have announced yesterday, it looks like that is a substantial enhancement from previous retrofit business with -- for example with American and FedEx. Is that correct? And if so, what does that mean for FedEx and American? Do their orders also get enhanced, and therefore worth more or what is going on?

In this case, we did a major upgrade to the aircraft. There is even aerodynamic changes that are being done at the same time to enhance its fuel efficiency. But we are replacing virtually everything in the cockpit, all the control systems. I mean, major upgrades to the equipment, as I noted, supplied by a variety of vendors.

The real significance is that we are talking about a couple million dollars in aircraft worth of modification compared to a flight deck update, which is about a 10th of that.

It really is a major systems integration program. Now, we have done major system integration when we did 757/67. I mean that we interfaced with 2000 signals in the aircraft and reduced 22 pieces of equipment, replaced it with ours. So that was the largest up until then.

Now, this one is even a step further. And what it really does is it positions us to be able to not only supply the flat-panel displays themselves, but to integrate the whole system so that we are not at the mercy of a systems integrator who would inevitably mark up our equipment by upwards to 30% odd. So it more strongly establishes our competitive position in the marketplace.

So what is the result of the -- or what is the impact -- or is there no impact on the 767/757 orders you have already gotten?

Not directly, I mean, although it clearly says that in future bids -- and remember, there is a lot of airplanes still to do out there -- that we will be able to take over a larger piece of the systems integration. And that is supply any and all equipment and manage the actual installation, which we are doing on this case. We are actually managing the installation of all of the equipment and supplying our equipment and other third-party equipment on the aircraft.

So that will give us an opportunity with a number of other customers to be able to do exactly the same thing, and not as we have been in the past been simply a third-tier supplier. It moves us up -- it may be a little presumptuous to say second-tier -- but it has moved us up significantly. And that is the significance of this order itself, besides the fact that it is $5 million plus worth of business and it is going to make a profit.

But the $5 million worth of business seems to be a drop in the bucket compared to the $2 million per aircraft (multiple speakers).

But we are not going to do -- the 57s are more advanced airplanes, so we wouldn't do that much work on a 757. But the 737s, we might do some portion of that amount of work on that existing Classic fleet of about 1000 worldwide. So it is another big opportunity, 1000 new opportunities. We come out of the program with an STC or our equipment and a variety of other equipment. So it is a big program. It is a strategically significant program.

But the $5 million for this initial business is not in the $27 million backlog. So the backlog could be $32 million as we speak?

That is a fair statement.

That is a fair statement. We expect the backlog to grow over the next six months. We are beginning -- I mean, it would be nice if we know whether we are going to be balancing our budget, but that is another problem. But when the uncertainty settles down, which we hope will happen soon, we expect that we will see even more business opportunities.

So the 737, the new business on the 37, that is potentially, for that one customer, 100 aircraft?

No.

Excuse me?

No, not with that one customer.

Not for that customer?

No, not for that customer.

Okay. So beyond the $5 million for that customer, which is, I guess, two or three aircraft, right? That is only two or three aircraft -- is that correct?

I literally cannot comment on that. I mean, as you can expect, this is -- it is not a program to be freely discussed.

Okay. And as far as the fourth quarter, it is going to be profitable you think, but will it be more or less profitable than last year?

I think our guidance last time was that we expect the second half to be similar to the first half, and our guidance in that respect hasn't changed.

The second half equals the first half in terms of bottom line.

That is the guidance.

Right.

We expected the second half to be similar to the first half.

Yes, precisely.

Right. Right, okay.

Until we see some -- before it progresses -- any major change, we will see. But is pretty far into the year to see too much of a change.

And you said that the Eclipse program, they have sold out through March of 2012. But you said they haven't started manufacturing. I don't quite understand.

They haven't started manufacturing new aircraft yet. But there are 250 aircraft out there that they are modifying and the owners want this new capability. So we see it as a total -- of total additional ones, we expect to get how many, Roman?

Yes, we expect to see -- install about.

Additional ones.

An additional 140 aircraft.

140 of the 250?

Well, we have done a bunch already.

Right. I mean, and we have orders and we have some backlog. So we are kind of giving you a net answer here.

So maybe 100 still to come. And then in addition to that, you hopefully start (multiple speakers). And then in addition (multiple speakers).

And we expect them all to happen.

Right. And if they start manufacturing, then you would have even more business, you think?

That's right. But they wouldn't start that -- I think the earliest would be starting of 2013. And I think there is a good chance of that happening. But I mean, that is speculation.

And we are actively and aggressively supporting that program. We are hoping and are gearing ourselves up to be able to supply equipment for the production aircraft if and when it goes into production.

Right.

(inaudible) we really don't have anything to comment on beyond that.

Right. Yes, okay. Well, I think it is certainly a big improvement over what you have been talking about in terms of potential business, and someday that will really take off. As far as the tanker business is concerned, is some of that in the backlog?

The portion of it that is the engineering, manufacturing and development phase is in the backlog. Production is not, not at this time.

Right. Well, they hadn't started -- they don't start production until next year sometime, right?

Two years.

For two years, as far as the production. They have got to go through their own trial phases with this and support the Air Force testing regimen before they go into production.

And that particular contract is not as complex as the 737; it is more simply flat-panel systems?

No, no, no. This is -- that flight deck is one of the most comprehensive. It has got 13 computers on it and a million lines of code. Trust me, it is very complex, and it is $20 million worth of engineering. It is a very complex system, but it is done. It is a very advanced -- maybe the most advanced (inaudible) -- certainly the most advanced light jet cockpit in the world.

Sorry. Geoff was commenting on the Eclipse. On the tanker, Boeing is modifying the 767 for the tanker program. We are doing the aerial refueling, operator console display units. And so we are doing that engineering and development phase for ourselves and supporting that for Boeing.

It has got its own set of complexity, since this is -- has some technology that has not yet been used on aircraft, but benefits us on other programs also.

Okay.

(multiple speakers) on that, because that is Boeing information.

Right, right, right, right, right, right. But this is the first time you have done anything for Boeing, is that --?

No, no, no, no. We have done a lot for Boeing.

We have done something very similar before. We supported Boeing with equipment sales when they did tanker programs for the Italian Air Force, for the Japanese self-defense forces. So this is an extension of that, further product evolutions, further product enhancements that the US Air Force wants in their aircraft.

Right, right, right. Okay, that is about it for me right now. Thank you very much.

Thank you, David. I appreciate it.

Thank you, David.

(Operator Instructions). James Fronda, Sidoti & Company.

Hey, guys, how are you? The tax rate [you see] bouncing around it. Would you happen to have a tax rate that we could use to forecast out?

I think you can use the tax rate that is embedded in the first three quarters as a reasonable approximation of the tax rate for the year.

Okay. And I guess another question I had was the use of cash going forward. Do you plan to do anything with it?

We have a significant amount of cash on our balance sheet. Our position has been -- since I have been here anyway -- that our objective is to maintain principal and liquidity. Principal, on the basis that a significant cash balance gives our customers some confidence that we can meet our commitments, particularly because we are competing, in many cases, against much larger competitors.

And secondly, if some of the bids that we have outstanding start to come to fruition, we would expect over the longer-term to probably need some cash for working capital. So it is sort of a difficult situation.

And with respect to preservation of principal, we are getting very little interest on the money at the moment. But we are reluctant to invest it in anything of a very long term at today's low interest rate level -- longer-term because of today's low interest rate levels, because the principal will erode fairly dramatically if interest rates start to bounce up, and we think they are artificially low.

That is a long way of answering your question. And I would add to that that the investment committee of our Board of Directors has been looking at the situation with some greater intensity than it has been over maybe a little bit prior, and it is an ongoing review, I would say.

That makes sense. Thanks, guys.

At this time, we have no further questions in the queue. I will turn the conference back over to Mr. Hedrick for any additional or closing remarks.

Well, thank you for joining our conference call today. As I said, we are optimistic for the future, and that is a change. And we see -- with a very large outstanding bid backlog, we expect some good news over the ensuing few quarters. Thanks for attending today. Bye-bye.

Thank you and that does conclude our conference for today. We thank you for your participation. You may now disconnect.