Innovative Aerosystems, Inc. (ISSC) Q3 2016 Earnings Report, Transcript and Summary

Good morning. And welcome to the Innovative Solutions & Support Third Quarter Fiscal 2016 Earnings Conference Call. All participants will be in listen-only mode. After today's presentation by management, there will be an opportunity to ask questions. [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 Geoff Hedrick. I would like to welcome you this morning to our conference call to discuss the third 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. 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 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. This third quarter shows promise for the future especially in that the growth and cash generation were very positive. And importantly have rapped major problems in flight management and aircraft system management computers which have consumed majority of our new product development efforts over the last several years. These efforts however have yielded two exceptional products that are flying now and performing very, very well. Both of these products' live will serve as see toward and expanded growth and new market opportunities. The transformation of the air traffic control system so called NextGen provides the industry another mandated opportunity. The anticipated changes in the air traffic control and air traffic system are thought to be long overdue by many. But their implementation should be transformative both from safety and performance standpoint. We've focused our energies towards satisfying this requirements and then new plan is flight deck provides 2025 NextGen compliance including ADSP in and out as well as full GPS augmented navigation and required navigation performance. In the PC-12 flight deck, it incorporates many important features that are not part of the eclipse requirements and significantly enhanced user interface and performance especially in the PC-12. A secured iPad and keyboard provides unparallel operational flexibility, enabling the flight crew to control all functions of the cockpit and full authority and then a full authority autopilot not only facilitates RNP navigation to provide significant improvement in safety and ease of use. It is risky development programs which we've invested in substantial amount of money all internally funded I might add. That gives a tremendous opportunity for the future. Now let me turn this over to Rell for a detailed description of the financial performance and I'll summarize at the end of the conference.

Thank you, Geoff. And thank you all for joining us this morning. For the three months ended June 30, 2016, revenues were $6.5million, up from $4.9 million in the third quarter of fiscal 2015. And comparing sequential revenue trends note that second quarter fiscal 2016 revenue benefit from accounting adjustment due to some changes in the contractual arrangement. In the third quarter, product sales were $6.4 million representing approximately 98% of total revenue similar to last quarter. We are continuing to generate revenues predominately from production contracts which were inherently more profitable. The increase in proportion of product revenues continues to drive the significant improvement in both gross margin and profits. For the third quarter, gross margins were 60%. This is consistent with the gross margin in the second quarter of 2016 exclusive the reversal of $1.2 million of deferred revenue and a contract loss accrual into 2016 fiscal second quarter. Together with higher revenues compared to a year ago, this growth will double in gross profit in the third quarter fiscal 2016. As we've reminded you in the past, margins can vary from quarter-to-quarter result of product mix shift as well as volumes in general. Nevertheless based on our results through the first three quarters of this year and the ongoing revenue that is heavily weighted towards production contracts, we anticipate that both fiscal 2016 gross margin and profits will be materially improved. Total operating expenses in the third quarter were $3.7 million, up from a year ago but down sequentially from $3.9 million in the previous quarter. Selling, general and administrative expenses were from a year ago primarily due to increased legal expense. We continue to believe legal expenses will remain at elevated levels for the next quarter two beyond which we are unable to perceive with any certainty what our expenses might be. R&D expenses were also up compared to a year ago and just marginally higher than in second quarter of fiscal 2016. This reflects our strategy to shift our emphasis from customer funded NRE to more internally funded production development, which enables us to develop product for the much greater market opportunity. For the third quarter of fiscal 2016, we reported operating income of approximately $232,000 and net income of $227,000 million or $0.01 per share. Because we expect it be profitable this year, our tax rate in the quarter defer from the statutory rate because we anticipated profit for fiscal 2016, it triggers the reduction in deferred tax valuation allowance. At June 30, 2016, the company had $17.5 million of cash on hand, up about $300,000 sequentially from the end of last quarter. For the quarter, we generated approximately $700,000 of cash from operations. Approximately $170,000 was used to repurchase 57,000 shares of our common stock at an average cost of $2.97 in the third quarter. The company is currently debt free. We believe the company has significant cash to fund operations as well as fund potential legal expenses in foreseeable future. I'd 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 third quarter as well as our current strategy and plan. As Geoff mentioned, revenues are up significantly over the first three quarters of this year as we've made tremendous progress implementing the strategy we initiated just about a year ago. From a high degree of reliance on large narrowly focused engineering contracts, we are now much more diversified product, customer and market and geographical perspective. As Rell related, 98% of our revenue is much more profitable production revenues. One of the more rewarding yet less visible developments over the past year has been the growing awareness throughout a markets of IS&S' proven track record on big fleet such as the 737, 757, 767 and other sophisticated aircrafts. This has started to lead an increased in repeat business. Once again we had strong booking ship order from existing customers in the third quarter. For instance, one of our long term customer of 767 flight deck is expanding their operations accommodates Amazon fleet. While some of the aircraft they are purchasing already have our flight deck, we are providing equipment for those that do not. That would most likely continue to take place under a booking ship agreement. This is the sort of activity we are starting to see on a more regular basis. Customers have had great experience with the performance of the IS&S products they have already installed. And now are coming back to us in a non bid situation to purchase more products on a simple booking ship basis. These customers become preference customers. The prestigious owners and operators joining this growing list give us an impressive portfolio of relationships that go a long way to improving our visibility and instilling confidence throughout our various markets. The growth of our booking ship business is encouraging but new orders are still a strategic imperative. We've been investing a lot of effort developing international opportunities and continue to deliver products in those markets. For instance, we continue providing equipment in the international C-130 market. We believe our flight for performance value proposition has brought appeal internationally. Of late, we've been talking with a lot of potential customers about our 737 flight management and display system. Our proven system extends the life, reduces the operating costs and improves the safety of a fleet they simply cannot afford to replace. We continue to add new enhancement and features to our flight deck offerings including new desired features for our flight management system. These new features are clearly appealing to international markets but also have sizeable domestic sales potentials as well. Although, our intensified international marketing efforts are relatively recent, we are creating interesting prospect in very prestigious companies for which we have high hopes. New products are also an important part of our growth strategy. Our product strategy is directed and oriented around NextGen requirements. This includes ultra high precision navigational capabilities that are included in a number of our systems as well as functionalities that help bring aircraft platforms in line with communication mandate such as ADSP. As an example the flight deck redeveloped for the latest PC-12 includes a full NextGen compliance cockpit that is capable of complying with all known upcoming mandates over the next 10 years. The system includes NextGen features such as ADSP in, ADSP out, LPV and RMP capabilities and many other desirable features such as synthetic and enhanced vision. As well as our unique auto throttle product. The utility management system developed for PC-24 program has entered the production phase. And although we carry only a small portion of the total opportunity in our backlog, we are confident that this product line will generate significant and steady revenues for many years to come over a number platform. On the PC-24 program alone we have already delivered several ship sets for flight testing and have received great positive feedback from the customers on the operation and reliability of their equipment they have been flying for well over a year. While we have not delivered product shipments, we do expect the small volume of production shipments in this fiscal year as they are on target to start delivering aircrafts to their customers next year. As we continue to develop new products and technologies, one of our strategies has been to move into adjacent markets. This provides us with the opportunity to bundle a number of what has previously been independent functionality. We can thus offer a more comprehensive solution that is already tightly integrated whether it be in other IS&S products or with third party equipment such as radios and radars. They simplify the purchasing process of the customers while growing the size of our individual orders. Other product strategies are focused on adopting our existing products from a single application to more generic applications such that with minimum engineering they can be applied to an ever increasing number of aircraft. As I highlighted last quarter, we have already converted the flight deck developed for one specific application for one specific customer into a more generic product that can be easily retrofitted to multitude of platforms. Finally and perhaps on recognition of the impeding implementation of NextGen requirements, we are starting to see increased activity in form of request for quote for ADSP out in the United States for a number or air transport, military and business aviation platforms. We have become more selective and tampered in our appetite for large engineering development programs which have the potential to monopolize much value and technical resources. Orders for the first nine months of the fiscal 2016 totaled over $20.5 million, a booking on even and generally not unpredictable in the short term. The bookings through the first three quarters of this year are up 50% from the same period of a year ago. We remain disciplined and selective in the programs we pursue, preferring aggressively to market our existing products rightly engineered to be adapted to specific contract of programs. Over the long term we believe this strategy can yield greater margins with lower risks. I'd now like to turn the call back to Geoff.

Thank you, Shahram. As I stated earlier, we are very pleased with the company's quarterly results as it is harbinger of expanded revenues and profitability. We have generated cash and profit at a time we are also funding lawsuits to enforce contractual obligations. The new product development is in high gear and we expect to provide new features for both our next generation solutions and our new product carriers. The patent pending auto-throttle will facilitate required time for arrival and required navigational performance approaches in the next generation environment. We thank you for joining us today. We will answer any questions.

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

Good morning, Geoff and Rell and Shahram. Thank you for having a good quarter and working so hard on new products. I'd like could someone email me a copy of your press release so I can print it. My research assistant is gone on vacation and I need to print of the press release please.

I'll take care that for you. This is Rell, I'll do that.

Thank you, Rell. Thank you. Is the contract dispute with the Delta, can you give us any details on the status of that in the court?

Well, I can't actually. But I can -- I only comment is that we are -- we intend to enforce the contract that we had with them. And that as simple as that and our process to date has --we've successfully had several decisions made in our favor but not against us. So we are not -- we haven't even selected a jury, we haven't gone anywhere on it yet so. That's the only comment I want to make. I want -- it is sensitive area. So in the next we expect a lot of activity in the next four month or so.

Okay. Can you give us any estimate for revenues or profit in the fiscal year?

This coming fiscal year?

2016 year, yes, another word the fourth quarter.

It will be better than last year. Sure, couples of things are hanging so we are not sure but significant but we expect to be better than last year in every case both in revenue and profit. Despite the fact that we've had very significant legal fees with the expense all of them absorb them so we probably have substantially more kind of double or triple the profitability. We went with this enforcement with our eyes open and we knew that we were prepared to fund it and see through a decision by the jury.

Right. Is the 60% gross margin sustainable?

Absolutely, probably it will grow. Historically we've had better than 50% so - product -- again our gross margins are result of pretty extensive engineering sometimes from my standpoint overly extensive. But it does pay off, the manufacturing costs for our products that remain very competitive in the market place I might add from our customers cost are very low and the model that we started within the company which was to keep the labor content down also include response to make more rapidly including doing things like doubling volume quarter-over-quarter. That ability is based on our ability to manufacture very, very efficiently with a very productive workforce. And that and trying to lead to low cost, lost cost lead to high margins. So it is a good formula, what we have done in the past has been that we've taken the potential margins and consumed in with developments and over runs and things like that. And hopefully we are out that mode. Shahram is grew even -- grew intelligent in managing blocking and tackling as well as the forward thinking so that's very good. Sometimes when things move quickly we lose sight of [mansion]. I think we've got it very much under control, I am very optimistic.

Is the NextGen capability included in the 767 flight deck work you are doing?

Say it again I am sorry

Is the NextGen capability included in the 767 that you are delivering?

Well, it's interesting. For 767, NextGen require there is a whole bunch of phases of NextGen. But one of the things they don't provide in the 767 is that LPV approaches. LPV is kind of an interesting thing, it essentially enables a huge number of 3 to 4 -- huge number of airfields 3 to 4 not capable of instrument approaches, to do instrument approaches, and it's a significant capability. As an example, the 777 in San Francisco it landed short on the runway, had it had an LPV approach when the instrument lending system of the airport was out, they could I am sure avoided that crash. That's just one example. So we can provide that and if I understand the existing solution provided by manufacture does not include LPV approaches.

Only on the 787 right now. No one provides LPV [multiple speakers]

But not on 777 and the interesting things that 36 -- over 3,600 airports now in United States they have approaches for LPV and the FAS being cleared about they are not going to support new ILS approaches and the increasing the LPV approaches in a whole North America including Canada and Mexico.

We are talking to people now who want our flight management system because of that. So it will provide opportunities with someone ripped out an advanced flight deck to put in LPV, our new flight deck that's not matured market. Because people don't want to waste the money. But it's still a major opportunity and we are getting -- new opportunities everyday, that's terrific.

Is the SA authorization includes any deadline for NextGen capability?

There is assuming -- honestly I don't remember most of the top of my head but there is series of -- over the next to several years that our stage the next one is ADSP out that's the latest. ADSP out is just simply that every aircraft will start reporting, it is out two -- speed and where it's going and what it's doing to everybody else in the air and the thought being as everybody knows what the other guy is doing it is going to be much safer. And that's very much true but the next generation is beyond that, I have separate dates and up to an including as far as 2025.

Okay. Thank you very much.

But it is important to know that it's more having been simply a mandate. A mandate forces people who don't want to change anything at all. But most responsible operators see the benefits of the proposed mandate have started implementing them earlier. As an example, a lot of the aircraft install reduced vertical separation minimal equipment two years; three years before the mandate was came because they recognize it had value. So I think this is very positive. Go ahead.

That's all. I just wanted to thank you very much and look forward to talking you soon.

Yes. I'll. Look talking to you. Thank you for calling in.

And I'll send that David, I'll send you that release.

Okay. Next call?

[Operator Instructions] It appears we have no more questions at this time.

Thank you very much. Thanks for joining us today. Good bye.

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