Innovative Aerosystems, Inc. (ISSC) Q2 2016 Earnings Report, Transcript and Summary

Good morning and welcome to the Innovative Solutions & Support Second Quarter Fiscal 2016 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. Geoffrey Hedrick, Chairman and CEO. Mr. Hedrick, you may begin.

Good morning. This is Geoffrey Hedrick. I would like to welcome you this morning to our conference call to discuss second quarter fiscal 2016 results, current business conditions, and our outlook for the remainder of the fiscal year. Joining me today are Shahram Askarpour, our President; and Rell Winand, our CFO. Before I begin, I would like Rell to read our Safe Harbor message. Thanks.

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 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 and other public filings. Now, I’ll turn the call back to Geoff.

Thanks, Rell. I am pleased to report that our every plan has remained on track. Our plan is focused on winning new production orders for our portfolio of existing products, penetrating new geographic markets and internally developing new products that will improve situational awareness and increased operating efficiency at lower cost for comparable technology. Revenues increased in a sequential basis for the second consecutive quarter, rising to $8.7 million for this quarter from $6.6 million. And over 90% of the second quarter revenues were from production contracts as aggressive marketing initiatives we have implemented over the past year continue to uncover new opportunities. Together with new contracts booked in the second quarter, we now have received more than $15 million in new orders over the first half of fiscal 2016. With revenues predominantly driven by production contracts, gross margin exceeded 50% for the second consecutive quarter and while the bottom line was impacted by a significant increase in both legal and internal research and development expenses, we still managed one of our most profitable quarters in several years while generating $900,000 in positive cash flow which added to the balance sheet. We also experienced strong book and ship business this quarter. Primarily demand for our portfolio, 757, 767, where our proven technology has generated repeat business with fleet owners returning to IS&S to retrofit additional aircraft in need of upgrades and improvements. As Shahram will detail, in addition to military, commercial air transport and commercial markets here in the United States, we are continuing to invest in expanding international marketing effort. In these markets we believe our price for performance value proposition is creating additional growth opportunities, specially for our portfolio of existing products. These are opportunities that could lead to new orders which could go into immediate production. The past several years have been challenging. Cancellation of a program that we had invested in and staffed up to produce was cancelled. This required us to reconfigure our business, adjusting staff and prioritizing engineering investments. I am pleased to say that we have recovered and recovered strongly with dramatic results in new products and reapplication of existing products like the Eclipse Flight Deck. We announced an auto throttle system at NBAA for turboprops. This product, I understand, is the first and only in the industry for turboprop application and offers significant safety advantages and performance enhancements as well as reducing pilot workload. Applications of this to multiple platforms, provide a very significant marketing opportunity. Supplemental Type Certifications are expected in December of this year with early delivery anticipated this fiscal year. This turnaround and cash flow coupled with unusual expenses further intensifies our confidence. Going forward it will allow us to resume programs previously suspended during the restructuring of our company. We are off to a good start and I am enthusiastic about the future. Let me turn it over to Rell for a detailed description of the financial performance.

Thank you, Geoff and thank you all for joining us this morning. For the three months ended March 31, 2016, revenues were $8.7 million, a 64% increase from a year ago and also a nice sequential increase from the December quarter. In the second quarter, product sales were $8.5 million or approximately 98% of total quarterly revenue, our highest proportion of quarterly product revenues in more than three years. Approximately $700,000 of second quarter revenues, all of which are product related, are attributable to the recognition of previously deferred revenue. As Geoff noted, it has been our plan to continue to a steady transition to a higher proportion of product revenues. The increase in proportion of product revenues is having a positive impact on margins and gross profits with consolidated margins exceeding 50% for the second consecutive quarter. Margins on both NRE revenue and consolidated revenue in the quarter benefitted from the reversal of $500,000 contract loss accrual which reduced NRE cost that was sold in the quarter. While margin can still vary from quarter-to-quarter as a result of product mix shifts as well as volumes in general, we do currently anticipate overall better margins this year compared to fiscal 2015 based on current backlog and production schedules. Total operating expenses in the second quarter were $3.9 million reflecting an increase in both selling, general and administrative expenses and internally funded research and development cost. Selling, general and administrative expenses were $2.6 million in the first quarter, up from a year ago primarily due to approximately $800,000 increase in legal expenses. It is anticipated that legal expenses will remain at these elevated levels for the next quarter or two, beyond which we are unable to foresee with any certainty what our expenses might be. R&D expense for the second quarter was $1.34 million, up from $932,000 last quarter and more than double then last year roughly $650,000. This increase is due to our increased commitment to internally funded product development. Recapping the unusual items that affected the second quarter. The January 2016 renegotiation of a certain customer agreement added $700,000 to product revenue and reduced cost of goods sold by $500,000. While our ongoing legal matter increased SG&A by $800,000 compared to the prior year period. At the end of the second quarter, we have closed all of the accounting adjustments precipitated by the January 2016 renegotiation of the customer agreement. For the second quarter we reported operating income of approximately $2 million and net income of $1.6 million or $0.09 per share. For the quarter, the tax rate differed from the statutory rate due to a reduction in the deferred tax valuation allowance. At March 31, 2016, the company had $17.2 million of cash on hand, up over $900,000 from the end of fiscal 2015. For the quarter, we generated over $900,000 of cash from operations. The company is currently debt free. We believe the company has significant cash to fund operations as well as fund any and all the potential legal expenses in the foreseeable future. I would like now to turn the call over to Shahram.

Thank you, Rell. Good morning, everyone. Let me provide an update on the progress achieved during the second quarter as well as our current strategy and plan. We believe revenues of $6.6 million in the first quarter and $8.7 million in the second quarter clearly illustrate that we have made tremendous progress implementing the plan we initiated just about a year ago with the widest foundation of customers and markets, so that we have the ability to offset weakness in anyone market with the strength of other markets. Our concerted market efforts penetrate Europe, Asia and Middle East has helped improve regional awareness of IS&S and our products. By leveraging proven track record on the 757, 767 and other sophisticated aircrafts of highly respected customers. We believe these markets are growing increasingly confident that IS&S offers the best price for performance value proposition in the areas where they need to improve the performance, reliability and safety of the fleet. Over time, we are optimistic that these markets will become a meaningful part of our future growth strategy. The wider foundation also means application of our advanced technology to more platforms. For example, the recent conversion of a flight deck developed for an OEM customer to a more generic product will significantly growth the retrofit application in multitude of platforms, represents our latest innovation, the future generation flight deck featuring our revolutionary patent pending auto throttle system for turboprop aircraft. While this has increased our internal research and development investment, over the long-term this is consistent with our goal to emphasize production contracts as opposed to less profitable customer funded engineering development program. This future generation flight deck provides an economical way to extend business and general aviation aircrafts' life, increase its residual value and bring efficiency and safety benefits to everyday operations. Our offering provides an advance cockpit with RMP and LTD capable flight management system, auto throttle, enhanced and synthetic vision systems, electronic flight [pad], stand-by display, integrated [landing] [ph] instrument and many many other important features. We believe this is a strong market opportunity for this product in the business aviation sector in compliance with next gen requirements. We already have taken this cockpit and applied it to the PC-12 aircraft featuring our patent pending auto throttle system. The prototype aircraft was first shown at NBAA late last year and received tremendous reviews. They have been able to leverage our existing product development efforts, expanded for the E550 cockpit and modified for a totally new market segment that we believe holds the promise of a significant number of retrofit applications. In and of itself, this is an important new product but it also represents an important advance of our strategy to include more content in our product offering and solution. They have also been increasing unique and exciting features in our flight management system utilized in the air transport and military markets. Coupled with our primary display system, product and features like ISU, LPV and IGNS are gaining more visibility by our customers. We are seeing increased activity in the marketplace for these products and continue to expand their applicability to wider platforms. Providing a more comprehensive suite that tightly integrates a number of independent functionalities which are primarily Innovative Solutions and Support products and augmented by a few third party radios and radars, increased the value of our offerings and more closely ties us with the customer enabling us to become more essential to their overall aircraft upgrade plans and strategy. For the first half of the fiscal 2016, orders totaled over $15 million. As can be seen in the first and second quarter bookings, new contract signings can be uneven and the timing of bookings is not generally predictable in the short-term. [indiscernible] to just that contract negotiations are usually more successful when they are not rushed to meet artificial deadline. So we live with the unevenness. Our plan is to remain focused on the strategies and tactics that have enabled us to deliver the results we have demonstrated thus far. This includes keeping close watch on costs. We are continuing to develop exciting new products in an effort to grow the business. While successful with our existing products in the second quarter, we need to maintain this momentum. The investment is made, the products are there, so we need to continue to aggressively market and generate a return on our investment. In particular, we are encouraged by the growing interest from 737 owners for our flight management system and flat panel displays. This is a large market internationally and our offering is rich in functionality, much needed by the operators to comply with regulations as well as improved safety, reliability and performance of the aircraft. I would now like to turn the call back to Geoff.

Thanks, Shahram. We are going to take questions in a couple of minutes. This year is off to the best start since 2014 of course. Our goal is to sustain the momentum as you have heard today. We have many initiatives underway to achieve the goal. Once again, we are moving forward from a position of strength with a balance sheet that supports our plan. In our view, as margins indicate, operations are efficient and capable of supporting the planned growth and producing attractive returns. As always, our goal is to grow profitably the business and generate cash, a solid strategy that has enabled us to build a brand that we believe has been recognized around the world for over 20 years. We thank you for your continued interest and support. Operator, we are now ready to take questions?

[Operator Instructions] The first question comes today from David Campbell with Thompson Davis & Company. Please go ahead.

Rell, you were talking about on renegotiation of a contract in January that I couldn’t quite understand exactly what you said. Was that -- is that added revenues and reduced expenses?

Yes. That happened in January. So the pieces of that are in the September for the K. We had taken a reserve on the unbilled of $1.3 million and then this is the other side of it because we had deferred revenue and a cost accrual on the books, on the balance sheet and it was relieved within renegotiation. Which is in January, which is Q2, so that’s why it comes back in in this quarter.

And what did it add to revenues?

It added a little over $700,000 to revenue.

The revenues. And impact on expenses?

It reduced cost to sales by $500,000. It's 1.2 all together.

Okay. So you could say $1.2 million of the quarter's profits came from this renegotiation?

Yes.

Okay. And Geoff and Shahram, ABX, which you have had a long, long history of contract and revenues from ABX here. As you know, they have announced flight operations for 20 767s for Amazon. Is any of that business going to come to you or has it already started.

So some of the aircrafts that they are purchasing for Amazon already have our display system installed in them. The ones that don’t, we believe we will be providing equipment for.

But none so far?

We have not delivered anything for that platform yet. But we provided them with quotes and they will be installing them.

How many of those 767s have the equipment already?

I don’t believe they bought them all, so really no.

You are not sure how many?

No, we are not.

All right. Are you delivering any product to ABX or for other because if they are taking on other aircraft as well as you know?

We continue supplying them. Every year we supply a number of [chipsets] [ph] to them. Not necessarily every quarter but when they have new demands, they buy our equipment.

Right, okay. And I would just like to go off quickly over the status of various contracts. For example, the American and FedEx contracts. Are they now complete or they are continuing to receive equipment.

They continue to receive equipment.

Okay. And what about, and a question for Department of defense. You have various programs with them including the C-130. Is that correct?

So right now we don’t have any programs with the U.S. Department of Defense C130. We have international C-130 business that we continue providing equipment for.

Okay. And the Pilatus business, are they taking on equipment now?

The latter, on the Pc-24?

Yes.

We have not delivered products and shipments but we do have some production shipments in this fiscal year for that aircraft. They are still on target on delivering aircrafts to their customers early next year.

We have delivered several chipsets that are in flight test. I think three to five. And chipsets, that’s 20 to 30 units. And they have been flying, we are happy to say, for well over a year now with no failures from any of the units delivered.

Great. Great. And finally, do you have any new business with European airlines?

We continue to deliver product to those. We continue engaging more -- next week I am travelling there again. And we have got several orders. We are talking to some opportunities which I am not prepared to talk about now. But we are talking to some of the very prestigious international companies that we have trades with, that we have [indiscernible].

And that would be for your flight management systems?

Everything. Display systems and flight management systems. The IGNS product, the standby. So those are the products that get...

Our products tend to be directed and oriented around next gen requirements. So that includes the ultra-high precision navigational features that we provide in a number of our systems. From flight management systems to the navigation, the integrated navigation system and communication and display systems. So as an example that flight deck for the PC-12 that we talked about, is a full next gen cockpit with ADS-B in and out and RMP performance and all the features for the next generation. Actually as far out as 2025. So that we have an answer to the full cockpit now for next gen.

In the United States the airlines seem to be paying no attention to the requirements.

They didn’t pay any attention to RVSM either but they are all using it.

We are seeing some activities even in the U.S. for ADS-B out and I am not mentioning the customer but we are getting calls and request for quotes.

And you know there is no mix that’s something mandatory yet and airlines aren't -- and air carriers aren't foolish. They don’t spend money they don’t have to. So they are going to wait until they believe that the FAA is firm on their date and in the past there has been some variables. But just like RVSM was implemented on schedule, we expect next gen to be implemented on schedule because the rest of the world is implementing it.

The rest of the world seems to be implementing it before the U.S.?

Well, in part because the U.S. isn't as antiquated as everybody talks about it. It has still probably the most advanced aircraft control system in the world. So our system is old but it’s incredibly extensive and comprehensive. You just fly over the board either north and south and all the airports and air traffic control disappears. We spent a lot of money on it over the years.

Right. Now what about the rest of the year. You said you might have some [indiscernible] about the rest of the year. I understand there is a lot of uncertainty with new business and potential new business. But do you have any visibility to revenues and profits for the rest of the year.

I will tell you what we are budgeting and planning and that is to stay at approximately at the rate we are at now. $30 million plus in [indiscernible] and we believe we can do that. So that’s what we are planning for running at and we think we will do that profitably. Very profitably. As you know I like making profit. Somebody told me that’s a good thing.

Geoff, you have always worked on making money. Some of the years it works, some of the years it doesn’t work.

David, we are pleased, I think our business is back on track. Shahram's has got great leadership and we are moving along well and we have got some exciting new products that I think will support growth which is the important issue. So we are very -- I am very pleased and especially the flight management system is we are adding enhancements and features to it that will increase its acceptance by the industry. So we see very positive results.

[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over to Geoffrey Hedrick for any closing remarks.

Thank you for attending the conference today. We are obviously guardedly optimistic, I think is probably correct, but absolutely enthusiastic. And the whole team is working efficiently and shares that enthusiasm. So thank you again for attending the conference call.

Thank you, sir. The conference has now concluded. Thank you for attending. You may now disconnect. Take care.