Innovative Solutions and Support Inc (ISSC) 2011 Q4 法說會逐字稿

Good day, and welcome to the Innovative Solutions and Support fourth quarter and fiscal year 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. This is Geoff Hedrick, Chairman and CEO of Innovative 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 ending September 30, 2011, current business outlooks and conditions. 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?

Thank you, Geoff. Good morning. I would like to remind our listeners that 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 10-K, which will be filed with the SEC. It is now my pleasure to turn the call back to Geoff Hedrick. Geoff?

Thanks, Ron. I'm pleased to report that for the third consecutive year we were profitable, while investing 21% of revenues into product development, in what may be one of our more challenging periods in the industry's history. For the year, revenues were $25.7 million and earnings were $0.04 per share, little change from fiscal 2010. While profits may have been modest, cash flow from operations this year was a healthy $2.3 million or 10% of revenue, a metric that we believe is a good measure of the fundamental fiscal financial health of Innovative Solutions and Support in a difficult period. These past several years have been difficult, but we have moved quickly to adapt to market conditions, sizing the business to succeed, improving efficiency and productivity to drive top profits, and building cash and new relationships, all which strengthen our brand and build long-term value for our shareholders. As a result, we believe that we have created significant value during a challenging times, not just in our consistent profitability and healthy cash flow, but most importantly, in the success that we have achieved in expanding our products and platforms to create growth opportunities in the large markets.

From that perspective, our performance this past year was notable. Consider the new markets that we have opened over the past year, due to the success of several new product introductions and the strategically significant new products we have been awarded. Our OEM contract with Eclipse has established our presence in the flight management and FMS market, which is new to us. Building on this success, we have expanded both laterally and vertically into the systems integration and cockpit avionics market, winning a $5 million plus system integration contracts for 2 737-400 aircraft. This contract includes installation of communication and navigation equipment, as well as our flat panel display systems. These two examples demonstrate how our investments to improve the functionality and performance of our existing product, first, our flat panel display, then our IFMS, have enabled us to grow into logically adjacent markets, where we can leverage our technology and significant cost advantages. Our marketing initiatives have been effective in taking our existing and new products into previously untapped markets.

We are growing our OEM business. We were selected by Eclipse to provide an advanced avionics suite in the new production model of the 550 and we have expanded our geographical footprint for EASA, the European Aviation Safety Agency, issued IS&S a supplemental type certificate for the Company's cockpit IP flat panel systems for the Boeing 757, 200's and 300's and the 67, 200 and 300 aircraft in Europe. Most encouraging, we are seeing opportunities for projects for which we would have not been previously considered, as every takeoff and landing of the growing fleet of IS&S-equipped aircraft furthers our reputation throughout the industry. We are very excited about new opportunities that are arising, as we become increasingly recognized for our ability to deliver a total package to cockpit upgrade, as a systems integrator for competitive pricing.

In addition to our customer-funded product development, we continue to invest in our own research and development programs. Last year, we spent $5.5 million, or nearly 21% of revenue on R&D. Coupled with the customer-funded engineering and various new products and platforms already under contract, we expect that our efforts will lead to a significant sales of growth over the coming years. Success breeds success, and our ability to engineer dependable, reliable cost-effective products is drawing increasing attention from the market. This attention has led to discussions now taking place with other operators willing to fund new development efforts, which supplement our own internal efforts to further leverage our innovative technology.

We begin the new year with an extremely strong balance sheet, that both instills confidence with our customers and provides us with the resources to self-fund operations and investments. Over the past year, we added nearly $2 million in cash, and we presently have over $42 million of cash on hand. After many years of hard work, we are very pleased with the accelerating pace at which the market is adopting the compelling value proposition of our technology. Now, I would like to turn it over to Ron Albrecht to go through the results in the quarter and the year, in more detail. Ron?

Thank you, Geoff. We reported fourth quarter net income of $12,000, essentially break-even earnings on revenues of $6.5 million. Both the top and bottom lines were up sequentially from the third quarter. And as Geoff mentioned, effectively allowed us to end the 2011 fiscal year at about the same revenue and profit levels as fiscal 2010. For the quarter, flat panel display system revenues were approximately $20.3 million or 79% of revenues, while air data product shipments were approximately $5.4 million, or 21% of revenue. Gross margins for the fourth quarter were 49%, net of inventory adjustments.

For the full-year, margins were 53.6%, down only marginally from 2010, and very solid and well within our long-term objective. Product revenues tend to carry higher margins than do funded engineering and development contracts. Taking into consideration customer-funded engineering contracts that we have been awarded, and that will be a major focus of our 2012 plans, we expect engineering revenues to increase as a proportion of total revenues, with an intended impact on gross margins.

Total operating expenses for the quarter were $3.1 million, of which $1.2 million or 18% of revenue were research and development. R&D has consistently averaged about $5.5 million a year, excluding customer-funded development. Selling, general, and administrative expenses in the quarter were $1.9 million, somewhat less than last year, but in line with recent trends. Operating income was $95,000, and pretax income was $119,000 for the quarter. For the quarter, we had a full-year cumulative tax adjustment, so the tax expense rose to $107,000. With that, normal tax adjustment reduced income to a positive $12,000 for the quarter, essentially at break-even.

Our cash flow and financial position remains strong. Cash flow from operating activities in the fourth quarter was approximately $400,000, and as of September 30, 2011 we had $42.6 million of cash on hand, an increase of nearly $2 million over the last 12 months. In the quarter, we purchased 62,400 shares of IS&S stock at an average cost of $4.79 per share under our Board-approved SEC rule 105b-1 program. Our strong cash balance is a competitive advantage, as potential customers view the cash as a reflection of our ability to make commitments. Going forward, potential growth in sales may require cash to fund working capital requirements.

I would like to address briefly, the American Airlines bankruptcy. On November 29, 2011, AMR Corporation, the parent company of American Airlines, Inc., and certain of it's other US-based subsidiaries, filed bankruptcy petitions for Chapter 11 reorganization in the US Bankruptcy Court for the Southern District of New York. The Company's revenues from American Airlines, Inc. accounted for 8%, 8% and 24% of total revenue for the fiscal year's 2011, 2010, and 2009, respectively. As of November 29, 2011, the Company has $760,000 of accounts receivable from American Airlines, Inc. Under US bankruptcy laws, debtors have the right to avoid certain payments made during the 90 days preceding the filing of the bankruptcy petition. No such avoidance action has been asserted or filed, and the Company believes that it would have valid defenses against any such action. In the 90 days preceding the filing of the bankruptcy petition, the Company received $828,000, in the ordinary course of business. Bankruptcy proceeding is in it's early stages, and it is not possible to determine the impact on the Company's fiscal 2012 results. Now, I would like to turn the call over to Roman Ptakowski.

Thank you, Ron. The Company pursued it's business development opportunities in each of the aerospace segments, commercial air transport, military, 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. Despite the market weakness of the past few years, commercial air transport remains a very large market opportunity. We have directed our research and development efforts towards enhancing product functionality, such as RNP, Required Navigation Performance, and ADS-B, Automatic Dependent Surveillance Broadcast. These features enable us to address both the Federal Aviation Administration's NextGen and Europe's Single European Sky initiatives. Both address the problem of increased flight volumes and overburdened air space, and both will be more widely mandated, as we move through the next few years. Over time, this will have the effect of increasing demand for the functionality, that we are building into our products today.

Recent commercial air transport successes, include the issuance of a Supplemental Type Certificate, an STC by Europe's EASA for the Boeing 767-200 and 300 aircraft, to compliment our EASA STC for the Boeing 757-200 and 300 aircraft. Awards during the year included the Aerial Refueling Operator [comp] Control and Display unit for the KC-46A tanker. We are working under a contract with Boeing, who in turn has a contract to deliver up 179 of these aircraft to the United States Air Force. The engineering modification and development phase of this project is in the current backlog. The production phase of this project is not included in the backlog at this time.

We are enthusiastic about our new contract as the systems integrator for the B737-400 aircraft. This is a $5 million plus contract from the National Nuclear Security Administration for a complete systems integration and cockpit avionics upgrade of their B737-400 classic aircraft. Under this contract, we will provide NNSA, both CNS/ATM capabilities, that's communication, navigation, surveillance, and air traffic management, and similar efficiency and performance to the Boeing 737NG, NextGeneration aircraft at a fraction of the cost. This integration effort eliminates legacy CRT displays in avionics, leverages commercial off-the-shelf technology, and provides a platform for future upgrades.

Included in the effort are an [amped] FMS, flight management systems, TCAF enhanced ground prox warning systems, NexRad satellite communications, and ADS-B capabilities. The added significance of this program, is that it not only gives us another aircraft type for upgrades, but that it moves us into a more valuable position in the aircraft supply chain, increasing the value of our typical contract by an order of magnitude. This contract is a logical extension of the integrated flight management systems work we have done with Eclipse. In addition, it leverages experienced gains on similar projects, such as the need to interface with 2,000 signals and replace 22 pieces of equipment on a typical Boeing 757 or 767 cockpit IP retrofit. When the program is complete, we will have an STC, Supplemental Type Certification, for our equipment and for a variety of new capabilities. That will enable us to market this functionality more broadly, and to open a new very large market for us.

This program is very strategically significant. In our general aviation business, our flight management retrofit contract with Eclipse Aerospace, upgrading approximately 250 in-service aircraft, is progressing on time, on schedule, and on budget. From that retrofit base, we have expanded our relationship with Eclipse, which has awarded us a contract for the advanced avionics suite on the production E550 aircraft that the new Eclipse is introducing. We are very pleased to expand our OEM capabilities, especially for this sophisticated avionics platform that the E550 offers. Based on the successful Eclipse FMS retrofit program, we are developing a complete portfolio of FMS systems for other aircraft types. As a result of the various new programs and platforms introduced, we have opened significant new market opportunities not previously available to the Company.

In particular, we now have products either completed or under customer-funded development to address the following markets, integrated flight management systems and advanced avionics, both for the retrofit and OEM market with an immediate $25 million OEM opportunity with Eclipse, the global fleet of well over a 1,000 Boeing 737 classic aircraft, cockpit system integration programs that encompass not only the Company's proprietary technology but also integration of third-party avionics and other equipment which increase the value of each individual aircraft contract, required NextGen and SESAR emerging United States and European air traffic regulations, upgrades that are expected to be phased in over the next several years.

At the end of the fourth quarter, we did have a backlog of $27.5 million, essentially in line with the level we have maintained throughout the year. Backlog does not include the potential $25 million equipment phase of the Eclipse contract, or the value of the equipment phase of the Boeing tanker contract. In addition, there are over $180 million of military, general aviation, and commercial air transport proposals outstanding.

In summary, this past year has been notable as an inflection point in the transition for many of our products, that have moved from the drawing board into the market. It is rewarding to see our many years of hard work bearing fruit. Everyone here at Innovative Solutions and Support is dedicated to making sure that we continue to meet or exceed the expectations of our growing customer base, by delivering exceptional value at a competitive price. I would like to now turn the call back to Geoff.

Thanks, Roman. Over the past several years, I believe we have been able to effectively manage through a challenging market, while simultaneously investing wisely, and to capitalize on growth opportunities. We are quoting turnkey installations on large aircraft, and we are adding auto throttle to integrated flight decks. We are preparing for a demand that will emerge through regulations, or from the pressure on operators for more cost-effective solutions. Specifically, our work with RNP, which reduces carbon dioxide footprint, has been a compelling change. In the near term, we don't expect any dramatic change in markets. However, over the longer term, markets will recover and we believe we have positioned ourselves well, to participate more broadly in a recovery through a continual improvements that we are making in our technology and organization.

More immediately, for the fiscal year ending September 30, 2012, the Company expects the revenues to increase modestly relative to 2011, after taking into account potential disruptions that may arise from current market conditions. Based on the success of the Company's new product and platform initiatives, engineering revenues and their associated margins are expected to increase as a proportion of our total revenues and margins in fiscal 2012. With that, I would like to ask the operator to open the call for questions. Operator?

Thank you. (Operator Instructions).

We'll take our first question from David Campbell. Please go ahead.

Good morning, everybody.

Good morning, David.

Good morning.

Roman, you didn't say a lot about the military potential business, other than the -- I don't know if you call it military now, but the contract you have for the 737s for the National -- is it Nuclear Association or something?

Yes. Nuclear Security Administration. That Boeing contract on the KC46A, that is a military contract.

Yes --.

And then we have ongoing business, both for air data equipment and flat panel display systems on other military platforms. P3s, C130s -- we continue to sell product to the government, to the military, for both international and domestic uses on a lot of the Homeland Security type aircraft that we've talked about in the past.

Yes. Right. Okay. And, Geoff, I assume your modest -- your comment about a modest increase in revenues for this fiscal year assumes little or no business from American? You seem to be recognizing that, is that the case?

Yes, that's the case, but what's significant is that the aircraft don't disappear. So, I think American may be getting rid of some of their airplanes, but wherever they go, I think that our upgrade will be desired. Remember, we're THE guys in the industry.

If I could elaborate on that, just on that, David. The American Airlines bankruptcy is in its very earliest stages, and we really don't have visibility. And it's very possible that the situation could evolve, so that it's more or less normal course of business. I think Geoff's comment was based upon a fairly conservative view of that situation.

Well, I guess it's up to a Trustee to decide whether to continue the program or not. Is that the way it works?

Well, no, I think the program is in place, and will continue. It would be difficult to operate a fleet, a disjointed fleet -- there was a reason to do it, and one that was justified financially. Remember, American, there's a whole bunch of reasons why American could have reasonably decided to go -- declare Chapter 11, sitting on $4.2 billion worth of cash. I suspect that, since they were the one airline that hadn't gone bankrupt, they were not exactly on equal footing with the rest of the industry. So, I think this may put them back on equal footing, and they are going to still operate the fleet. They have ordered new airplanes, but the new airplanes won't come for quite a while. So, they have an interest in implementing the new requirements, including RNP and things like that, which are implemented through our flat panel display system.

Well, I would -- the accounts receivable, that was as of September 30, Ron, is that $760,000, is that right?

Correct.

And they had to pay that before they -- you would give them any more, I'd assume?

Well, they've paid the receivables that were due at the end of September.

Okay.

The receivables that are unpaid are those for deliveries in -- so far in the first quarter.

So they are not -- they are not delinquent.

They are not delinquent, at this point.

So, they haven't stuck us with a big load. And we would hope, and we would hope that we would get paid. Maybe they would stretch it a bit, but I would expect them to get paid. Certainly, they want to support their fleet.

Right. So, you mention $828,000 of revenues in the last 90 days. Is that what you haven't been paid for?

That's what's outstanding, yes.

No, that was -- the $828,000 was what we collected.

$828,000 was collected, we have $760,000 outstanding, I'm sorry, David.

So the 7 -- at this point, $760,000 of AR, is accounts receivable?

Yes.

Right. But that's the -- Geoff, that's the only hesitation in your forecast for revenues in fiscal 2012, because of the lack of visibility?

David, we're obviously looking at two things. We're also looking at the planned cuts in defense spending, and how that may impact us. But we're happy to be broadly based -- as we've often talked about, one-third, one-third, and one-third -- having a good, sound position in the commercial air transport and packaged pairing business, as well as a good situation in the general aviation. We have an outstanding bid, a significant bid for a new OEM contract for a biz jet. And that would be a significant sized additional OEM contract. The nice part about a few of the OEM contracts is they would further balance and distribute our market revenues. So, we're being prudent. And the thing that keeps us going is having a distributed revenue over the three markets.

Right. And what was the shortfall in the fourth fiscal quarter? It looked to me like it was less than you would have hoped for a few months ago.

I think it was -- in a couple of areas. One of them, obviously, we looked at revenues from American slipping out a little because before they declared bankruptcy, we saw some evidence of shifting revenues out of the fourth quarter. And we had a number of -- a couple of military programs that slipped into the following quarter.

Yes.

Nothing huge; a variety of things.

So, the December quarter could be better than it usually is? Seasonally it's usually a bad quarter.

Seasonally, it's a bad quarter. We're doing what we will, to make sure it is --.

-- there is a reasonable result.

Exactly.

Right.

But we see a lot of very positive news. I mean, a position as a systems integrator opens up a huge (inaudible). Traditionally, we've sold our products through a systems integrator, which will bid to the primes and first tier, and mark up our products by 30%. That makes our products less competitive. Our ability to now serve as a systems integrator -- remember, as an example, on the Eclipse, we are going to be doing auto throttle on a fully integrated cockpit, extremely advanced, maybe one of the most advanced cockpits in general aviation of any size aircraft. And we're now looking at doing a large fleet of aircraft, a completely turnkey operation, taking large aircraft and doing a complete installation of our equipment, with entire teams of installation mechanics working for IS&S.

Yes, but your comments also include the larger percentage of your revenues in fiscal 2012 will be related to engineering and, therefore, lower profit margins. Is that right?

That's right. That's the outlook now. We hope to fill the -- with production revenues over this oncoming year. But right now, we have an established large engineering revenue. And by the way, the byproduct of that engineering is strengthening our own product development, because you always get collateral contribution of technology to our own products.

The importance of funded engineering is that customers are prepared to fund the development of new products.

Well, and they do -- and it makes our products broadly more valuable and more attractive.

Does that switch some of your research and development expenses into the revenue line?

Traditional -- we would hope not. But because we have a couple of significant programs that we want to invest in, which we believe will have long-term, large, very large revenue generation. So, there's some product development programs that are well on their way, but will be funded into completion. And we intend to keep that investment now. We think the investments in this economy are critical because we want to be able to catch the wave when the recovery starts. And that's what we're doing. Traditionally that's always been a sensible move that during difficult times you want to be -- that's the time you really want to be investing in product development.

Right. And I guess my last question is -- working capital. Is there some sense that the focus on engineering, or the increasing revenues from engineering will reduce or increase working capital requirements? Is that correct?

Our expectation would be that we would be cash positive for the year. But there's no doubt that higher spending on -- a continued high spend on internal development, coupled with possibly lower margins on engineering programs could have an impact on working capital. But as I said, our hope is that it would be negligible. And we would -- we are still working toward a positive cash flow for the year.

Okay. I -- (Multiple Speakers).

-- the areas where -- and we're seeing some very positive results of our internal efficiency improvement, too. So, I mean, that continues to be positive. The interest in improving our internal efficiency is as much driven by the fact that we want to position ourselves to be able to respond to what we expect to be a significant increase in demand, hopefully near the end of next year.

Right.

We want to be prepared for that. And we're prepared for it now, but we think we see some significant improvements in our efficiencies, which allow us to become better, more responsive more quickly, which means that we can take orders in and ship them quickly and effectively.

And my last one on American is -- so, basically the receivables are now this $828,000 of revenues from the last 90 days.

No, it's -- the receivable is $760,000. And I don't think we actually make comments on revenues for particular customers, so I wouldn't comment on that.

But we have a receivable of $760,000 at American. And we'll see what happens as the situation at American develops over the next 30 days.

Right. But they are not delinquent at this point, in there?

Not at all, no. And remember, they got -- I don't know, some multi-billion dollar contract order for new aircraft --.

Aircraft between Boeing and -- (Multiple Speakers).

-- and they made an announcement that bankruptcy is not going to effect that contract. So -- and they need our equipment to operate the existing airplanes that they have, which is a multi-billion dollar asset. I can't imagine them having no interest in supporting that asset.

Well, I can't either, but you haven't got it in your revenue forecast for fiscal 2012.

I don't understand the question. Do we -- are you asking whether we have American Airlines revenues in our forecast for the year?

Right.

The answer is yes.

Yes, we do.

You do. So the --?

Because they have indicated to us that there is going to be no change in the installation rate of our equipment. That's the (inaudible) -- they say -- look, we don't know, but we're not -- we're telling you -- we are not telling you to stop. They are simply saying -- we are all waiting to hear what is going to happen. But they are going to continue operations, and we anticipate that they will proceed this year.

They said that anything delivered within the bankruptcy, post-filing bankruptcy period, is going to be paid normal course. So, we're anticipating, and hoping that that occurs.

So, a modest increase in revenues, to me, sounds like a couple of million dollars for this fiscal year. Is it not -- American, it's a short fall -- something else is not growing. I mean, there's no growth anywhere.

I think what Geoff said was, he conditioned his comment, in the context of the market disruption, the implication being the market disruptions caused by American. We would still hope to have a modest increase in revenues, despite a worst case in American.

Okay. Thanks. I appreciate the help.

Thank you, David.

(Operator Instructions).

At this time, we have no further questions. Mr. Hedrick, I would like to turn the call back to you for any additional or closing remarks.

Yes. Thank you for attending our earnings report. We are positive in an uncertain market. And we see very -- we're investing heavily into broadening and strengthening our appeal to our customers, and have a guardedly optimistic view of the future. We appreciate your interest today. Have a good day.

Ladies and gentlemen, this concludes today's teleconference. We thank you for your participation.