Innovative Solutions & Support - Earnings Call - Q2 2018

Transcript

Speaker 0

Good morning, and welcome to the Innovative Solutions and Support Second Quarter Fiscal twenty eighteen Earnings Conference Call. All participants will be in listen only mode. Please note this event is being recorded. I would now like to turn the conference over to Mr. Hedrick, Chairman and Chief Executive Officer.

Please go ahead.

Speaker 1

Good morning. This is Jeff Hedrick. I'd like to welcome you this morning to our conference call to discuss the second quarter fiscal twenty eighteen results, current business conditions and our outlook for the upcoming year. Joining me today are Sharon Mascupur, our President and Rel Wennan, our CFO. Before I begin, I'd like to like Rel to read our safe harbor message.

Rel?

Speaker 2

Thank you, Jeff, and good morning, everyone. I would remind our listeners that certain matters discussed in the conference call today, including new products and operational and financial results for future periods, are forward looking statements that are subject to 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 ks, which is file with the SEC and other public filings. Now I'll turn the call back to Jeff.

Speaker 1

Thank you, Ralph. In the second quarter, both revenues and backlog were up sequentially from a weak first quarter. However, revenues are down 20% as compared to a year ago, reflecting a lower beginning backlog in the quarter. In the quarter, we maintained our high level of investment in new product development, representing 28% of the quarter's revenue. This investment in new product development was in line with the year ago quarter and has not significantly changed during the past year regardless of the changes in the level of our revenue.

Today, you will hear discussion about our auto throttle program. Our auto throttle is not is not simply a cruise control, but an important addition that enhances safety and protects vital engine components from damage. Our ThrustSense auto throttle is the only certified turboprop auto throttle available for part 23 aircraft. Business and commercial aviation news referred to us to refer to it in a recent feature article as a and I quote, as such, the system marks a major step in reducing pilot workload, especially in these aircraft that are typically flown by a single pilot. We continue to invest in innovative solutions.

Recently, we were awarded an STC for a standalone autothrottle, which is controlled by our integrated standby unit for the Platus PC-twelve. It builds on our existing STCs for turbo prop auto throttles integrated with our display for the PC 12. It incorporates plug and play technology that reduces installation time and offers owners an economical solution to put this technology into their PC-twelve. As such, we expect to provide a template to reduce time required to add certifications for other aircraft platforms. We are now working on a standalone autothrottle for the King Air.

To accelerate the development, certification, and demonstrations, we purchased a 2,008 King Air aircraft, which will enable us to control all aspects of the program. Consequently, we believe we can reduce the time to obtain a King Air STC so we can enter the market of more than 5,000 King Air turboprops. We continue to focus on our sales and marketing. In particular, we are continuing to build a global MRO network by signing distribution agreements with domestic and international MRO organizations. This provides a brand new channel to market for the company.

At the same time, we are also building up our internal sales and marketing resources and activity. We will strengthen our auto auto throttle focus with the addition of a product line director with proven product and market experience. We are investing we are also investing in building a portfolio of new products, implementing our new sales and marketing strategy and getting key distribution partners and sales resources in place. We believe this strategy will allow us to better control our operations while reducing the inherent risk of large engineering contracts over the long term, it is a right decision. We remain in a strong financial position to implement our strategy.

Historically, we have been an operating cash flow positive. We are focused on returning us to these traditional levels of performance. Ultimately, it is about developing what we believe is the industry's most compelling price for performance products responsive to impending next gen mandates. We believe that it is what will enable us to grow the business and create value for our shareholders. Now I'd like to turn it over to Ralph for some more detailed financial discussion.

Speaker 2

Thank you, Jeff, and thank you all for joining us this morning. For the three months ended March 3138, net sales were $3,700,000 compared to $4,700,000 in the 2017. Consistent with recent quarters, the majority of revenue was either from production contracts or customer service, including revenues recognized on intra quarter book ship orders. For the 2018, gross margins were 44%, down from 51% in the year ago quarter. Product mix in the quarter included a high proportion of units with higher material costs and reflect effort of lower sales volume reducing the coverage of fixed costs.

This is consistent with our observation that margins can vary from quarter to quarter as a result of changes in either product mix or volume. Total operating expenses in the second quarter were $2,800,000 In the year ago quarter, we reported a total operating expense credit when we booked a reversal of a $3,600,000 unbilled receivable reserve coincident with the settlement of the Delta lawsuit. On a sequential basis, total operating expenses were up modestly from the first quarter, reflecting some increased general and administrative spending. Research and development investment was relatively unchanged from a year ago and has been running at a relatively consistent $1,000,000 to 1,100,000.0 to $1,200,000 per quarter for some time now. We continue to remain committed to funding internal new product development.

Note that in the year ago quarter, we recorded $4,100,000 of the double settlement as other income. For the 2018, we reported a net loss of $1,300,000 or $08 per share. As a result of the Delta settlement, net income and earnings per share were significantly higher in the second quarter a year ago. Income tax expense for the 2018 was $200,000 with an effective tax rate of negative 18% and reflects a change in the valuation allowance in the current period. Income tax expense was $1,200,000 for the three months ended March 3137.

The company remains in a strong financial position. At the quarter end, we had $23,400,000 of cash on hand and no debt despite being somewhat operating cash flow negative for the first time in several quarters. Although capital expenditures have been relatively late in any particular quarter recently, I would note that we are likely that we will have a $2,300,000 purchase of a King Air airplane, which we expect to complete in the fiscal third quarter. We believe the company has sufficient cash to fund operations in the foreseeable future. Now I'd like to turn the call over to Sharon.

Speaker 3

Thank you, Ralph. Good morning, everyone. As Jeff mentioned, both revenues and new orders in the second quarter were up from the first quarter. This is consistent with our expectation for steady improvement over over the course of this year. Orders in the quarter were EUR 4,200,000.0 and backlog as of March 3138, was EUR 3,800,000.0.

We are undertaking a concerted effort to strengthen our autothrottle franchise. Once CSTCs are obtained for the King Air series, we will have a range of autothrottles in the market that address a fleet we estimate totals 5,000 aircraft. As we increase the potential installed base of our autothrottle by developing additional SPCs, product recognition from industry publications complemented with our increased emphasis on sales and marketing is resulting in growing interest in the autothrottle product line. We expect to broaden up from this space with products for other turboprop aircraft that leverage the technology behind the design of our stand alone autothrottle. To that extent, we are in discussion with a number of potential candidates as part of the process of hiring an experienced oral throttle product manager to be the focal point for program management, marketing and sales of this high potential product line.

We also have been approached by a major engine manufacturer with an interest to team and jointly market our autothrottle with our engines. Our discussions with various aircraft OEMs with regards to offering our utility management system continues to gain momentum. Pilatus PC-twenty four is now in commercial production and is providing a steady pace of ongoing orders as we are the sole source supplier of the utility management system on that platform. International opportunities continue to be a focus of our sales and marketing efforts. In fact, in the second quarter, 40% of our revenue was from international business.

In China, air cargo growth continues, and many operators are looking to convert all the Boeing seven thirty seven, seven fifty seven, and seven sixty seven aircraft into cargo planes. This is an area where we have great product and retrofit expertise. To capitalize on the local knowledge, we are partnering with MROs in that region to develop opportunities. And MROs remain an important factor in our overall sales and marketing strategy. In addition to the local knowledge they can impart, they offer a cost effective means to globally expand our distribution network.

We plan to continue with growth of our MRO network within The U. S. And international. The number of aircraft on which we have installed equipment continues to increase. As a result, we are experiencing a steady growth in customer service revenues.

In summary, we are focused on creating value for shareholders through our strategy to develop the industry's best price performance products and to grow the sales by expanding our marketing reach. Let me turn the call back to Jeff for some closing remarks. Thanks, Cheryl.

Speaker 1

We are pleased that we are on our way to a steady improvement in revenues and backlog. I believe that the direction that we are taking in building a strong franchise with the development of a portfolio of autothrottles through our sales and marketing team. And with the aid of our growing MRO network, we are expanding our ability to get these products in front of ready buyers around the world. In Asia, the surge in cargo air traffic is expected to be a spark for renewed growth in some of our legacy products as well as the new ones. These are opportunities we are aggressively pursuing.

And though it all and through it all, we are excuse me, we maintain a strong financial position that will enable us to make strategic decisions that will create value for our shareholders over the longer term. I appreciate your interest today. And now I open the call for questions. Thank you.

Speaker 0

We will now begin the question and answer session. On your touch tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, The first question comes from David Campbell of Thompson Davis and Company. Please go ahead.

Speaker 4

Good morning, everybody. I'm glad to hear your voices and thanks for your comments. I just wanted an update on the status of the next gen aircraft modifications that are supposed to be going into the FAA plans at some point. I see increasing talk about companies developing products for that for that that system, including one company that's been on newswire is on has been commercially advertising the the connectivity systems between aircraft and citing that this will be very much big savings to aircraft operators in taking off and landing aircraft. I don't know if you've seen the commercial, but could you give us an update on the on the status of of all that and and what you're doing to participate?

Speaker 3

Sure. Guess connectivity has been kind of bribed by a number of larger companies such as Honeywell, for example, where they project that all aircraft will talk to each other and tell each other about the weather upfront and all of that great stuff. One of the main things that of NextGen is is is getting tighter in tighter air spaces, aircraft that that they can closely do faster landings. To that extent, the the a lot of the air transport aircraft, they're all equipped with flood management systems that have very good vertical navigation capabilities as well as autothrottle. What we have done by developing and introducing an autothrottle into the business and general aviation market, coupled with our VNAV flight management system that we have developed is bring that technology into that those platforms.

That's unprecedented by any other major avionics manufacturer or minor avionics manufacturer for that for that reason. So this is what we're doing for NextGen.

Speaker 4

So that that combination of auto throttle and fleet and flight management systems is is unique in the in the industry.

Speaker 3

Ability of the business aviation industry, it is. What it allows aircraft to do is to follow each other tightly into landing. In when we talk about in a three d space, when we talk about doing RNP approaches and required time of arrival, these are all the things that it's going to be Right now everybody's got their heads wrapped around this ADS Bout, which is only the beginning phase, the stepping stone, the first stepping stone for NextGen. Once all of that's going to be done by December 2019, the emphasis is going to be on now how do we take advantage of that technology. And we have developed the tools to be able to take advantage of that technology by allowing the business aviation aircraft to be equipped with required time of arrival and precise three-dimensional, if you add the time to it, what they call the four dimensional navigation, that is going to be the future of aviation.

Speaker 4

But in order to be effective, you need to have an autothrottle STC for all of the business aircraft that are used?

Speaker 3

Well, some of the business aircraft. When you look at high end business aircraft, like Gulfstreams and and some of those, they already have autothrottle in them. Oh, you go. Yeah. In the mid market of of King Airs and the and and and the the other turboprop aircraft, the PC-twelve, a lot of the regionals don't have autothrottle.

And without autothrottle, you cannot have a very good vertical navigation capabilities. You will not be able to accurately monitor speed and time of arrival. It will be too much pilot workload to try to manage all of that. So we bring that product into those markets, which clearly lack. Even new airplanes that they make today don't have that capability in those

Speaker 1

types of aircraft.

Speaker 4

Right. And so so you see you see this developing during calendar nineteen and calendar 02/2020?

Speaker 3

I think that's when people are gonna wanna take advantage of all of these money they've been spending on telling other airplanes precisely where they are and when they're going. So so that when when when they start taking benefit from that, we have developed the products in order to do that.

Speaker 4

Mhmm. And this commercial has been on television citing that they can they can do that. It seems like they're they're saying they can do that.

Speaker 1

They can do it if they have an autothrottle for commercial air transport is about $200,000. And it and it weighs upwards to 40 pounds, 50 pounds. And it's big, it doesn't fit readily in any any turboprop reasonable turboprop aircraft. And that's why they're not used. And also because there was no critical requirement for speed control until NextGen came along.

NextGen is coming along, and already we have we we already have airports now with slot times where you're allowed to arrive and land in a in a two two minute window. That's gonna be increased with required time of arrival. It means that you have to constantly monitor your speed and adjust it. And that when it goes to high levels of adjustment, it puts an incredible addition on the pilot's workload and also puts the engine at risk by overspeeding it or underspeeding it. So that's why autothrottles are attractive.

But to date, they've been heavy, expensive, and difficult to install. And our unit can be installed, as an example, in a PC 12 in a few hours. It's remarkable instead of a week. So it's those features that we believe is making it attractive. And, oh, by the way, the leading this jet periodical part of Aviation Week did a cover story on it, our autothrottle, in in the February issue.

So and and raved about its performance and the fact that it acted like a a a copilot. So we think it's a good product. We see a lot of opportunity. And for the for engine manufacturers, it provides a a real protection of the engine preventing overspeed and over temperature conditions, which seriously impact the life of the engine.

Speaker 4

The OEMs already have that built into their their engines. Right?

Speaker 1

No. The the new engines some of the new turbo fan engines, the fan engines are FEGEC engines, full authority digital engine control. And they protect the engine from over from over speed and overtemperature and hot starts and a bunch of things. However, they don't automatically protect the airplane from overspeeding, which, you know, puts the aircraft at risk or underspeeding, which makes you fall out of the sky or other serious problems. That requires an autothrottle.

And if you couple the new engine with the autothrottle, you can get what we produce in a single autothrottle for about a quarter or a quarter of the amount of money.

Speaker 4

How long will it take to get the King Air STC done?

Speaker 1

A few months. A few months. Just to give you an idea, we purchased a used airplane because the modifications that were necessary, the test flying with the FAA, etcetera, we we simply could not find an airplane, a a reasonable airplane that the owner was prepared to essentially shut down for a year and and have major modifications done to it. So we ended up doing it this way, and we we believe we can resell it and either make money or at least break even, we hope. So it's a practical way to do it.

We labored looking at the alternative for about five four months or five months, and was delaying the program. And the board, overwhelmingly said, go ahead and do it. That's why we have cash on board. And, it's not gonna affect the balance sheet, and we can resell it when we're finished demonstrating it. So that's why we got it.

Speaker 4

Yeah. Sounds like a sounds like a great idea to accelerate the the King Air market, which needs an FTC. That's all it needs. And then you you could start start using it.

Speaker 1

You're absolutely right. We we kept we kept, we we did a couple of opportunities with with partners, and they were they tried to be very helpful, but it was compelling that we that it just wasn't gonna work. We could not have the airplane available when we needed to actually do the installation. This is we got one. It's excellent.

We will get delivery of the airplane sometime the end of next week or the week after and start immediately start installation of our equipment and start flight testing and demonstrating to the FAA. With the paperwork delays and the rest of it, it's gonna take a couple of months. But we're well on our way moving quickly.

Speaker 4

Do you put the flight management system in that plane too?

Speaker 1

Yeah. We don't do that. Right now, we have it in the PC 12. We were looking at doing exactly the same thing in the in the in in the King Air. Right.

Yeah. It depends on the configuration. The newer ones have a a flight management system, albeit not a not one that uses an autothrottle because the airplanes don't have an autothrottle. So the flight the FMSs that are in there don't use that feature. Ours does.

In the older units where we completely we would replace the cockpit avionics with our system, which has an integrated vertical navigation, three d navigation system. It incorporates the the auto throttle. And you can do things like follow the airplane in front of you by precisely two miles or three miles or four miles in in complex holding patterns, and it'll do it all automatically. You could never do that manually.

Speaker 4

Yeah.

Speaker 1

That's all tied into the next gen and all of that stuff. ADS B coupled with ADS B, you could sit there and and follow the the airplane in front

Speaker 3

of you at a

Speaker 1

precisely same speed.

Speaker 4

Mhmm. Alright. Sounds great. Okay. Thanks for the thanks for the answers.

Thank you very much.

Speaker 1

Thanks. Thanks, David. It's good talking to you.

Speaker 4

Yeah. Thanks, Jeff.

Speaker 0

At this time, I'd like to turn the conference back to Mr. Hedrick for any closing remarks.

Speaker 1

Do we have do we have anybody else in in line? Looks like we have a couple of people in line.

Speaker 0

Yes. Two have just entered. If it's okay, I'll take their questions if you wish.

Speaker 1

Go ahead. Go ahead. Okay.

Speaker 0

We have a question from Jason George, Private Investor. Please go ahead.

Speaker 5

Hi there. Thanks for taking my call. Hello? Yes.

Speaker 1

Hello? Yes.

Speaker 5

For taking my call. Yes. I've been a shareholder for the last couple of years, and I just had two questions, if you would. I noticed at the end of the last quarter's conference

Speaker 6

call,

Speaker 5

you spoke about other companies perhaps expressing interest in acquiring ISSP. Is there any update on that given the compelling nature of the

Speaker 1

Actually, last quarter, I talked about the fact that we were considering engaging a company that we do that we do regularly to evaluate the best use of our funds. And that's all. We had we've had people a number of people contact us, But that's ongoing. That's been going on since we went public. Nice.

There's nothing new and no progress and nothing to comment on, I guess, is the answer.

Speaker 5

Okay. Alright. And then my other question is and this this is pretty far out, but just given the announcement by Uber yesterday about having flying cars in the next five years sort of things, I was kinda curious about whether Autospata was the type of technology that could be applied to that to that type of vehicle.

Speaker 1

Yeah. I understand. I I think we'll we'll see if it's around five years. The lady that

Speaker 3

the

Speaker 1

lady in Texas instead probably doesn't think it's a great idea.

Speaker 3

None of the flying cars. None of that. They're done with driving them. Now they're flying. But I'll tell you

Speaker 1

what we do do, which is very interesting. And and there's an article coming out in Flying magazine in the next month or so in which we let the one of the editors, senior editors, fly the airplane, and we showed him that from rotation, from liftoff of the airplane to flying to a destination, I don't know, a 100 or 200 miles away, and and and going all the way down to a 100 feet over the or 200 feet over the runway. He did it without touching any control on the airplane. Wow. The autothrottle did it all automatically.

The auto the flight management shifts and navigated automatically at a level of precision that I don't think you can do manually and brought the airplane precisely to the edge of the runway 200 feet above the runway. Wow. And we already did that did that. So we beyond that, I'm a pilot. Trust me.

If I'm sitting in the back, I want a pilot to land the airplane. Although, big airplanes land themselves all the time. I tell you what the hardest part is. Putting it on the brakes and steering it on the ground. It's not flying in the air.

That's easy. But once you get it on the ground, putting it on the brakes and and making sure that you go onto the taxiways. Essentially, driving the car, I guess. Go ahead.

Speaker 5

All right. Well, thanks for taking the call. That really helps.

Speaker 3

And appreciate

Speaker 0

we have a question from Charlie Pine of B. A. And Clemons and Company. Please go ahead.

Speaker 6

Hi. Good morning. I have a couple of questions for you folks. First off, can you just give a little more clarification on the process of how it what's transpired over the last, say, six to nine months about the the FTC for the auto throttle for the King Air. I was under the impression that last fall, you had an announcement or a deal.

You were partnering with a company called Blackhawk Holdings to, to do an install and the testing for it. And then we didn't really hear much about that. And then late last year, we were informed that were supposed to have an FTC or the testing was supposed to be completed by January or February this year. And now we're hearing that, you have to go out and buy your own aircraft. So I'd like to get more clarity and around the process that that's been occurring with this and, you know, how much comfort you actually have now in in as to where you are at and that you actually really do feel you're gonna have an STC in a couple months.

Speaker 1

Well, the quick answer is yes. We do. And I'll explain what happened. And that's well, that was what precipitated actually purchasing the aircraft. Everybody that we found as a partner had an airplane but did not wanna commit the airplane up to an uncertain time and take it in in in in certain cases, they were they were modifying an airplane and selling it, and they didn't want to tie up the capital, the cash, on their credit line for an indeterminate amount of time.

We kept running into this, and we kept hoping that we could solve it. And in fact, we couldn't. And it was at that point, we finally determined and I went to the board and said, look. This is a problem. We can't get a commitment.

They're they have a problem tying up or committing their aircraft. So that's when we went ahead and purchased an aircraft. And the the

Speaker 6

How many flight let me let me interject for a second. How many flight hours are required for the testing of this?

Speaker 1

Not a lot not as many flight hours, but you have modification hours and installation into the aircraft. And it's and it's not so much the number of hours, which probably could be done in twenty to thirty hours. That's the that that, if it was a straight continuous time, would be easy. But that's not the that's not the problem. We say, okay.

We want the aircraft. And they say, well, you can have it for ten days. Well, you can't start a program with the FAA and say, oh, well, you only have ten days to approve this, so get going. It's always an open ended process. So there was no way that we could first of all, you have to dramatically modify the airplane, and then we would have to demodify the airplane and give it back to them.

So that would double the amount of time. And for many of these people, they say, well, you know, I'm not sure I want you to modify and then demodify. So it became a constant a recurring problem, and that's why we went ahead and did it. And it's we feel that now we can do this and move along. The airplane will be delivered.

Actually, the the people it's it's right now, with Textron Services in Florida, it's actually the manufacturer. And they have a service center, and they're gonna be doing the modification as well. And they are also very interested in our product.

Speaker 6

Let okay. A quick couple quick follow ons. So the STC that you're that you're going to be applying for with for the auto throttle on this particular King Air, is this the s is this for a stand alone the stand alone drop in auto throttle, or is this the one, like the predecessor that you first got for the Pilatus p t PC 12 where it's the auto throttle and your flight management system. Which one is it?

Speaker 1

It's a stand alone drop in, auto throttle. And and that's the first one we're doing. And, I'll I'll could get the details from Sharon. Sharon, pick this up.

Speaker 3

Sure. Yep. So for for the first STC on the on the King Air, we were doing the stand alone ortho, Jeff. Oh, that's you. Which which goes in with our with our standby instruments.

So, essentially, we replace the standby instruments in the aircraft with our standby instrument, and that provides all the controls for the for the autothrottle. And we've done that because a lot of the more valuable haul aircraft have modern cockpits in them. So this is going to give us the quickest path to revenue is is is to provide this stand alone overpower system. Once we're done with that, we will we will look into getting an older aircraft where we would do the full cockpit replacement for it with our with our display and flood management.

Speaker 6

Okay. Great. Thanks. Now I have one other follow-up. This has to do with your with your MRO channel partners.

You folks talked a lot about over the last year all of these MROs that you've signed agreements with. There was a big press release that you had regarding your, your relationship with Lufthansa Technique. I'm curious as to this point of time now, you've been involved with these MROs, and and you've been more aggressive with them as far as, you know, having relationships now for about a year. Are you beginning to see some revenue lift from these relationships? Or is that still yet to come?

Are we starting to see that in this quarter? Or and and if not, when can we anticipate that we're going to?

Speaker 3

Okay. Now typical and and just to give you some background, when we talk about Air Transport, our typical sales process takes about two years. From when we start talking to an airline until we actually start seeing revenue. It takes about two years. So the MRO relationships that we've had, including Lufthansa Technik, we're seeing a good progress, although has not turned into revenue.

We're hoping over the next few quarters, we'll be able to see because we've done a lot of quotes with them. We've done a lot of joint offerings, which hopefully will turn into orders.

Speaker 6

Okay. That covers it for me then, I guess. Thank you.

Speaker 0

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.