Good day, everyone, and welcome to the Innovative Solutions & Support Second Quarter 2017 Earnings Conference Call. [Operator Instructions] And please do note that this event is being recorded. I would now like to turn the conference over to Mr. Geoffrey Hedrick, Chairman and CEO, please go ahead.

Good morning, this is Geoff Hedrick. I'd like to welcome you this morning to our conference call to discuss second quarter fiscal 2017 results, current business conditions and outlook for the upcoming year. Joining me today are Shahram Askarpour, our President; and Rell Winand, our CFO. Before I begin, I'd like Rell to read the Safe Harbor statement. Rell?

Thank you, Geoff, 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-K, which is on file with the SEC, and other public filings. Now I'll turn the call back to Geoff,

Thank you. We continue to make progress in the second quarter. Revenues were primarily derived from product sales on which we continue to generate attractive margins. Consolidated results reflect a $7.75 million we received in the settlement with Delta, and for which we have previously booked significant reserves at the inception of the legal action. Most importantly, we've added to our already strong financial position so that we continue to have resources to invest in new product development and to implement our growth plan. First, we were awarded the STC of our PC-12 next generation flight deck which is fully compatible with our autothrottle impending certification. This autothrottle is the first and only autothrottle to be certified by the FAA for non-FADEC turboprops. The autothrottle has a pending STC and patents pending. The system provides engine monitoring protection reduces workload and enhances safety. In the second quarter, we booked an order for the PC-12 NextGen flight deck, and I think it just got installed. We anticipate broad application into the very large turboprop market with additional sales order in the current quarter. Approval is imminent because of its first-of-a-kind -- because it is the first of its kind to be certified by the FAA, we are -- they have been especially deliberate in their approval process. We signed an agreement with Lufthansa Technik, who will become a global MRO for IS&S. Lufthansa is the world's largest MRO and, frequently, the MRO of choice of major fleet conversions. Under our agreement, when the operator has a fleet for conversion, Lufthansa can now offer our cockpit upgrade. Lufthansa has set our cockpit upgrades at value with its ability to extend the operating life of the aircraft on which it's installed. Because of its very short payback period, improved safety and fuel savings…

Thank you, Geoff, and thank you all for joining us this morning. For the 3 months ended March 31, 2017, net sales were $4.7 million compared to second quarter fiscal 2016 net sales of $8.7 million. Consistent with recent experience, over 95% of quarterly revenue was production-oriented. For the second quarter fiscal 2017, gross margins were over 50%. Despite lower product revenue, we managed to maintain gross margins in line with recent quarters. However, 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 a credit of $634,000. This is due to the Delta settlement which resulted in a reversal of the reserve of the Delta unbilled receivable in the amount of $3.6 million. Reserve was initially a charge of selling, general and administrative expenses in fiscal 2014. The remaining $4.1 billion of the Delta settlement was recorded as other income. As Geoff mentioned, we maintain our strong commitment to research and development investment which was $1.1 million this quarter, down slightly from $1.3 million in the year-ago quarter as we continue to focus on internally funding our new product initiatives. For the second quarter of fiscal 2017, we reported net income of $5.9 million or $0.35 per fully diluted share. In the year-ago quarter, we reported net income of $1.6 million or $0.09 per fully diluted share. In the year-ago quarter, the company recognized a $1.2 million benefit when it reversed deferred revenue and a contract loss accrual as a result of a contract renegotiation. For the quarter, the tax rate differed from the statutory rate due to a $1.9 million reduction in the deferred tax valuation allowance, primarily the result of a bad debt reserve now being deductible and the utilization of R&D tax credits. March 31, 2017, the company remains in strong financial position with $23.7 million of cash on hand and no debt. Cash flow from operations was $5.6 million in the 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 Shahram.

Thank you, Rell, good morning, everyone. Let me provide a quick update on the progress achieved during the quarter and, more particularly, the significance of our recent major announcement. The STC for our new PC-12 NextGen cockpit was recently awarded. This is an integral part of our overall autothrottle strategy. As previously mentioned, we have been lining up initial orders for our autothrottle, with a large customer having installed our equipment and revenue being generated from this product in the second quarter. While the FAA seems satisfied with our autothrottle , because of it being the first non-FADEC turboprop autothrottle as well as the first Part 23 turboprop autothrottle, it requires new rule-making, which was the cause of delay for the autothrottle STC. Fortunately, FAA issuance of the companion flight [ ASTC ] has us confident the autothrottle STC is not far behind. We also previously mentioned that we intend to market this product not only through our direct sales organization but also through partner MROs. In this context, MROs provide 2 services. First, it provides a cost-effective, efficient distribution network. Second, it provides installation and first line of customer support. Over the past year, we have emphasized the MRO channel, and now we're beginning to actually see sales being generated. The PC-12 is an aircraft that is frequently individually owned, and many of these owners rely on their local MROs for their routine maintenance and repairs. Consequently, it makes sense to let the MRO channels pursue sales to the individual PC-12 owners and operators while we focus our direct sales organization on opportunities suggested by larger fleet operators. We are in discussion with several of these fleet operators. Our agreement with Lufthansa Technik takes our MRO strategy to another level. With some 35 subsidiaries and affiliates, the Lufthansa Technik…

Thank you, Shahram. We remain confident in the future. We have a discipline -- we have been disciplined in adhering to our plans and strategy, confident that owners and operators looking to improve the safety, efficiency and operation of their aircraft, whether mandated or otherwise, will increasingly choose innovative solutions and support systems growing portfolio of products because of our growing reputation for the industry's leading price for performance proposition. I appreciate your time and interest today, and I'm happy to answer questions. Operator, please?

[Operator Instructions] And our first question today will be David Campbell with Thompson, Davis & Company.

Good to hear you so optimistic about the future. The quarter, of course, decreased in revenues from the previous quarter, and I wondered if you're confident of reaching more sales in the coming quarters because if you don't use that $5 million of revenue each quarter, you'd be losing money, assuming you're SG&A stayed at where it is. So you must have some plans to exceed growth of that $5 million threshold.

Absolutely. A couple of things. First of all, the certification of the autothrottle system where we believe we would've had a significant number of sales already was delayed because it's a very, very new innovative product that the FAA has never certified before. So they, among other things, went out to the industry and look for comments. And so the approval process was longer than normal but appropriate for the product, obviously. And so that's delayed us somewhat, and we expect the STC within the next week or 2. We believe that's going to be a source of significant income as well as some of the other programs that we talked. So we're looking at an increase in revenue going forward, and we expect to make reasonable profit. Remember, we're investing 26% of our revenue in R&D. We only reduced the R&D by a small amount despite the revenue reduction. So that's our recovery path. We're optimistic that it'll work well and the patentability and the performance of autothrottle , which has a broad application to 10,000 kind of aircraft, is -- we think it's going to be a great opportunity.

David, the other part, that is G&A you mentioned, we expect that to decrease. In this quarter, there were some residual legal from settlement, so we anticipate that will go down.

But the key is to get sales up, and that's what -- and we want to return sales to the $8 million a quarter kind of sale level as quickly as possible, and then to continue that growth. So that's in the plan, and we think we have a path to do that.

And Geoff, you mentioned earlier that the STC from the PC-12 had been approved and was installed, the actual NextGen flight deck had been installed. But I guess that was without the autothrottle?

Yes. But the autothrottle is ready to go as soon as we get the STC within I mean -- literally, it will take a couple of days to turn it on in the airplanes, so that's not a problem. [indiscernible] operating in our airplane it works fine, works wonderfully actually. Everybody has been -- we've gotten a number ADS-B writeups on the performance and the airplane that's been very complimentary.

Right. And are you involved with any of the auto cargo conversions out there for -- by Atlas and ABX Air to -- where they're turning those aircraft over into cargo aircraft for Amazon? Is that business any of yours?

[indiscernible] We're doing the Amazon airplane, and we see obviously, the Atlas, as a target as well. But Amazon is using our equipment on their airplanes.

[indiscernible] is a customer box, and those airplanes do have a cockpit in them.

ABX Air has been a customer for many years, and I just thought that you've probably gotten some business from them for these this cargo conversions.

Yes, we have.

And aside from that you're doing aircraft for Amazon that they're acquiring separately?

We're in discussions with all of those operators.

Right. In the status of other contracts, your early comments on, let's say, Boeing, American Airlines, Federal Express and Eclipse. What's the status of all those contracts?

Well, American Airlines have done all of their conversions to our cockpit that we're aware of. We continue supporting them. And as we're developing the new features for that 757/767 aircraft, we are also making -- offering those to American Airlines. We believe there is potential for more sales there as the center displays in those aircraft are becoming an attractive proposition for replacement. Eclipse, we continue supporting them. They buy equipment from us. Obviously, the sales are not what they used to be, historically, because they've slowed down in the number of retrofit that they have been doing and the, overall production, is kind of the whole plan now. Similar to American, they've done all of their outfits for the 757. They are asking us for some new features and some new products that we're working with them to provide.

Does American and FedEx currently providing any revenues?

Very little based on very little maintenance repairs. [indiscernible] company all of their [indiscernible] .

And Boeing tanker, of course, that continues to roll along, I guess. And so your revenues from them are, not every quarter, but they're still in the future right?.

We provide equipment to them on a quarterly basis. [indiscernible] .

With the contracts with Lufthansa and their MROs, will that be sort of a backlog business or will that just be like the air data equipment sales, the military? Will that just be recorded as business when you get it?

Depending on receipt times, it could pull it to backlog or it could just be booked and shipped in the same quarter.

Okay. But it's really you haven't got anything on the backlog as of now?

No, nothing. We don't have the current business from Lufthansa yet, which is a brand-new agreement.

Right. And then Geoff, do you have any ideas on resuming the stock buybacks using almost, what do you have, $20 million in cash now?

We're looking at it for sure. We are -- the board is actively reviewing what to do with the cash and how to best allocate it, so that's one of the options for sure.

Are the any these programs you're working on require a great upfront extension? Or just -- it's all in the R&D I guess, right?

Well, there's a number of reasons. As I said before, we want to keep a reasonable cash balance, so when we engage in major programs, there's a confidence -- our customer has a confidence that we had the resource in place to support the program. We're bidding on a $165 million program right now. It's a long-term program. And the customer has to be comforted that we have the resources immediately available to support that program. And that's one of the reasons we keep maybe a larger than absolutely necessary balance, cash balance. We've always done that. But when it gets too big, we do -- we find use for it. And in the past, we've done distributions, and that's fine. But -- and that's seriously considered, but right now we're taking a look at what programs we're bidding and making sure that our financial conditions look excellent for our customer.

One last question, you mentioned a new altimeter development for the aircraft, is that a commercial product or...

It's an 80-year-old product.

Well, not quite, but almost. No, it's a product that's been around for quite a while. It's evolved, and it was one of our innovative products. We've made thousands of them. This is just another opportunity that we always expected, but we actually expected it 10 years ago, so it's all coming to fruition now. And the good news is the product works extremely well, we know how to build it and we know how to make a profit when we build it. So those are all good things. New product are terrific, but they always come at a price. This one happens to be already in the pot, as they say.

Who is doing the installations, is it commercial airlines or...

No. It's a military application for F16s in Europe.

And our next question is going to be [ Vincent Manzo ], he's a private investor.

My first question was already answered about the $23.7 million, what the plans were. Just maybe you can give me a little clarification on one thing. As of 3/31, you announced you had $23,700 in cash which increased $5.5 million, but I think you had gotten $7.5 million of this settlement, so if you can clarify the $2 million difference?

Well, we had to pay taxes and we had to -- normal operations of paying payables and things like that. So we generated $5.5 million. I guess, you're looking for a $7.75 million, but continuing operations you had to fund those operations.

We don't say the [indiscernible]

Yes, we pay -- we had to make a tax payment.

Yes, on the revenue.

And our next question today is going to be [ George Moreno from Pareto Ventures ].

I'm new to the company, so I don't have all the tribal knowledge, but what kind of impact to ISS is the ADS-B NextGen mandate? What sort of effect or opportunity does that provide for ISS over the next few years?

The next couple of years not as much as it will be when it's fully implemented in about 5 years to 7 years. It continues to be an opportunity for us, but it's not going to be this huge, this immediate spurt. Certainly, in the next 3 years, it won't be. But we'll see an increasing amount of business as ADS-B gets broadly applied and implemented. Unfortunately, or fortunately, they're delaying the implementation date by a couple of years already. So that's sadly be expected.

But this will not look like the vertical separator?

Well, we don't see it as RVSM. We actually see some of our other product with that kind of -- with similar opportunities without the mandate. Parts of the ADS-B or, more accurately, the next generation air traffic control system, will require times of arrival. And our autothrottle and flight management systems make that feasible and implementable. So we see an attractive market there. We're looking at markets that are quite large, and I don't know that they needed a mandate to be implemented.

On the last quarterly call, in the Q&A, you mentioned about -- you talked about cargo conversions, and you sort of mentioned the opportunity was in hundreds of million dollars. I'm assuming we're talking about industry-wide and not that kind of opportunity for ISS? Is that..

Industry-wide. And one of the leaders in those conversions is Lufthansa Technik. They come in, and they will bring up a passenger airplane in and it'll get converted to a cargo aircraft. And during that process, we hope that they'll choose our flight deck, and Lufthansa can actually install during the conversion process.

I see your agreement with Lufthansa has a large footprint of their operations of 35 locations.

They have an outstanding reputation, and it's very large and very good by the way.

They're a large MRO. What sort of hopes and expectations do you have for that relationship in terms of volumes over the next few years?

I don't know that we've quantified it in those terms yet. It’s new, and we're allowing it to get settled in and trying to get them to take a look at -- now that we have them all signed up, what they believe and get that feedback. So we'll be developing that plan over the next 3 to 6 months.

And it seems like the company is focused more on product more so than service side. Where are we in in this transition? And what's the endpoint goal of that transition? Or am I characterizing it correctly even?

I think we've always been very product-oriented, and we do very little services. If anything, we look at a possibility of providing some services but, in fact, we're really not a service -- really don't provide any services at all other than installation as required. But we're a product-oriented, our R&D is all oriented towards the products.

When the autothrottle gets approved, it sounds like you're -- is this -- is that -- would you characterize that as our most exciting opportunity in the near term here?

It certainly is an exciting opportunity. After it gets certified, there's already anticipated other applications that will require some additional certifications, but additional certification is going to be the main one because, as I said, this has never been done before, surprisingly enough. And as people see it, they realize that it's a very valuable addition. So it's one of our very good products. We think our utility management system is a wave of the future as well. It's being put on probably one of the most advanced bizjets now and it really is performing extremely well.

If you look out and had to rank which parts of your business you see the most growth in, how would you rank the top 3 parts of your business?

Well, I think, I don't know that -- I don't know that there is, I guess -- we believe in the 3 -- what we consider the 3 segments of the business which are commercial air transport and cargo, general aviation and regional and the third being military. We see opportunities in all 3 of those as almost uniformly growth areas. It's a timing issue that makes one bigger than the other. But historically, we've maintained almost a 1/3, 1/3, 1/3 over the years, and it has served us well. So we expect that to be a similar situation. We're looking at an application now that was originally a general aviation application that now could be applied in the military environment. So they move from one to another and sometimes they're countercyclical.

And our next question is going to be [ Erwin Goldman ], a private investor.

I've met with you on a couple of your annual meetings a few years ago, and I've had a continuing interest in your company for many years. You're my major investment, and I'm 94 years old. Okay. Anyhow, I would like to focus in on NextGen and on your flight deck, and I would like to know about competition and how they are on certifications and what kind of patent protection you have afforded yourself. Can you answer those questions for me?

Specifically, on the autothrottle , we have patents pending. They've been searched. We got a clean bill of health by the patent office and we're in a process of getting that issued. So it gives us a fairly strong case for patent protection. NextGen, as a group, may or may not have patentable features other than as an example, autothrottle . autothrottle augments -- significantly augments NextGen operations like required navigational performance. But we have good protection of our intellectual property, and we have successfully defended it in the past against -- so we're reasonably -- where not overly confident I hope. I think we're doing the right thing, put it that way.

You want to focus in on the competition and their certification position relative to yours?

Nobody in autothrottle , nobody has one certified. The FAA tells us, it's never been done before. It never certified one. So that's why it took maybe a longer period of time to get the official certification. And it's worked out okay. We're happy to say that FAA has been incredibly cooperative, so we have no problems there. But it's new and when it's new and novel, they literally go out to the industry in an announcement of the technology and solicit comments. And that takes 60 days and another 60 days for analysis and completion. So that has delayed it. As far as having patents that we would infringe on, we're not aware of any technology that would impede our ability to pursue the markets we got right now.

You want to address the competition question?

I don't think there's anything specifically to address there. Our competition are people like Honeywell, Collins, Garmin are typical competitors. And they do a very nice product. It's different than ours, we have a -- we tend to focus on products that we have very special expertise in designing and manufacturing. And so although the products may be very similar, they don't overlap as much as you would expect. But there are -- they're out there as competitors, they've been there since we founded the company.

And our next question today is going to be Michael Friedrich with BISA.

I'd like to talk about the Lufthansa deal. With those jets, the legacy 737s and the 757s and 767s, can you give an idea like how many of those planes still need to be brought in for serious cockpit upgrades? Yes, I figure this has been going on for a while. You've been doing the flat panels and been doing those planes. Can we reasonably expect that there's 500 out there? Do you have a number on how many planes we're talking about that would actually need major upgrades?

So addressing the classic 737, there's a fair amount of cargo converted 737 in China. And part of the strategy to partner with Lufthansa Technik is that they have a very strong presence in that part of the world, and they see that as an opportunity for at least a display upgrade on those aircrafts. Also, what we're seeing is that more and more of the Dash 400 being converted to cargo operations. And when they plan to keep those airplanes past 2020, 2021 actually, they're going to have significant issues with their existing CRTs in their airplanes because the original provider of those CRTs have announced that they no longer support that product. So we see an upgrade potential there. With regards to the 757/767 we've got so far penetrated probably over 20% of the market, and we've never seen a drop in the demand. Obviously, in the early days, we got 2 of the larger operators, being American Airlines and FedEx, and they carried large orders with them. But since then, we've picked up a lot of small airlines, and we continue doing that, with 20 airplanes, 10 airplanes, and we continue selling those products. We have not seen a drop in that demand.

And it's the same outsourcing issue for the CRTs in the 757/767.

On the planes you've already done over the years, the American planes and some of the other ones, what is the lifespan on those cockpit upgrades? I mean how often do these things need to be recycled back through?

I have to give you an example. On American Airlines, we have about over 20 million hours of flight history on them. In the meantime, [indiscernible] our displays are seeing hundreds of thousands of hours of operations. So to realize those things are amazing.

And they will probably be used for -- probably close to 20 years. They're probably good for operation, 15 years to 20 years. Because the technology is now using flat-panel displays which allow you to change the configuration of them, the system, depending on your requirement. You can change the complete look. In the old days you were fixed with a fixed style and mechanical presentation.

Now in your press release, you put the flat-panel displays on for scalable growth to satisfy operators' demands as well as platforms for NextGen and [indiscernible] requirement. So does the flat-panel display meet the ADS-B requirement and the RNP requirement? Or are those just things that can be added to it?

So the ADS-B has 2 sections, what they call, the ADS-B Out, the transformer upgrade and the GPS.

We make GPS.

And we make GPS. So -- but then, once everybody gets fitted with the ADS-B Out, what they call the next generation, which is ADS-B In, well now you can take all that information from all the aircraft which are around you and you can convert that into display features to give pilots guidance on how far away he is from the aircraft in front of him and the traffic around him. Those are the [ digital ] features that we would sell to our already existing customers that have our systems installed in them. So essentially you sold them the computer, and now you're going to sell them additional software.

And I think you had mentioned in one your reports that there was an RNP mandate. Is there actually an actual firm mandate on RNP? Or is that just something that you're forecasting for the future?

The mandate of the RNP, it will never be improve matters for RNP anytime soon that I can think of. But what we're talking about is if you were to go to a particular airport, like if you wanted to go to Schiphol airport in Amsterdam. If you don’t have RNP operations, you can't land your airplane. So that's the kind of mandates you get. And then obviously, more and more airports internationally that give preferential landing capability to people who are capable. so a lot of the operators, like one of our European customers that they bought IGNS from us which is our navigation system. It allows them to fly RNP approaches in Europe at a fraction of a cost of going to get an OEM operate for both, for the 757s. And they did that because right now, some of the airports that they will fly to does not allow them to fly in there without RNP capabilities in their airplane.

Preferential treatment is tantamount to a mandate because if you -- high-traffic airports will give preference to people with RNP because it profoundly reduces -- not only reduces the time you're in the pattern, but it also, for the operators, significantly reduces their fuel consumption as well.

Okay. And do most of the planes that exist right have these capabilities? Or is there is still a large opportunity for cockpit upgrades in the existing fleet?

A huge opportunity.

Okay. I mean, percentage-wise, do the planes out there have the necessary capabilities, would you say that?

Depending on the type of the planes so, obviously, the newer airplanes that...

Yes, understanding that. But if you had the commercial aviation planes, the main carriers that are in service, would you say half of them have these capabilities?

That's a good guess.

All right, and one more question for you. Since Lufthansa is servicing not just Boeing jets but also Airbus on a large scale, is there any thought of trying to get your products into the Airbus world as well?

We have initial discussions about that with them.

Okay. And you would have to have those with Airbus specifically or would you have them with Lufthansa?

We would develop the product and STCs ourselves. We won't typically work for the OEM.

We can distribute through Lufthansa and...

And distribute it through Lufthansa.

And our next question is going to be a follow-up from David Campbell with Thompson Davis & Company.

Surprised that you're putting off the NextGen ADS-B installation potential for 5 years to 7 years. I mean it seems like a new president realizes that the aircraft -- airport needs modernization, and this is one of the things, a major part of upgrading commercialization which he wants to do. So why are [ seeing ] from a 2020 deadline to 2025 or 2027 deadline?

It's 2023 actually, but that's okay.

So the 2020 deadline still maintain -- unfortunately, the old President gave a get-out-of-free-card to the [indiscernible] industry. And they don't have to, what we call, a [ WAAS ] which is an offering, a GPS upgrade to the aircraft. So if they've got any old GPS in the airplanes till 2025, they can continue to fly as long as they can provide the plan as to what they're going to do in 2025. So it's kind of a [indiscernible]. But what happened in Europe also was that -- I mean that was supposed to be 2014, then it was 2017 and now it's 2020. There is a strong lobbyist from the airlines in D.C. And they like making money, they don’t want to spend it.

Well, remember there's a -- as new equipment comes out, they did the same thing with RVSM and waited until the last year and then started doing it. But the thing that makes it compelling and actually made it compelling for RVSM, as an example, is that you got preferential treatment if you had the equipment, if you didn't have the equipment, you're still flying your airplane but you probably ended up flying 20% further routes because you had to circle and wait for landing clearances and things like that. So I think it's going to be implemented, I just don't know that the mandate itself will come out. I think -- and most of our customers will start doing that conversion, hopefully, before the mandate comes.

Ladies and gentlemen, this will conclude our question-and-answer session. I would like to turn the conference back over to Mr. Hedrick for his closing remarks.

Thank you very much. I remain confident, as I said, about our prospects in the future. The investment in research and development for new products is bearing outstanding fruit, as far as I'm concerned, and we think that promises the kind of expansion that we have planned for. So God willing, we're going to do just fine. So thanks for coming in today on our conference.

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