Innovative Aerosystems, Inc. (ISSC) Q4 2017 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Innovative Solutions and Support Fourth Quarter and Full-Year 2017 Fiscal Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. At this time, I would like to turn the conference over to Geoffrey Hedrick, Chairman and CEO. Please go ahead, sir.

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

Thank you, Geoff, and good morning everyone. I would remind our listeners that certain matters discussed in the conference call today, including 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 from 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 will turn the call back to Geoff.

We reported profitability and generated over $5.9 million in cash flow this past year. However, operating performance in fiscal 2017 did not achieve the results that we would have expected. Over the last year, we have substantially completed our transition to a strategy that is centered on growth through internally developing new products and anticipate demands of the NextGen technology. Consequently, despite more revenues in 2017, we maintained our investment in research and development at 2016 levels. This investment was supported by our strong financial position. We are pleased with the progress of our latest product, the Autothrottle. It is the only FAA certified turboprop Autothrottle and has been widely hailed as a major advance in aviation technology by some of the industry's leading authorities. Many acknowledged industry experts writing in aviation publication such as Flying, Aviation Today, Av Week, and Aviation International agree that the Autothrottle is a significant safety advancement for turboprop aircraft slashing pilot workload from takeoff to landing. One of the Autothrottle's primary functions is a protection of the engine through effective management of torque and temperature limits, two of the -- two biggest issues that have historically bedeviled the operation of older engines. It provides speed envelope protection by computing and controlling appropriate power levels, providing pilots with the ability to automatically control power settings. The system is currently approved for the PC-12 flat panel avionic system. However, we are working on certifications for other avionics packages, including the PC -- the Pilatus PC-12 NG as well as Twin Autothrottle Systems for Beech King Air. We signed our first King Air B200 customer for the flight tech and Autothrottle. Because of our efforts with the PC-12, we expect development time to be much shorter. With over 5,000 Autothrottle candidates, King Air represents the largest single pool of upgrade candidates. Once the King Air Autothrottle is certified, all aircraft addressable market could exceed 10,000 aircrafts. This makes the market for Autothrottle among the largest and thus the most important growth opportunities. We have also acquired for a patent for the Autothrottle. With patent protection, we will be able to extend the Autothrottle market's lifespan, which is another goal of our internal new product research and development strategy. This year we are focusing on reducing our time to market. This internal process restructuring will bring our technology to market more quickly and more cost effectively. We have also made progress with our recently introduced strategy to build global distribution network of both domestic and international MRO centers. These centers will act on our behalf to market and install many of our existing products. Recently we announced that we have added Triumph Group, one of the aviation industry's premier service providers to our network. Together, we have Lufthansa Technik, the world's largest MRO. We now have agreements with two of the industry's largest and most respective -- most respected maintenance and repair operations. Entering the New Year, I'm enthusiastic that our innovative Autothrottle technology partnerships with industry's leaders like Black Hawk, Lufthansa Technik, Triumph, and Success internally developing promising new technologies has positioned IS&S to capitalize on the growth opportunity arising from increasing adoption of NextGen technology. Let me turn this over to Rell for a discussion of our financial results. Rell?

Thank you, Geoff, and thank you all for joining us this morning. Revenue for the year-ended September 30, 2017 was $16.8 million, down from $28 million in fiscal 2016. Revenues for the year reflect decreased shipments in the commercial transport retrofit markets in fiscal 2017 relative to fiscal 2016. As a result of our strategic shift to more internally focused new product research and development, we continue to generate a majority of our revenues in production orders. Production revenue typically yields gross margins 50% or greater. However, since we do have a relatively stable production fixed cost structure market can be affected by sales volumes. And in fiscal 2017, as result of the sales volume decrease, margins were lower. Total operating expenses for the year were $8.2 million, down from $14 million a year ago. For the year, research and development was down marginally from 2016 levels, reflecting our continued strong commitment to internally develop new products. However, there was a substantial decrease in general and administrative expense, primarily due to a $3.6 million reversal of a bad debt reserve due to the submits of the double litigation, for which we had previously booked at bad expenses. Legal expenses were also lower compared to a year ago. While there was an operating loss for the year, reported net income of $4.6 million or $0.27 per share, compared to $2 million or $0.12 per share in fiscal 2016. In fiscal 2017, net income includes $4.9 million of other income rise primarily of $4.1 million from the favorable submit of the double litigation and the sale of the Pennsylvania State R&D Tax credits. At September 30, 2017, the company remains in a strong financial position with nearly $25 million of cash essentially unchanged sequentially from the previous quarter, and up over $5.9 million from $18.8 million from the same point a year ago. The company continues to have no debt. Cash flow from operations was $6.1 million for the year, up from $3.6 million in the fiscal 2016. We believe the company has sufficient cash to fund operations for 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 some of the strategies and operational progress achieved in fiscal 2017. As Geoff mentioned, 2017 was a year of significant transformation. We have taken several steps optimizing our product development that has resulted in reduced time to market of our new product ideas. We have also implemented a new strategy that we believe best positions us to leverage our industry-leading price for performance technology to capitalize on large growing markets, and are emerging from the increasing adoption of NextGen technology. At the heart of that strategy is our new Autothrottle. Our first certification of the products was in conjunction with our NextGen Cockpit for the legacy PC-12 aircrafts. We received FAA certification for the complete system in June 2017, and are in process of obtaining our success [ph]. To date, we have put in place four new dealership agreements and continue to expand our dealership network both domestically and internationally as part of our attractive marketing strategy to this product line. In the Autothrottle available to 1,500 PC-12 aircraft variations, including the PC-12 NGs, we have developed a standalone Autothrottle that is controlled by our integrated standby unit. This amazing product has a much lower cost of ownership than the full cockpit and is applicable to three times as many aircraft with a single certification to all PC-12 variants. We have successfully completed all certification efforts, and the rating FAA SPC issuance. This is another example of our production in time to market by carefully accessing and combining certification activities for similar aircraft types. In twin engine airplanes, the Autothrottle provides a number of desirable safety features. For example, our Autothrottle engine out process control automatically adjusts the remaining engine power, if the airspeed falls below minimum control airspeed. The pilot can maintain, control, as Autothrottle mitigates the [indiscernible], allowing the aircraft to safety accelerate under full control. Our first certification of the twin engine Autothrottle is expected to be in conjunction with a standby instrument and certified for the King Air platforms, opening a market of all the 5,000 aircraft for this product line. The standby instrument on Autothrottle product will enable us to capture platforms with existing advanced cockpits that don't need replacing. With our first Autothrottle SEC in hand, we have been strengthening our business aviation sales and marketing departments to take full commercial advantage of our product line. As the Autothrottle market develops, we intend to capitalize on the demand for products that can provide improvement in safety, situational awareness, and operational performance. In addition to the latest FAA NextGen [indiscernible] we believe that some of the work is done with the Autothrottle, and I'll just credit success for future mandate such as required time of arrival, where we believe our Autothrottle provides us with significant competitive advantage. The Pilatus PC-24 with speed certification from FAA and ASA [ph] just last week, this is a historical milestone for Pilatus and a great long-term opportunity for us being the sole supplier of the utility management system for the PC24. Additionally, we are in ongoing discussion with several OEMs regarding adaptation of our utility management systems in the new designed aircraft. As our air transport products continue to bring revenues for us, the recent teaming agreements with Triumph Group had allowed us to provide customers the option of full turnkey installation at their chosen facility. Triumph Group will serve as a major installer of our cockpit IP flat panel display and flight management system for classic series 737, 757, and 767 Boeing aircrafts throughout the world. Our systems are already in service on over 320 Boeing aircrafts, and Triumph believes that adding the IS&S and its product to their total lifecycle solutions program enhances their avionics retrofit capability. Triumph is joining our network along with Luftansa Technik has significantly expanded our global reach both in depth and breadth. In the air transport market, we are raising approval of our cockpit installations modifications from Chinese authorities, at which point we believe our MRO partnerships can be instrumental in capitalizing the growing air transport and cargo markets in Asia, and particularly China. In summary, we believe we have developed exciting and novel technologies in the past couple of years with our internal funding and our focus on sales and marketing aspects of these product lines and the key element to bring value for our shareholders. Let me turn the call back to Geoff for some closing remarks.

Thanks, Shahram. Fiscal 2017 results provided additional financial strength, which enabled us to maintain our investment into product research and development aggressively pursuing growth opportunities for expanding market portfolio and continue to build our global MRO distribution network, in particular with its patent pending we believe the Autothrottle represents an important inflexion point in our strategy to develop new products with a longer lifespan. We are looking forward to an exciting 2018. I appreciate your time and interest today, and I'll be happy to answer any questions. Operator, please open the mic up for questions and answers. Thank you.

Certainly, Mr. Hedrick. Ladies and gentlemen, we will now begin the question and answer session. [Operator Instructions] Your first question will come from David Campbell of Thompson, Davis. Please go ahead.

Hey, Geoff. Hey, Rell.

Hi, good morning.

Good morning.

I just have a few questions. You didn't mention anything about new orders in the September quarter or December quarter, can you have any -- do you have any information on those?

We really don't -- yes, just…

They're flat.

Yes, they're flat.

What does that mean?

I mean, they run a hell of lot of them. It's what it means. We believe that there's a number of orders that are going to -- we expect at the end -- in the New Year right after the first of the year. There's opportunities we bid on, and a lot of this gets pushed out because of the holidays, and it's happened to us before. We expect an upfront strong uptake in '18 -- calendar '18.

And that would be primarily for the Autothrottle?

No, for a variety of -- we have a lot of programs for our traditional cockpits for the 757-67, for the 737; the traditional products are going to be the one. And we expect -- what we want to do is get back, continue to move, and we will build on that with the Autothrottle opportunities.

All right. Is Triumph a -- in the U.K, or is that in the United States?

In United States right down to the streets, actually, it's not far; it's in Pennsylvania, the headquarters.

The headquarters is in Berwyn.

Yes, it's in Berwyn, Pennsylvania.

But they're going to be working on your -- basically your NextGen installations?

Yes, on all of our installations, say, there are formidable MRO and distributor in the industry, and they've chosen to take us on as a supplier. And it's -- I think a good opportunity to further enhance Lufthansa Technik, they're MRO position. That's a worldwide distribution.

And Rell, that was this $600,000 plus other income item in the September quarter, is that the tax credit -- sale of tax credits you mentioned?

That is correct.

That's just -- that's a one-time event, right?

That is correct also, yes.

Okay. Well, that was a very good help to produce your numbers in the September quarter. And I think that you have still a lot of potential in these new products, but they've been slow in coming; the King Air certification you expect in the near future?

Yes, we do. And David, just specifically, I mentioned the fact that we are restructuring our internal systems to enhance and significantly reduce our time to market. Our time to market on the Autothrottle was far shorter what we are at home and parked through a number of things, including dealing with other products and supporting other products, and pursuing other areas. But it's apparent to us that this product -- this Autothrottle is a very valuable and patentable product. And we looked carefully at how -- why did it take as long as it did? And as a result of that, Shahram has implemented a series of changes in the organization that we expect you will dramatically prove our time to market. And that in the long-term will change these gaps that we've seen in the past, and give us a more level and stable growth pattern.

All right. Well, you've already got approval for King Air Autothrottle installation, is that correct?

PC-12, Pilatus…

Well, that's Pilatus.

Pilatus. Yes, and that's already -- we already have that approved and the cockpit. And now we can take that cockpit and that Autothrottle fundamentally and put it into a King Air. We have a customer already. We signed a customer, and we will be starting the installation the 1st of January.

How can you be doing that without seeing FAA certification?

You put it in and certify it in that airplane.

Okay. And then that will work for -- that certification will go for…

For all similar airplanes, P200 King Airs. So, what we do is -- the first, we're going to install the Autothrottle and an Autothrottle control system into the King Air. We'll operate that as soon as we do the test flying and certification flying, which we expect to do in the end of January, beginning of February. We will then start the cockpit upgrade in that airplane to certify a full cockpit with the Autothrottle. It's a hell of a lot faster than we have in the past.

Does the customers have more than one King Air, or is he a fixed rates operator, or what is he?

He's a charter operator, and he's committed that airplane to this modification. So he's excited about getting it in his airplane. And this will provide us the basis. And it's preferred this way because it gives us the [indiscernible] it happens to be -- that the airplane happens to be 10 miles away from here. So, it makes it a very easy installation. It gives our engineers access, ready access to the airplane. And he's -- the owner is more than cooperative. He's very enthusiastic about the whole program. So, it's just sort of an ideal situation to get this thing certified.

And once it's certified, do you expect other operators like Lufthansa and Triumph to also use it?

Well, selling into operations throughout the world. The King Air is -- you know, used everywhere, and this is more than just a nice convenience feature. It's truly a significant enhancement in safety. And I think that we will see -- this is never -- what we're doing now has never been done before. So, it's all very exciting, and the Aviation Press as I mentioned, has applauded the emergence of this product.

Well, the installation of Autothrottle is great, but it won't have the same -- the same value in terms of dollars that the flat panels had. And the other systems that you -- like the NextGen, it's the most…

Well, let me clarify that. Autothrottle by itself is a nice functional safety feature, but when incorporated with our flat panel display system, which has a very -- the most sophisticated general aviation flight management system, a full vertical navigation 3D control flight management system based on our commercial air transport technology, we now provide full authority, control of the airplane, significantly impact fuel savings and on time performance. So, it is an integral partner with our flight jet. The King Air certification is simply for the Autothrottle, while the flight jet is already been certified on a PC12, and adopting it to the King Air is relatively simple. And we expect that total cockpit, we will -- the cockpit with the Autothrottle is very cost competitive, and provides huge safety performance features.

So, the new King Air customer will get this entire cockpit installation?

Well, in both cases. There are some King Air installations where the customer has already installed some upgrading cockpit. They're probably trying to sell to an upgrading -- somebody that's just spent half-a-million dollars to upgrade your cockpit, and tell them to rip it out is improbable at the best. So what we did is we developed two systems; one system that provides Autothrottle for those limited number of aircrafts -- roughly under 500 of them, out of 5,000 that has cockpit upgrades. And we offer to those people that have already spent a significant investment in upgrading their cockpit, an Autothrottle addition that provides them many of the features that you get with an Autothrottle, the full airbrake and the full capability of the Autothrottle has integrated it with the flight management system, you only get with our cockpit. So we feel that we're actually expressing both parts of the market, and it's -- I think very effective. It generates an enormous amount of income. Oh, by the way, the Autothrottle is non-trivial from a revenue generator by the way.

Uh-huh. This new customer for the King Air, the first one you have, he does not have an upgraded cockpit?

No, he does not.

So you'll be doing that too?

Yes, we are. I said that. The first thing we do, right, in January, the end of January, beginning of February, we will certify the add-on. Then following that, which would be about the middle of February, we will start the installation and certification of the full cockpit and Autothrottle. I will have both of them completely done with the King Air.

Why would users of King Air's -- why would they buy a new King Air instead of putting your upgraded cockpit and Autothrottle system?

You can always point to that saying, why are you doing? But the new one is a nice airplane. And the new ones, most of the new ones are bigger versions of the existing 200. We're going to be able to do all of them. And by the way, this -- the add-on Autothrottle, what I talked about that we're doing first is applicable to the new airplane. So if the factory decides this is as good as everybody else or it is, maybe they'll be installing it out of the factory. You never know.

My last question is just as far as fiscal '18 is concerned, you're hoping to get significant new business from the Autothrottle flight management systems and so forth…

Absolutely.

Right. Right. And Boeing continues -- that program continues, you still have that system, right?

26, we also have PC-24. PC-24 that had remarkable certification effort, they got the ASA certification in record time, and FAA certification. So that airplane is going to be an incredible success. It's a remarkable airplane, a unique airplane with short field performance that allows them to operate at something like 5,000 additional air fields because of its operating performance. It's an amazing airplane.

And so that's another potential for this fiscal year?

Yes. We will be -- we're already supplying production as it is right now. This last fiscal year, we supplied production equipment; we will be for the next foreseeable future.

Okay. Thanks. I'll let someone else have it.

Okay.

Thank you. [Operator Instructions] Your next question will come from David Wright of Henry Investment Trust. Please go ahead.

Good morning. Can you talk about the total revenue opportunity for Autothrottle?

It's 10,000 aircraft. If you look at just the turboprop market, and business aviation, there are about more than 10,000 aircrafts out there. But the potential of the Autothrottle is not just limited to that; you could apply to also the turbo fan engine aircrafts who are non-Autothrottle, and there's plenty of them around in the business aviation market, and we see military applications as well. So, the overall opportunity over the next five to ten years, it's very, very significant compared to all levels of revenues as we have seen historically.

Understand projecting that market as we're just getting into it now, and we're trying to be a little careful, and prudent in our estimates.

Okay. Well, I'll ask it another way. What's the revenue opportunity per plane?

We don't typically give guide -- kind of pricing. The revenue opportunity in the process [ph] on average is probably $150,000 per airplane.

Okay, that's helpful.

I mean that's an average. That's contributed by revenues that are plus or minus 50% from that.

Right. So I mean, relative to a company that did $16 million in revenue…

It's a lot. It's a real lot. And it's nice because the patents have all been reviewed and fundamentally allowed. They're not issued, but they're very -- confident that we will get them issued. And it's more than just a functional path. It's all derivative safety aspects, and we're very excited about it. And it's part of group of products, including the cockpit, which has got a very, very, very advanced aircraft flight management system that will be ideal for the next-generation operation. They're going to require down the road seven years plus, required time of arrival, they basically do what many air fields do today which is give you slots, they'll say, you have to be at the approach and within plus or minus one minute and they give you a time, and you have to plan your entire flight. So you'll arrive at that point within plus or minus a minute. If you go get there within in a minute, you go in a whole for 45 minutes. So the penalty is huge. So the future national airport in Washington used to have that kind of thing. And it was the only effective way that could handle it, the magnitude of traffic. This is what's going on for NextGen. An Autothrottle and a flight management system like we make is absolutely essential to meet this requirements. And we have a good, very good relatively low cost solution.

Okay. My second question, with $25 million in cash, that's more than half of the company's current market cap, the stock is on the new low list this morning. Where are you potential stock buyback?

That is constantly under consideration, and we are personally looking at that. We're looking at bunch of alternatives, including stock buyback. As you know, we've already purchased a significant number of our stock, and we have an appetite for it; put it that way.

Right. So, is that another way of saying, $25 million is probably more cash than you need for…

Oh yes, it is, but we kept it for some very good reasons that included our creditability on a major -- a big and we've gone beyond that now, and a potential acquisition, which we've resolved -- solved. Those were two big issues that we kept the cash for. We are going to be discussing it in that Board in next meeting.

Okay. Well, thanks for taking my questions. Good luck.

You are very welcome. Thanks for your interest.

And ladies and gentlemen, this will conclude our question-and-answer session. And it will also conclude the Innovative Solutions and Support's Fourth Quarter and Full-Year 2017 fiscal earnings conference call. We thank you for joining today's presentation. And at this time, you may disconnect your lines.