Innovative Solutions and Support Inc (ISSC) 2012 Q3 法說會逐字稿

Good morning, and welcome to the Innovative Solutions and Support third quarter fiscal 2012 earnings conference call. All participants will be in a listen only mode. (Operator Instructions). After today's presentation by management there will be an opportunity to ask questions. (Operator Instructions). Please note this event is being recorded. Now I'd now like to turn the conference over to Geoff Hedrick, Chairman and CEO. Please go ahead.

Good morning, this is Geoff Hedrick. I want to welcome you to our quarterly conference call. Before I start, I'd like our Chief Financial Officer, Ron Albrecht, to read our Safe Harbor message. Thanks, Ron. Go ahead.

Thank you, Geoff, and good morning, everyone. I would like to remind our listeners that certain matters discussed in the conference call today, including operational and financial results for future period, 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. Now I'll turn the call back to Geoff.

Thank you, Ron. In last evening's release we reported a third-quarter revenues of $6.1 million, a modest increase from a year ago. Although these margins were down a bit as a result of a shift to more funded engineering, we remain profitable with a net income of $260,000 or $0.02 a share.

With a higher level of engineering revenues and related spending, we were pleased that we met the engineering resource requirements of our new products. These products that we were developing for the future have also generated profits for our shareholders in the near-term.

We were engaged in a number of programs that we believe that will enhance our business and increase shareholder value. During the third fiscal quarter, we completed development of the first stage of the NNSA Boeing 737 classic flat panel display system. Since the end of the quarter we have completed the STC flight tests for the FPDS and expect to receive the FAA certification shortly.

The flat panel display system for the Boeing 737 is the first of several new products to arrive from the NNSA program. We have developed a turnkey solution that can provide an operator with a complete FPDS installation and return to service in 24 hours. This installation time is 5 to 10 times the savings of -- and out of service -- of similar competitive systems. This 737 is based on our 757 system, successfully operating on more than 160 aircraft.

In June, Eclipse Aerospace announced that it had launched initial production of its twin engine EA-550 jet, for which we have an advanced avionics contract. Upon completion of the engineering modification and development for the EMD phase, we expect production to commence in Q2 of 2013 in accordance with the production requirements of the Eclipse Aerospace.

The utility management system under development for a new production aircraft is progressing well with the recent completion of the customer's preliminary design review project milestones and receipt of the initial year's production commitment. This program will generate substantial revenues well into the next decade.

In context of the changing economic conditions, we are focused on developing these new platforms. The 737 STC and the Eclipse Aerospace initial production plans are positive signs for opportunities to supplement our current production volumes. The potential production value of various development contracts on hand is significant, almost none of which is included in our backlog.

Now let me turn this over to Ron for a more detailed discussion of our financial performance.

Thank you, Geoff. And thank you all for joining our call this morning. Revenues for the third quarter were $6.1 million, slightly above those in the third quarter a year ago. From a product standpoint, flat-panel display revenues in the quarter were approximately $4.8 million, while air data product shipments in the quarter were about $1.3 million, approximately 79% and 21% of total shipments, respectively.

We experienced a slight increase in air data volume this past quarter as the military appears to be increasing spending somewhat on repairs and improvements to equipment. Gross profits in the third quarter were $2.6 million or 42.6%, reflecting the anticipated shift in mix towards lower margin engineering development revenues.

At the same time, total operating expenses for the quarter were $2.3 million, down approximately $1 million from $3.2 million last year. Most of the decrease resulted from lower internally funded research and development, which totaled $400,000 in the quarter, compared to $1.4 million in the third quarter a year ago, as engineering resources this year were focused on funded programs. Total engineering spend is growing in relation to historical levels because more of our resource is used to support customer funded programs.

Selling, general and administrative spending in the quarter was $1.8 million, down slightly from $1.9 million a year ago. For the quarter, we reported operating income of approximately $355,000, compared to an operating loss of $105,000 in the same quarter last year. Net income for the quarter was $260,000 or $0.02 a share and we are profitable for the year to date.

Our balance sheet remains strong with $41.8 million in cash and virtually no debt. Operating cash used in the third quarter reflects primarily the impact of timing difference between our expenditures and customer reimbursements on the engineering development programs. For the full year fiscal 2012, we expect to be profitable on modestly reduced sales compared to 2011, a result that would represent a third consecutive profitable year. Now I will turn the call over to Shahram Askarpour, our President, for some comments on the current market conditions and our business development efforts. Shahram?

Thank you, Ron. As discussed last quarter, the Company's executing on its growth strategy, focusing on managing four separate engineering modification and development programs through the engineering phases. And bringing the related new products and capabilities to market. We believe that our execution of this strategy will increase our addressable markets, both OEM and retrofit. This increase is expected to result in a sizable topline growth over the next five years.

Let me briefly review the status of our engineering modification and development efforts. The system integration and cockpit avionics upgrades of the National Nuclear Security Administration Boeing 737-400 is proceeding. As Geoff mentioned, we have completed successfully the STC flight tests with the FAA for the first phase of the program and expect to receive NSTC shortly. The first phase includes the primary and standby flight display systems.

This STC will enable us to sell the same flat-panel display system upgrade to a market of approximately a thousand aircraft. We are now in the process of adding the IS&S flight management system to this aircraft. At the conclusion of the contract, we will have the capability to offer to Boeing 737 classic operators, a model flat panel display system, an RNP-compliant flight management system, SATCOM radios, an ADS-B-compliant transponder and TCAS system. The effect of this capability will be to enhance the performance of the Boeing 737 classic aircraft, to meet upcoming next-gen mandates and to increase significantly the value of our system offerings.

On June 4, Eclipse Aviation announced formally that it's initiating production of its new twin engine E550 jet with deliveries expected to begin next year. That is welcome news because IS&S is on the contract to supply the E550's advanced avionics suite for the aircraft. We anticipate participating in the success of the production phase of this exciting new aircraft. The completion of the development phase of the contract and the shift to the production phase will provide us with the opportunity to develop similar products for other general aviation aircraft with the potential to increase the size of our addressable market.

In contrast to our previous general aviation products, the completed advanced avionics suite provides enhanced functionality, including flight management systems, autothrottle and RNP-capable, compared to the more limited utility for a simple flat-panel solution. By offering owners and operators a more broadly-based solution, we have created further growth opportunity.

The development phase of the Boeing aerial refueling operated control and display unit is progressing. Last month we completed successfully the critical design review with Boeing and the U.S. Air Force. In this fourth quarter, we plan to deliver seven preproduction units for Boeing integration and evaluation. We'll concentrate our first contract holds for 179 units to be delivered for the new United States Air Force fleet of KC-46 tankers.

A contract to develop OEM advanced electronic monitoring and control systems represents another general aviation opportunity. We completed successfully the preliminary design review with our customer in June and are proceeding with the detailed design of the product.

At the end of the third quarter, we had a backlog of $23 million, which includes the first year of production for the OEM advanced electronic monitoring and control system. Backlog does not include significant potential future revenues from the production phase of the Eclipse contract, production beyond the first year of the new OEM advanced electronic monitor and control system contract and the production phase of the Boeing KC-46A tanker contract.

Bringing these new products to market will deepen our capabilities and increase our growth opportunity. Completion of these new programs will enhance our ability to bring cost-effective solutions to market and provide better opportunities, both OEM and retrofit, in the commercial air transport, general aviation and military markets.

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

Thank you, Shahram. I would like to close with a few comments and observations. Simultaneously undertaking significant EMD contracts has made this an unusually challenging year. A year in which we've invested about 15% more in engineering than last year while still maintaining revenues and profits.

We are several quarters into the challenge of creating four new products for four different customers and platforms. I am pleased with the skill that we have shown in the planning, executing and managing these new opportunities. As our successful 757/67 COCKPIT/IP programs help to create these four opportunities, we believe similarly that the success of these new programs will lead to new opportunities with a wider variety of operators and OEMs in all of our markets. This is very exciting.

For the fiscal year ending September 30, our goal remains to manage the business prudently and maintain its profitability. Longer term, we believe we are positioned to grow profitably and deliver very attractive growth and returns to our shareholders.

Operator, will you please open the call for questions?

(Operator Instructions) Jim Fronda, Sidoti & Co.

Good morning, thanks for taking my questions.

Good morning, Jim.

With the flat-panel displays for the Boeing 737 program, so that's still in the testing certification phase? When do you expect to begin receiving revenues from this program?

Well, we're already generating revenues from the program.

Okay.

Contracts for the initial two -- for the two aircraft was a full systems integration project which included not only the flat-panel display system, but as we mentioned, 16 other systems in the aircraft. The program was well over $5 million for the two aircraft and we have already -- we're already receiving revenues based on, for this year, on that program.

We will proceed with another phase of the program near the end of our fiscal year, which will substantially complete the first aircraft, and the second aircraft will have substantially no engineering, but just the installation and the profitability from that. So, we're already there. The FTC now allows us to go out to the field and start offering it to the rest of the world.

Okay. And with the shift to more EMD programs and the engineering costs associated there, is R&D spend for this quarter what we can expect going forward? Or, if you have less of these funded projects, you'll direct more of your resources towards R&D?

(Multiple speakers) go ahead.

Well the answer is, that going forward we would expect to spend more on R&D. In the short-term, what you see in the quarter is probably what you'll see for the next quarter or so.

We're going to try to track the best we can revenues with investment in the engineering, so that we continue, while making major, substantial investments into engineering development. I guess we're talking about 25 -- close to 25% of revenues are being invested in engineering. We're still able to maintain a small profit and we're going to continue to hold that kind of line, and we've been very successful in managing schedule and achievement on our projects.

Okay. And a final question, you've done very well maintaining profitability even when revenues have been down. Are there more cost cutting measures you can make, or at this point do you really need a boost in revenues to see big improvements?

Clearly, there's always some cost cutting opportunities and I don't mean that just sort of vaguely. Shahram has done a remarkable job in assessing the business and has taken a number of actions that have maintained this profitability with the massive increase in engineering investment.

What we believe that we're going to focus on getting the topline and going forward, it's going to be the topline growth that we're targeting to be substantial, that will not only -- that will fund additional investment in product development and generate profits. So it's going to be focused on the topline.

Remember we're spending more than double what our rule of thumb standard of engineering investment. The good news is that we've been able to get funding for a substantial portion of it, but that funding generates very little margin. We don't seek to generate a lot of margin from our customer-funded engineering. We're more focused on covering our costs, so that the customer is covering the cost of their requirements but not generating huge profits to the Company. So, the profits are coming from substantial margins of our production and it's a very good sign, actually.

Great, thank you, guys.

Thank you.

David Campbell, Thompson, Davis & Co.

Hey, good morning, everybody.

You're slipping, David. Good morning. I usually expect to greet you number one.

Well, I mean, I must've been a little slow on --

You missed it, you didn't hit the button quick enough.

I know, I know, I know. Well, I was trying to come up with some good questions, although that's debatable whether I can do it or not. (Laughter). But I do have a couple of questions, as usual.

Shahram, I just wanted to clarify some of your comments. The first thing you said was that the design review for the Boeing installation has been completed and that I heard you say you were going to deliver seven of the units in your fourth fiscal quarter. That's seven out of, eventually 139, is that what you meant to say?

Well, first of all it's 179.

179 (multiple speakers) Okay.

And secondly, so these are preproduction units for their evaluation.

They are paid.

And they are paid for. But no, the 179 remains -- those are the actual, final production units.

Okay. Well, so you will get revenues from these seven units in the fourth fiscal quarter?

That's correct.

But despite that significant amount of revenues, from the press release it sounded like you'll have very modest increases in Company revenues in the fourth quarter, compared to last year. Am I reading that right?

That's correct. Again, the key here is that a fair amount of the revenue is coming from the engineering development programs, which we're not making a lot of margin for.

Okay, and then after Boeing you talked about design review of something else and I couldn't understand what you were talking about. I guess that's the fourth new product you're working on?

Yes, this is the electronic monitoring and control system. We actually completed the preliminary design review on that product. The critical design review, it's scheduled for around December-January time frame.

When it will be completed?

At that time we expect it to be completed and then we proceed with the final design and getting in to production of that product. Now we have received the first year production contract for that --

Geoff Hedrick Commitment.

Commitment for that product.

And what is -- I mean, is this a commercial aviation? What is this?

It's a really nice airplane, that's all. We can't comment on the airplane. But we will shortly.

Okay, is it as big a potential program as Eclipse?

Yes, I mean we don't want to comment, but it's that kind of program. It will be an ongoing production program. And as I commented, it will generate revenues well into the next decade. We see this as a long-term -- basically, foreseeable future kind of program.

Okay (multiple speakers). Eclipse has published their plans, saying that they're going to take a year to produce the first aircraft and then ramping up to full production in 2014. Does that mean that you'll get anything from this in fiscal 2013?

Absolutely.

Yes.

They're going to produce production units but not at full volume. I mean they're going to ramp up, unlike the last try. They're doing it in a very structured and planned way. So, yes, they'll start -- I think the first aircraft is still planned for about midyear calendar 2013, and we will obviously be supplying equipment prior to that. It's going to be an amazing aircraft.

Just -- what I didn't comment on in my speech because the information just came in, but I can now, is that the -- we've just finished the initial flight testing on our autothrottle system. It'll be the most advanced aircraft, probably for not only in its price range, probably in the price range double or triple its cost. It will have an autothrottle and we're doing flight testing as we speak.

So it's going to be quite a remarkable airplane -- dual FMS, flight management systems, synthetic vision systems, autothrottle and electronic circuit breakers. A truly, truly advanced aircraft.

Wow. 50 to 100 aircraft in calendar -- I guess that's calendar 2014, that's a lot of potential revenues. Are the revenues per unit for this aircraft comparable to the revenues you were getting on flat-panel sales? Or just for flat panel --

(multiple speakers) equate to it, and I would -- David, I'd prefer not to comment on it at this point, but we will obviously give you some information for your guidance so that you can put your charts together. But right now we're not prepared to comment on it. We're still -- with the development of the autothrottle and the various other things as part of this new aircraft program, there's a cost and schedule flux, so we're not prepared to comment right now.

But, David, you need to keep in mind that Geoff did preface his comments on Eclipse by saying that it would be a slow production ramp up. They weren't going into full production immediately.

No, no, I know, right.

Right.

Okay, back to the 737 installations, is there any commonality with your avionics package there and the new 737s that are coming off the production line of Boeing? Or is that not important?

It's not -- I guess it's not relevant. I don't know if it's important. Obviously, if we had the production flight deck for the new 737 we'd be very happy and so would you. It is different. It is designed so that you can install it in existing aircraft in a matter of 24 hours. If you were to try to install the new system in an aircraft it would take probably a month and a half.

And recognize the importance of a short installation time. Leaving an airplane on the ground, depending on the size of the airplane, costs the operator anywhere from $35,000 to $75,000 a day. So, when you have a five day installation, you're talking about costs that may exceed the cost of the equipment that you're putting in the airplane. So by us reducing the installation time, we are reducing the installed cost of the equipment in -- less than half, so it's quite an achievement.

What you begin -- what you'll offer these installations for, other 737s, are they the 737-200s, 300s and up? Or just the 200s and 300s?

300s, 400s and 500s.

There's a lot of those still in operation. You mentioned 1000 --

There's more than 1000.

There's a lot more than 1000, but that were saying 1000 we think are applicable (multiple speakers).

Okay, good. Let me see if there's anything else, I'm sorry -- I'll come back in a few, thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Geoff Hedrick for any closing remarks.

Do we want -- David, do you have any other questions so that I can answer them with everybody else on the phone?

(Operator Instructions).

Yes, Geoff, just --

Yes.

Yes, Geoff, and everybody, Shahram. You've mentioned there are other programs, OEM programs, related to the Eclipse development. Have you been marketing that to any other OEM programs yet, or is that something in the future?

Were in the process of doing -- we're not marketing it right now, but we will be marketing essentially an Eclipse cockpit to other aircraft. It will be -- and it is with Eclipse's endorsement and enthusiastic support. So, yes we hope to make it available to a number of other manufacturers but on an OEM basis and on a retrofit.

Yes. And, Ron, you mentioned $1.2 million of cash was used to fund operations. Does that mean it comes back into the Company in the fourth fiscal quarter?

I don't think you can draw that conclusion, David. Some of it was advance payments that we had received prior to the quarter, and some of it changed -- some of the outflow was a result of spend but not yet billable receivables. So it's -- you can't make that distinction precisely. The connection.

Okay, so we will be using -- we won't be using any cash in the fourth quarter or don't you know yet?

Well, we do make projections, but I don't think we typically share projections. Our hope is to be positive for the year in cash -- operating cash.

We're not trying to generate a lot of cash. Remember, we took cash and we bought back stock over this past year. We have an active and increasingly aggressive program to repurchase stock. We are -- the Board is very committed to the repurchase plan so we do use some cash in that area.

Our interest is to take the cash we have and utilize it in sensible and prudent ways. And if repurchase or small amounts invested in longer-term projects, we'll do it, but we -- as you see, we've accumulated a substantial cash reserve and we want to make sure that we, when appropriate, we can use it. To date we haven't; we've try to maintain -- keep profitable and keep at least cash neutral. Those are both objectives that we try and I'm happy to say we've been very successful at it.

The last question is the backlogs. Shahram, I think you touched on it. It includes the advanced electronic monitoring control system, or the first year of production. That's Eclipse, right?

No, no, that is the unnamed OEM.

That's the unnamed OEM. Okay.

Mystery, mystery.

Unnamed potential boom.

No potential; it's there. But, yes, there's a significant portion that doesn't appear in our backlog, which has to do with production programs that we intend to go on, on a longer-term. You may have a program that you expect revenues, and actually plan revenues on for other purposes, that could run 5 or 10 years but we do not have in our backlog, because we don't have a firm order for delivery of that component.

As an example, if we were supplying on an OEM contract to Boeing, as an example, or Airbus, we would get an annual purchase order, and that's all that would appear on our backlog. Although the program for the airplane could be hundreds of millions of dollars, we only show the backlog for that released order.

Right, right.

So, and we don't want to go into how much and relative and all that, because it's obviously inappropriate. But we do want to tell you that we are -- our focus in this Company over the next year is to try to build the topline out. We have a good, solid base; we're investing strongly into product development and that is -- we're doing that specifically to look at larger, longer-term, repetitive programs that will supply revenues to us that we can build on, that will provide a foundation for production so that we'll have OEM business that is repeatable, predictable revenues, upon which you build your retrofit business and match both of them. And that's the strategy and it's starting to work.

Okay.

All right?

Great, thank you very much for answering all of my questions and I appreciate it. Thank you very much.

Okay, thank you. Thank you all for joining us today. I hope we were able to give a little bit clearer picture of where we're going and what our strategy is. It's uncertain economic times, as we all know. We don't need to hear that again. But the answer is you can't win the race if you're not in the race, so we're determined to be in the race and build a strong foundation for the future. Thanks again for joining us, bye-bye.

The conference is now concluded. Thank you for attending today's presentation, you may now disconnect.