Innovative Solutions and Support Inc (ISSC) 2012 Q1 法說會逐字稿

Good day and welcome to the Innovative Solutions and Support first-quarter 2012 earnings conference call. Today's conference is being recorded.

At this time I would like to turn the conference over to Geoffrey Hedrick, Chairman and CEO. Please go ahead, sir.

Good morning. This is Geoff Hedrick. Welcome to Innovative Solutions and Support first-quarter 2012 earnings conference call. With me this morning are Roman Ptakowski, our President, and Ron Albrecht, our Chief Financial Officer.

Before getting started I would like to ask Ron to read our safe harbor message.

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, from those discussed, including other risks and uncertainties reflected in our company's 10-K which is on file with the SEC.

Now I will turn the call back to Geoff.

Thanks, Ron. Results in the first quarter of our fiscal 2012 reflect the progress that we have made on growth opportunities that we created over the past year by leveraging our core technology to win important new OEM and retrofit contracts. Beyond the immediate production opportunities with our customers, we have expanded our portfolio of products and will be in a position to compete for substantially higher value programs in large and growing markets.

Our immediate priority is to execute on these contracts. Accordingly, the results in the first quarter reflect our focus on advancing our flight management systems, advanced avionics suite, systems integration, and cockpit avionics programs. As is typical, the life cycle of these new products begins with lower margin engineering and development revenues and progress to more profitable production phases.

I am pleased to announce a new OEM program for an advanced electronic monitor and control system. This program for a new aircraft is expected to contribute up to $60 million in revenue through 2024. This product technology is expected to find several other applications on other OEM aircraft.

Roman will provide some additional insight regarding production demand and current backlog, but our overall expectation is that through the combination of engineering and production programs we expect to maintain the 2012 revenue at levels modestly improved from last year.

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

Thank you, Geoff. Revenues for the first quarter were $4.8 million compared to $6.5 million in the first quarter of last year. As Geoff stated in the earnings release, deliveries were impacted temporarily by certain pricing renegotiations.

Engineering revenues comprised 15% of first-quarter revenues. To put this level of engineering revenues into some perspective, engineering revenues comprise just 2% and 7% of total revenues in fiscal 2011 and 2010, respectively.

As we expected, the increase in the proportion of typically lower margin engineering revenues coupled with lower production volumes weighed on first-quarter gross margins. Nevertheless, margins were maintained at nearly 45% and within our expected long-term gross margin range.

Total operating expenses for the quarter were $2.8 million, down from $3.4 million last year. Of the total, research and development expense in the quarter was $800,000 compared to approximately $1.4 million last year.

As a proportion of revenues, investment in research and development expense was about 15% this quarter, somewhat below our long-term expectation of approximately 20% of revenues. That said the actual engineering spend is higher than that expectation when funded engineering costs are added to the internal research and development expense.

Selling, general, and administrative spending for the quarter totaled $2 million, down slightly compared to $2.1 million in the same year-ago quarter and comparable to the fourth quarter of last fiscal year. For the balance of this year we expect general and administrative expenses to run at about the first-quarter level on average.

For the quarter the operating loss was $658,000. After interest income and other income of roughly $64,000 and an after-tax benefit of $252,000 we had a net loss of $343,000 or $0.02 per share. This result compares to a net profit of $285,000 or $0.02 per share for the first quarter of last fiscal year.

Despite the operating loss, we generated positive cash flow from operating activities of approximately $622,000 in the quarter. As a result, our balance sheet remains strong with $42.8 million in cash and no debt. We continued our share buyback program, repurchasing almost 89,000 shares in the quarter.

With respect to American Airlines, sales in the quarter were $902,000 and receivables from American at December 31, 2011, are at that level. Of that amount $760,000 are pre-bankruptcy receivables. Based upon the present status of the bankruptcy proceedings we are not able to determine the amount, if any, that would be uncollectible and therefore have made no provision.

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

Thank you, Ron. Let me briefly review our accomplishments during the first quarter and engineering production and future business opportunities for each of our three target markets -- commercial air transport, military, and business and general aviation.

Our commercial air transport efforts are focused on delivery of flat panel display systems and air data products for the major airlines and package carriers. As said on our previous calls, our commercial air transport strategy has several elements. We continue investing to extend the capabilities of our existing flat panel display technology in advance of new regulations that address overburdened air space in both the United States and Europe.

Federal Aviation Administration's next-generation and European Single European Sky initiatives are expected to be phased in over the next several years. We have made product enhancements that improve overall system functionality, such as RNP or required navigation performance, and Automatic Dependent Surveillance-Broadcast to address these initiatives.

Last quarter we discussed our new B737 400 systems integration contract with the National Nuclear Security Administration. In the first quarter we made progress on this contract. We are in the process of installation on the first aircraft.

This is a $5 million contract from NNSA for the complete systems integration and cockpit avionics upgrade of their B737 400 Classic aircraft. Under this contract we will provide NNSA with both CNS/ATM capabilities and similar efficiency and performance for the Boeing 737NG next-generation 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 are capabilities, such as an FMS, flight management system, TCAS, enhanced ground proximity warning system, NEXRAD weather display, Satcom satellite communications, and ADS-B.

Upon completion of this contract the supplemental type certification for the B737 Classic aircraft will permit us to sell to a market of about 1,000 aircraft. It also moves us into a more valuable position allowing us to increase the dollar amount of our typical contract by an order of magnitude.

Our military strategy is geared towards providing the market with cost-effective, technologically advanced solutions. A recent military success was the contract with Boeing for aerial refueling operator control and display units for the United States Air Force's 149 KC46A tankers.

In the first quarter we made progress on the engineering modification and development phase of this project. Our general aviation business leverages our core technology to address adjacent and complementary technologies in the cockpit. EMD, engineering modification and development, revenues in the first quarter were generated for development of an advanced avionics suite for the new Eclipse 550 aircraft and another to develop an advanced electronic monitoring and control system. Both of these are precursors to the production phase of these OEM programs.

At the end of the first quarter we had a backlog of $25.7 million, essentially in line with the level at the end of fiscal 2011. I would note again that backlog does not include the production phase of the Eclipse 550 contract, the production phase of the new OEM electronic monitoring and control system contract, or the production phase of the Boeing KC46A tanker contract. Additionally, we have over $174 million of military, general aviation, and commercial air transport proposals outstanding.

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

Thanks, Roman. Before we open the call to questions, let me reiterate our strategy with relation to our expectations for the balance of this year.

For the fiscal year ending September 30, 2012, we expect revenues to increase modestly relative to 2011 after taking into account potential disruptions that may arise from current market conditions. With our emphasis on engineering requirements of various new products -- including reduced carbon emissions -- platform initiatives, engineering revenues, and the associated margins are expected to increase as a portion of our total revenues and margins in fiscal 2012.

Fiscal 2012 represents an important transition year. The programs under development, together with our existing portfolio of products, present us with an opportunity to bring more comprehensive systems to market that is demanding both leading-edge performance and compelling value. Over the long term we believe this strategy will reward our shareholders.

Operator, please open the call for questions.

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

Morning, Geoff, Roman, and Ron. Thank you very much for giving us a chance to ask you questions.

I just wanted to start with the -- your revenue optimism for the year. I call it optimistic because it's the first quarter you were obviously down in revenues, and it included some revenues from American Airlines which I don't know that will continue. Is the reason you are relatively optimistic is the fact that so much of it is in this EMD work, which is -- I assume it's in the backlog, but then relatively assured of getting that work?

If I could answer your question, David -- and Geoff and Roman may have further insight. Our expectation from American Airlines is that business will continue more or less as usual through this year. We have heard nothing to the contrary and the opportunities for delivery are ongoing, so we don't expect any change there.

In addition, we have a fairly substantial backlog of funded and engineering for this year, which gives us a base as well. So for that reason, as well as I would say of somewhat better order book in terms of for deliveries this year, I think we have a bit more optimism than we might have had otherwise.

Okay. And, Roman, you mentioned -- you went pretty fast; I couldn't write it down. I think you said $174 million of outstanding proposals. That is a lot more than -- I recall it was roughly $110 million sometime ago. Where is the increase?

Yes, I did say $174 million of outstanding proposals, and that is net of the fact that we did get some orders in here that we have taken out about because we have put them in backlog.

The increase right now is -- we are seeing it in the 757 and 767. Our enhanced functionality there has created interest, particularly in Europe. We are seeing that -- that is the area that is showing the largest increase right now in interest.

We have got a proven product. We have over 140 aircraft actually flying with our equipment and the number continues to grow each month.

Right. So these are -- a lot of this increase is in commercial aircraft obviously and some of it's in -- from European airlines?

That is correct. Airlines and their package carriers as well.

Right, right, right. Okay, thank you.

Ron, the reason for the R&D being down I assume is some of those revenues, some of those expenses that used to be your costs are now being funded in the EMD and, therefore, those costs are up in cost of sales. Is that --?

Absolutely correct. If you looked at the total engineering spend, it's actually somewhat higher than it has been over the last few quarters.

Right, right, right. Okay, that is great. What about flat-panel sales in the quarter? Of the $4.8 million, how much was flat-panel sales?

I don't have the exact number, but it's probably in the 90% range.

Substantially (inaudible).

But probably -- very probably small levels of the legacy products.

Geoff, can you explain what you mean by pricing negotiations that delay deliveries? What is that all about?

We are negotiating some price increases. Without going into details, which would be inappropriate, we proposed some price increases that need to be negotiated and [it will lighten some] deliveries. Short term, that is all.

So you are confident that --

You could ship it (inaudible) price or the proper price, and I thought proper would be more appropriate. And by implication accept that lower price going forward; it's clearly not.

But it was planned, it had to be negotiated and we wanted to get it done. And if it impacted deliveries that were associated with those price increases that was -- it's not a decision where it will happen. It's only, literally, negotiating the actual amount of the increase, that is all.

The negotiations have been completed? Geoff? It's cracking up a little bit. Are the negotiations completed?

No. We are still in negotiation. They will be done, we expect, in the next few weeks. Certainly in this quarter we should expect to have them finished and move on. They impact of deliveries going forward and the value of those deliveries going forward, so we need to get it resolved early in this year. That is it.

So you would expect the March quarter revenues to reflect the -- to not have any delayed deliveries?

That is correct. It's really a question of making sure -- I mean this impacts deliveries for the next several, two years. We need to get it done. It came up and it is effective.

It would start the beginning of this calendar year. That is why it needs to get done and that is why it bled over from December into January, because it was a calendar year effect. Nothing, no great thing.

Okay. Okay, good. So, Ron, the backlog -- I mean, Roman, the backlog excludes contracts you have for both the 500 and 550 Eclipse aircraft?

That is correct. So we -- the backlog is not bloated in any way with production-type phase contracts. What we carry in backlog for Eclipse is only like the current quarter's shipments or the shipments with immediate deliveries.

Needless to say, the new program that we just got, that large anticipated amount that was through 2024 is also not in backlog. Only a portion that is immediately executable is in.

Right. So what revenues you have from Eclipse are qualified as EMD revenues?

No, we continue to sell upgrades for the existing E500s as they are very successfully positioning the product. The integrated flight management system that we introduced is something that is of great interest to their owner-operators. They have their planes -- when they do their maintenance schedules and so on they are doing upgrades so we continue to get revenues from that.

In addition to the FMS, our GPS receivers go on those aircraft and they are -- again the performance of that combined product is very well accepted and respected by the owner-operators.

They love the IFMS. It's a real leading-edge solution, it's quite remarkable. It's very, very advanced. And we are now looking at an auto throttle for it as well, so it would further enhance it and make it probably the most advanced [biz] jet with the exception of the $30 million, $40 million jobs. It's really a remarkable aircraft, amazing aircraft.

One last one and I will let someone else have it and that is the military budget issues. Have you seen any impact from the Department of Defense cutting back on their business?

We see it. It hasn't directly affected us, but it's not -- but they are doing things that -- for instance, they canceled an amp program, an upgrade program which we weren't part of, but not before they spent $2 billion to upgrade four airplanes. That helps.

At any rate, that program -- we are seeing a number of cutbacks. As you know, even some of our competitors have announced the impact in lower revenues because of pending military programs. If I remember right, it's $678 billion, but that is over 10 years, on a defense budget that is about $750 billion. So I mean it's about -- it's less than 10% reduction in the defense budget.

We all expect an impact. You don't take $60-odd-billion out of an annual budget without having some impact. But for us it may emphasize the need for more cost effective solutions and may, in fact, and probably should, give us better opportunities.

Right. Okay, thanks. Thank you very much.

Good talking to you.

(Operator Instructions) And there are no further questions at this time. I would like to turn it back to Mr. Hedrick for any additional or closing remarks.

Thanks for joining us today. If you have any further questions, contact Ron Albrecht at the factory. We appreciate your interest. Have a good day.

This concludes today's conference. We thank you for your participation.