Innovative Solutions and Support Inc (ISSC) 2015 Q1 法說會逐字稿

Good morning and welcome to the Innovative Solutions and Support first-quarter fiscal 2015 earnings conference call. (Operator Instructions). Please also note this event is being recorded. I would now like to turn the conference over to Mr. Geoff Hedrick, Chairman and CEO. Mr. Hedrick, you may begin, sir.

Good morning. This is Geoff Hedrick, Chairman and CEO of Innovative Solutions and Support and I would like to welcome you this morning to our conference call to discuss first-quarter 2015 results, current business conditions and our outlook for fiscal 2015. Joining me today are Shahram Askarpour, our President and Relland Winand, our CFO. Before I begin, I would like to let Rell read our Safe Harbor message. Rell?

Thank you, Geoff and good morning, everyone. I would 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 risk 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, Rell. I'm pleased to report a profitable first quarter. Revenues for the first quarter were $6.7 million compared to $11.1 million in the same quarter, but the net income for the quarter was $594,000, or $0.03 a share. The gross margins were up reflecting the anticipated decrease in low breakeven margin or on engineering and development revenues and our typical 50% or better margins on the revenue for product sales.

As reported previously, the purported cancellation by Delta Airlines of their MD-88/90 update program has had a significant impact both on our backlog and near-term revenues. However, as we approach mediation, we are confident that we will find a reasonable resolution in accordance with the terms of our agreement with Delta and will be reached. We believe we can substantially mitigate the loss of revenue and loss of opportunity due to key engineering resources for the program being applied for the last four years.

We've adjusted our expense level to reflect our anticipated fiscal 2015 order intake and revenue expectations. We remain profitable while establishing a model that will generate better margins, lower cost and we believe can lead to another profitable year in 2015. We continue to make progress in a couple of significant engineering development programs, the largest of which is a utility management system for the Pilatus PC-24 aircraft. Coupled with the Boeing 737 Classic aircraft, the Eclipse 550 and the C-130, we have several programs on which we anticipate production orders over the next several years and will grow both our revenue and our profitability.

We are also looking at new programs that will be placed on the back burner as we concentrate our efforts on our existing engineering commitments. On balance, we actually increased internally-funded research and development spending this quarter reflecting our confidence in the multitude of opportunities we see before us.

We also increased the marketing of our existing portfolio of products, including the recently announced Boeing 737 Classic Flight Management System upgrade. As we continue to add to our portfolio of existing products such as the 737 FMS, we expand our addressable market and increase the opportunity to quickly generate production revenues that offer attractive margins.

All of these efforts are geared towards capitalizing on our industry-leading price for performance value proposition in anticipation of the imposition of more demanding regulatory requirements. In the near term, intra-quarter book and ship business represents an opportunity to supplement the revenue generated from backlog. Historically, intra-quarter orders have been an important source of revenues and although it is not captured in our reported backlog, at the same time, we are ramping up on new program efforts, which takes us somewhat longer to produce results.

In addition, revenues generated from engineering programs currently under contract will contribute incremental margins. As we move through the year, you will also see expenses decrease, an action which we have implemented in light of our current situation. Together with better product mix that should yield improved margins, we are organized to remain profitable and grow. Although as previously cautioned, quarterly results can be variable.

Since we have always operated conservatively, we have the balance sheet and financial strength to support our plan. Just a few weeks ago, we said that fiscal 2015 would be a year of adjustment. While there are some changes remaining, we believe the first quarter's progress has sent us on a course to achieve our goals for the next year. Now let me turn it over to Rell for a detailed description of our financial performance.

Thank you, Geoff. In the fourth quarter, we reported revenues of $6.7 million compared to $11.1 million in the same quarter a year ago. The decrease primarily reflects the loss of a large engineering development contract, but also reflects last year's strong product sales in what has historically been our slowest quarter of the year. Despite the decrease in revenues, we generated net income of $594,000 or $0.03 per share, including a $411,000 tax benefit arising from the retroactive restoration of the research and development tax credit effective January 1, 2014.

In the first quarter, product sales were $4.5 million, a decrease of $3.2 million from the year-ago quarter while engineering and development contract revenue was $2.2 million, a decrease of $1.2 million. As previously noted, as engineering programs wind down, we expect these revenues to decline over the course of 2015. While engineering revenue is typically marginally if at all profitable, revenue from EDC contracts in the first quarter of 2015 were more profitable than a year ago resulting in a contribution to margin. Consequently, although we expect engineering-oriented revenue to decrease over the course of the year, we also expect it to be less of a drag on margins.

As a result, and with production margins in the 50% or greater range, gross profits in the quarter were 41%, the strongest in several quarters. Quarterly gross margins, of course, can fluctuate depending amongst many factors, including product mix and revenue levels. Total operating expenses were $2.6 million in the quarter, a year-over-year increase of $200,000. As Geoff mentioned, internally-funded R&D was up year-over-year and included customer-funded R&D; over 35% of first-quarter revenue was invested in new product development.

Compared to a year ago, selling, general and administrative are marginally higher, primarily due to an increase in sales commission and travel. In addition, the year-ago quarter benefited from a nearly $100,000 one-time reversal of a legal accrual. As previously discussed, we have taken action to better align our cost structure with current business conditions. We should begin to see the full effect of these actions with second-quarter operating expenses.

We reported first-quarter pretax operating income of $183,000 and with the addition of a $400,000 tax credit, net income was $594,000 or $0.03 per share. At December 31, 2014, the Company had $14.2 million of cash on hand compared to $15.2 million at the beginning of the current fiscal year. In the first quarter, operations consumed cash of $726,000 primarily due to a $1.8 million reduction in accruals and payments of accounts payable. The Company also repurchased $254,000 of its stock in the quarter.

Over the course of fiscal 2015, we generally expect to reach billable milestones on various engineering programs with unbilled receivables. As a result, we expect these receivables to be converted to cash. I will now turn the call over to Shahram Askarpour. Shahram?

Thank you, Ralph. Good morning, everyone. Since we spoke just a few weeks ago, let me offer just a quick overview of the status and progress achieved in the first quarter. We have quickly adjusted to the disruptions caused by a large contract-purported termination. Costs have been reduced and engineering resources redeployed either to help accelerate and improve the performance of existing programs or to pursue new programs in which we have previously not participated. New business development efforts include more intra-quarter book and ship orders, as well as a focus on leveraging the investments we have already made in our portfolio of existing products. We are putting a great emphasis on marketing our existing portfolio of products that, as we have expressed in the past, deliver gross margins higher than 50%. These initiatives are expected to produce positive results both in the near term, as well as over the longer term.

Currently, our engineering programs are all progressing well. The foreign military C-130 program is nearing completion of its flight test certification. The Pilatus PC-24 program is scheduled for first flight in May 2015 and the Boeing KC-46A program has entered the flight testing phase with a successful first flight in December of 2014.

While the revenues on these programs are not particularly profitable during the development phase of the programs, once they enter production, they offer stable, long-term revenue opportunities and that opportunity is not included in our backlog. Development programs, which comprise approximately a third of fiscal 2014 revenues, are expected to be replaced with product shipments in fiscal 2015, which should lead to an overall improvement in gross margin.

During the first quarter, we began marketing our new Boeing 737 Classic Flight Management, which we believe has outstanding potential with an estimated addressable market of 1300 shipsets. As jet fuel prices drop, that opportunity may improve as additional operators find it more advantageous to refurbish rather than buy new aircraft despite the higher fuel burn of older models. Backlog was $5.8 million in December 31, 2014 and as previously mentioned, it does not include the production phase of programs that are progressing through development such as the Pilatus PC-24 and the KC-46A aircraft.

Our focus at this juncture is to rebuild our backlog; however, the longer contracts that generally comprise the bulk of the backlog tend to go through a relatively longer sales cycle. We are moving from a period where operations were heavily focused on the engineering and development needs of key programs and products to a period where we can strategically deploy our engineering resources to develop variations of those products that expand our market offerings.

In both new and existing products, our competitive advantage has been our ability to offer leading price performance solutions that support initiatives such as next-generation cockpit technology and system integration. As we pursue our commitment to recover from the drop in our backlog, we are experiencing greater opportunities that could yield significant growth in our market penetration. Our technology is superior and we are determined to succeed by meeting the immediate needs of operators with our innovative solutions. I would now like to turn the call back to Geoff.

Thank you, Shahram. Although quarterly results could be variable, I'm confident that 2015 will be a strong recovery and profitable year. In the matter of the dispute with our customer with the reported termination we discussed previously, a large contract is proceeding to nonbinding mediation. Since all of the financial consequences associated with this contract have been eliminated from our financial statements, we believe there is only upside opportunity in the resolution, which could potentially benefit our already strong cash position.

At the request of the Board of Directors, I am fully engaged in supporting Shahram and looking forward to the exciting opportunities I believe that are unfolding for Innovative Solutions and Support and our growing reputation for the industry's best price for performance value proposition. I would like to now turn the conference over to -- the call in for questions.

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

Geoff and Shahram, thank you for giving us the opportunity to ask questions. I have some sort of a general question first related to the next-gen directive of the FAA. They seem to be moving better on the next-gen implementation. They've got airports that have been using some of the procedures and saving millions of dollars of fuel in doing it. It seems to be proceeding to generate eventually over $6 billion of business from airlines. Am I correct in hoping that your equipment, your flight management systems will be needed by some of these airlines to generate the ADSB and the data communications and the automatic en route communications and so forth? And why did Delta suggest that it doesn't need the equipment?

The answer is yes, definitively yes actually. We really have a strong -- we're continually building a very strong support for the next-gen systems, which include reporting, for ADSB, reporting of the position and intent of the aircraft and navigation enhancements in multiple different ways, even with our ability to enhance existing FMS installations in aircraft that obviates replacing the FMS, but puts a large package of ISS equipment in a very much more cost-effective solution.

As you know, Shahram hired a Vice President of next-gen programs who spent the last 10 years working actively and closely with the FAA on next-gen solutions. He is guiding and moving the strategy and doing an excellent job and just recently we have several significant contracts bid just this past week and customers all in this week. So we're seeing a lot of activity. The $6 billion I can't comment on, except that I suspect it's going to be somewhat less than that, only because I think our equipment provides a far more cost-effective and much more rapid solution to the problem.

So this is -- you're not disappointed. This development is continuing to provide potential for the Company?

Oh no, I think it's absolutely terrific. Remember that the program that's now in question was never our original intent to take that. We pursued that program in support of our customer, which we believed would be a broader customer in 57/67 solutions, etc. In fact, we were told directly that was why we should take this program. We recognized that it was substantially a dead-end program except to the extent that we would have applied our flight management technology to another aircraft. We have proven the performance through -- and FAA acceptance of our performance in the FTC certification of our 737 flight management system on the NNSA airplanes and comments from the pilots who say it flies like a dream, it's outstanding, so we're delighted. We're very pleased and we have another major FMS program in the work now that opens an opportunity for literally hundreds of millions of dollars of additional business.

So we now can take our resources that were formerly applied to the program that we discussed and now apply it to the broad range of opportunities that we see out there and which have significantly larger follow-on opportunities. We respect our customers' ability to change direction in response to the demands of their airline. That's intrinsic in any deal that you ever make with a customer in the industry. Unfortunately, we expanded an enormous amount of resource, committed resource to that program that could otherwise have been applied to some of these other ones. So we're in a little bit of a catch-up situation, but we're doing well. We're doing remarkably well and Shahram is very engaged and doing a great job. So I'm enthusiastic and I'm hoping that I can go to Florida and use the condominium I rented for three months.

Well, we don't want you to spend too much time down there. We need you in Exton.

I'm fortunate to have Shahram here. We work well together and he's doing a great job. So I think we're going to do fine and find ourselves in some respects recovering stronger and you're going to start seeing the business realize profits and profitability more consistent with historical norms. The massive development programs that we engaged, there were three big ones going on at the same time and each one tended to impact the others. So straightening this out should help us enormously.

All right, thanks. On the expense side, Relland, you mentioned that expenses will be going down in future quarters. Are you talking SG&A or are you talking R&D? What expenses precisely will be going down?

All, all of them should be.

Manufacturing as well.

All across.

That's one thing we know what we're -- we know how to manage our resources. We continue to invest a great deal of money proportionately, almost disproportionately high investment and engineering development. And we obviously don't keep people in the overhead unnecessarily. So it's been an across-the-board evaluation. We've done a forced ranking of every individual every month so that we're sure that we're not losing any of our key people. So it's actually a very -- I think ultimately a strengthening exercise.

So the EMD revenues were more than I thought they'd be in the quarter. They are going down substantially though in the next few quarters, are they not?

Yes, as I said before, they are ramping down, so they will be less than what they have been recently.

And some of the people supporting the EMD programs are contractors and they will -- if they are not needed for some other critical program that may come to light in the interim, they will leave. So we've got this managed up for the next four months. We've looked at it very carefully and to be blunt with you, when you're a small business, you have to do that kind of thing. You have to think about every single person and every single resource in the organization to make sure that you manage it correctly.

Right. And how much of the book -- how much of the product deliveries -- roughly what percentage of that was the book and delivery or the book and order -- order and book -- I'm sorry -- book and delivery business, the air data business?

We don't break that out. We just show product as one continuum.

Right.

(inaudible) air data product. It's still a good strong product and we're doing it and it has real life left in it for the foreseeable future to be blunt. We're very -- we continue to make improvements and new products. Now we make a standby for a number of programs now that has air data (inaudible). That looks like an expanding program because we're able to offer some features for next-gen in that product. So it's really exciting.

Right, right, right.

(multiple speakers) programs and once it should turn in quickly and I think relatively low risk as well.

Right, right. Okay, I will turn it over to someone else. Thank you very much.

(Operator Instructions). Showing no more questions, this concludes our conference for today. We thank you all for attending today's presentation. Have a great day and you may now disconnect your lines. Thank you.

Thank you.