Innovative Aerosystems, Inc. (ISSC) Q2 2019 Earnings Report, Transcript and Summary

Good day, and welcome to the Innovative Solutions and Support Second Quarter 2019 Earnings Conference Call and Webcast. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mr. Geoffrey Hedrick, Chairman and Chief Executive Officer. Please go ahead.

Good morning. This is Geoff Hedrick. I’d like to welcome you this morning to our conference call to discuss our performance of the second quarter of fiscal 2019, current business conditions and our outlook for the coming year. Joining me today are Shahram Askarpour, our President; and Relland Winand, our CFO. Before I begin, I’d like Rell to read our 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’ll turn the call back to Geoff.

Thank you, Rell. Company’s second quarter results continue to reflect the cost controls and marketing refocus initiated at the end of last year. Both revenue and backlog increased, and we were profitable for the second consecutive quarter. In addition, the business generated $900 million – $900,000, I’m sorry, in cash. Each one of the three market segments: commercial air transport, general aviation and military contributed to that improvement. This quarter, we generated revenue in all three segments, and we generated revenue in both product and engineering contracts. Retrofit programs for commercial air transport and general aviation PC-24 production primarily drove the second quarter sales. The highly successful Pilatus PC-24 jet program is in full production, and we believe a steady stream of order will be received over the remainder of this year and years to follow. Our general aviation sales included sales of our new PC-12 NG autothrottle, PC-12 classic full cockpit upgrades with autothrottle and the sale of our UMS product to multiple OEMs. In the military, we are completing our work on new air data computer development contracts. Test units have been delivered to the navy for their evaluation and testing. If testing proves successful, we believe that the navy will proceed into the production phase of the order. As I discussed in – on the last earnings call, we are focusing our resources on fewer, more promising opportunities. This focus shows an improved productivity and shorter development cycle times. We continue to remain optimistic in our outlook for our patented ThrustSense autothrottle. We believe that the ThrustSense has broken new ground especially in the twin-engine turboprop market. Several days ago, we announced the receipt of a STC for the ThrustSense autothrottle for retrofit in the King Air. The ThrustSense autothrottle provides engine protection like the most advanced jets, and is a full-regime autothrottle for takeoff to landing, including go around. ThrustSense computes and controls power levels, which are designed to reduce pilot workload, and which we believe brings a new level of convenience and safety to King Air owners and operators, which are, I think, there’s something like over 10,000 airplanes out there, so. So we’re applying the ThrustSense autothrottle into other applications that show great promise. We are aggressively marketing the autothrottle, focusing on what we call its ability to provide fourth dimension control of the airplane. Market interest and awareness is now increasing for what we believe is a compelling combination of safety features and low installation cost. Let me turn it over to Rell for discussion of financials.

Thank you, Geoff, and thank you all for joining us this morning. Revenue for the second quarter fiscal 2019 were $4.2 million, a [indiscernible] increase from the second quarter of 2018 and our second consecutive quarter of revenue growth for fiscal 2019. Product sales comprised approximately 88% of total revenue with the balance comprised of revenue related to engineering services on the F-5 development contract. Gross margins for the quarter were 56%, an increase from 44% from the same quarter last year and also a sequential improvement from the first quarter of 2019. We believe the improvement in gross margin reflects better leverage from increased revenues, reduced direct material costs and the benefit of the work force reduction implemented in the third quarter of fiscal 2018, as well more profitable pricing on the engineering contract. Total operating expenses for the second quarter of fiscal 2019 were $2.2 million, down $600,000 compared to approximately $2.8 million in the second quarter a year ago. Research and development expenses were down $400,000 from this quarter compared to the same quarter of last year while selling and general and administrative expenses were down approximately $200,000 for this quarter compared to the same quarter last year. Each of these decreases reflect the impact of the third quarter fiscal 2018 work force reduction as well some variability between quarters due expenses such as accounting, legal and other. Our R&D spending is down from a year ago, a shift in our strategy has enabled us to improve the productivity of our spending by investing in fewer, but we believe are more promising technologies. Income tax expense for the third quarter of fiscal 2019 was $8,000 due to the utilization of tax loss carry-forwards. Income tax expense for the second quarter of fiscal 2018 was $200,000 due to change in evaluation allowance. We reported a quarterly net income of $202,000 or a $0.01 per share during this quarter compared to the same quarter a year ago. We incurred a net loss of $1.3 million or $0.08 per share. We believe that the company remains in a strong financial position and has generated positive cash flow in the quarter. At March 31, 2019, we had over $21 million of cash on hand and no debt. 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, and good morning, everyone. Over the past three months, we have continued to make steady progress across the organization and for the second consecutive quarter, posted increase in our key financial metrics. [indiscernible] our developmental efforts, employing more aggressive sales and marketing initiatives and implementing tighter cost controls have made us a more focused, efficient organization, and we are operating at a high level. Consequently, the second quarter was as successful as the first quarter, and we are seeing steady increase in our revenues and profitability. Much of the quarter’s revenues were in our commercial air transport segment. From flat-panel displays for the Boeing 757 and 767. Encouragingly, these are orders for our portfolio of existing cockpit technology, which require little additional engineering and are therefore, quite frequently our most profitable products. I just mentioned, the Pilatus PC-24 is one of the most successful new aircraft launches in the industry. As the supplier of the aircraft utility management system, shipments are keeping pace with the sales of Pilatus is ramping up to full capacity. Keep in mind, that although we believe Pilatus will be ordering a significant quantity of chipsets per year, we only include a very small portion of this future revenue in our backlog that reflects orders for delivery within 2 quarters. We are also experiencing increased interest from other pilots and optionally piloted aircraft manufacturers for the UMS product. The military market, the KC-46A program continues to enjoy steady production. As mentioned last quarter, we are looking at some additional opportunities, reforms in international of military customers. In addition to product sales we’re also generating profitable engineering revenues in our military segment. Our contract to develop a new air data computer for the U.S. Navy, leverages our experience on the A-10 air data the computer. Though our development costs and time have been minimal compared to other development arrangements where we are not as familiar with the technology. We see interests for similar military air data computers for other platforms in the U.S. and international military markets. Of course, echoing Geoff’s sentiment, we believe our greatest current opportunity is in the general aviation market with our ThrustSense autothrottle. Having recently received the STC for the King Air, we now have a baseline STC that we hope will open the door to a market of what we believe to be over 5,000 variable King Air air crafts. To capitalize on this opportunity, we continue to rollout our comprehensive marketing plan and strengthen the underlying infrastructure needed to ensure the launch is a success. The manufacturers, installers, MROs and others, with whom we have been conducting demonstrations, have been impressed with our ThrustSense autothrottle technology. As mentioned last quarter, we have made deliveries of both the standalone and cockpit autothrottle configurations, and we are optimistic that activity will grow as more installations are performed. The addition of a twin engine version to our product portfolio as the result of the groundbreaking ThrustSense product as we believe helped to overcome the daunting challenge of getting a twin turboprop autothrottle approved by the FAA, and paved the way for what should be easiest ThrustSense expedition of additional piloted and optionally piloted air craft. Finally, I would note the 5.3 million in the second quarters orders and the $5.5 million in March 31 back log, has recent hard water marks, that further affirm the steady progress that has been the goal of our recent tech strategy. I would also note that we have several long-term production contracts, on which we took – we book only the most immediate orders. Broad based improvements we have achieved across our commercial air transport, military and general aviation markets is an encouraging endorsement of a more focused strategy. We believe, the new products rolled out and under development, offer even greater promise for continued progress. Let me turn the call back to Geoff for some closing remarks.

Thanks, Shahm. Steady progress achieved in the second quarter is an encouraging sign that our end markets are improving and our strategy is on target. Interest is growing in our advanced Flight Deck, a unique autothrottle and utility management systems, all of which deliver what we believe is industry-leading price for performance and a responsive to ever growing needs for improved safety amid new or impending tighter regulations. I am very pleased with – where we are as an organization, as a productive, and focused as ever. So in conclusion, I appreciate your attention today. I will open up the call for questions.

[Operator Instructions] The first question comes from David Campbell. Please go ahead.

Thanks for hitting my estimates for the quarter. Yes, I know it’s amazing. You had my estimates, Congratulations. Shahram, you talked about the commercial aviation, it sounds like you got some new business there. I imagine the 767 business is coming from cargo – cargo conversions. I’m a little confused why where the 757 business is coming from, can you elaborate?

That, that – that again is coverage. Some of that is from existing customers. In light of recent situations, 757 continues to be an attractive airplane.

So you’re upgrading their Flat Panel Display that, that’s what you’re doing, right?

The 757, because it adds up – next year, end of next year, there won’t be any support for the existing equipment. So it’s important for them to do the modifications of the airplanes.

And how about the 767, doesn’t that matter, right? And most of those are the cargo conversions.

Somewhat similar situations.

Mostly they are, yes.

So we have a stronger position on the ‘57, as you know.

We’re also selling to some of our existing airline customers as well, internationally. As they add to their fleet.

Right, right, right Well it sounds great because everything seems to be clicking. At the same time with their – with commercial aviation going up and the King Air business hasn’t started yet, right?

Not really. It’s just about to start and we see real promise in that. It’s a huge market. If we do our job right, we’ll do very well. The product works great.

And you’ll be selling those to fixed base operators, is that what you do?

We’re already doing that, we’re showing them – them, all kinds of people right now. And remember, it’s Africa [indiscernible] as Africa – well everything, from a piston turbo – piston airplane, all the way up to a conventional turbofan jet, so it’s really quite a remarkable product line.

Right. Right. Right. This is a –do the – this is a fight with China over the trade disputes, does that have any up potential for your company?

No, I mean China, I guess there’s obvious uncertainty in China but if you think about China, they don’t do business, they’re pragmatic business people. They do business with us because they have to, and because we provide the best product for the money. So my opinion is, if you do your job correctly, you should still be okay. Obviously consumer products have a different problem, but – in our case, to the extent that we sell our standard product and are not involved in trying to share technology and things like that, we’re delighted to work with China it’s a great opportunity. It’s a great market.

And overall revenues for the rest of this fiscal year would be appropriate to slowly increase them on a sequential basis from where you were in March?

Yes. We see it – we see a slow – we see a ramp up. Yes, you can see it in our backlog, obviously as that increases, our sales should follow accordingly.

We expected sort of a – we hope a nice steady increase. So that’s what we hope we see. And we’re certainly betting on it, and the backlog obviously reflects what we think we’re going to be shipping. So if you see an – although we don’t talk about targets from the sales, if you see the backlog is going up and consistent with the backlog going up, you’ll see our revenues for the quarters go up as well.

Yes. Yes. Well, I was estimating a backlog of $5.5 million at the end of March. So that’s what happened, right?

Well, that’s because you’ve estimated it. We said it. You estimated it more. If you had estimated it 6, we would have 6. We just – we don’t what to do, yes.

Well, congratulations. Thanks again for doing such – doing so well.

Thanks for your support all these years. I appreciate it, David.

Yes, I’m going to continue supporting.

The next question comes from Charlie Pine of Van Clemens & Company. Please go head.

Hi, good morning, and I’d like to congratulate you all on another good – on more good progress in the second quarter.

Thank you.

Thank you.

I have a few questions. The – primarily would be addressed on the recent STC that you got for the King Air. I guess I was slightly surprised. I had been anticipating that from your – some of the earlier comments in the prior call that it didn’t sound like that you were going to be able to get the STC until sometime this summer. Was that incorrect? Or did something just kind of happened that actually moved it up a little bit more?

First, let me ask you. Is that good or bad?

No. That’s very good.

Okay. Look, it was actually sort of a strategic deployment. The autothrottle for the King Air has a bunch of optional features. And each one of those optional features is new technology, which I’ve had a number of people comment about trying to get their head around it, trying to understand it. What we did – chose to do is get the fundamental autothrottle system with the actuators in control of the engine and safety features all fully operational and certified. And we did. And now we can add additional features on for additional protection. And they’re all, by the way, optional features that you get – you paid for. So they’re going to be incrementally added over the next couple of months. So what that gave us is, first, allow people to start installing sooner than we had hoped. And ultimately, we’ll get the same total penetration in the end or, in fact, more but we’ll be able to get started much earlier. Does that make sense?

Yes, it does. Let me follow up on a couple other things. First of all, just as far as overall as far as getting the STC, it was a long way but better late than never.

It was a tough one. I mean, it’s never been done before. If you – the pioneer will always – is a guy that gets the arrow. I mean the guy ahead of the line usually gets shot. And we have – it was a tough, tough road. But I will tell you it wasn’t because the certification authorities were being difficult. I’m fairly difficult. To the contrary, they were all enthusiastic about the product and we actually have some of them – these are saying that there are several – 200 to 300 people die every year and we’re going to save their lives. So that’s an amazing thing for them to say. But they went through the hard work of making sure it was right. And it was tough, and at times, it was painful for us. And in light of weather problems, I’m sure they had their own distractions. So I’ve got no complaints at all. I think just – when it’s unique, the people who are certifying it are used to saying, "Well, okay, I could do that because in the past I’ve done this and the other." That wasn’t the case. It had to be all new. And we’re grateful and delighted that we got through it.

Well, I’m very happy and I’m sure everybody that’s been sticking for this amount of time as you’ve gone through the process is also...

Me too.

Pleased that finally getting to – getting across the finish line. I’d like to have you explain a little bit of a distinction I’m having a bit of problem with. Geoff, you mentioned in your prepared remarks that there’s over 10,000 planes for the King Air. And then, Shahram, you said that it was 5,000 King Airs. What number should we really be using to model on to be...

Talking about operational, addressable market and non-addressable, et cetera. The 5,000 or 6,000 number is probably the more conservative number.

Okay. So 5,000 to 6,000 for the addressable market and...

But that’s just...

And that’s only with King Air.

It’s only King Air.

We finished at 10,000. It was including PC-12 and...

[indiscernible]

That we’re going after.

Just to find the better twin turboprops.

Okay. All right. Okay. Thank you for clarifying that.

I’m sorry about that.

And also, I guess I’d like ask what would be a sort of natural follow-up. How soon do you believe you could start to recognize some meaningful revenue on the King Air autothrottle installs?

Well, I’ll tell you what we’re doing and partly because we have a little bit of breathing room. We want to make sure that the installation is simple and fault-free, and that’s going to take us to do several installations with our team in place to make sure that we’ve got it optimized. I want it foolproof. And so we’re going to spend a little bit of extra time in focusing on the installation, and, some of the optional features that we talked about and be able to have a complete package and not rush it into the marketplace. We learned that from one of our OEMs who showed better judgment than I have by moving their airplane production deliberately and the volume in such a way that they didn’t end up with fire drills at the end of the line.

Do you think that there is a possibility that you could start to see some meaningful revenue in your fourth quarter? Or do you think it’s more – it’s not – it’s more probable that it will start to show off in...

And the simple answer is we’re not sure. The reality is that if we get lucky, the installation kicks – work well, we don’t have any big problems, we could get installations and revenue in the fourth quarter. If not, it will be the first quarter of the following year. But I think, honestly, for the first time, we don’t have to rush into this. And that, I think, is going to pay off very, very handsomely in the future. So the simple answer is I’m not sure. There’s a chance it’s the first – it’s the last quarter or the first quarter.

Okay. Well, we waited this long. Another few months isn’t going to...

I just like to – an airplane to get it flying and not have a problem in the first installation. I want it to be smooth. And whatever it takes for us to do that, we’re going to do.

How many partners are you working – I’m just kind of curious. How many partners are you working with as far as on the installation side of it right now?

How many what?

How many of your partners, MROs and other field operators are you working with right now on the installation aspect?

I don’t know the actual number, but we have a significant number of service centers that are – that signed up for that installation. What we want to do is refine the installation, put it in a video format so that the mechanics all over the country, for that matter all over the world, have a reference document that they can look at and know exactly where every wire. It’s not the equipment in the airplane. That’s the easy part. It’s the wiring and how you attach it to the other systems of the airplane, and that’s critical obviously. So those are the things we’re refining. We’re making sure that, that wire length of as much as 20 feet are accurate within an inch or 2. So those are the kinds of things we need to do.

Okay. All right. Well, great. Well, thanks for answering those questions. And once again, congratulations on finally getting the STC and also for the continued return to profitability in the business. It’s very gratifying to see again.

Thank you very much. I’m a little bit embarrassed to realize that I’ve been complimented. I’m doing what I said I would do when I said I would do it. I thought that’s what I was supposed to do. I had a director who ran Boeing’s engineering department for many years and he said his boss told him that integrity was doing what you said you would do when you said you would do it. I’m going to try to do a better job of that.

Well, stay at it, Geoff. We appreciate it.

The next question comes from Mr. Michael Friedrich. Please go ahead.

Some questions on ThrustSense and I wanted to get – have you provide a little more color on not just the safety end but the engine protection portion or the value proposition of the engine protection end of it and maybe provide a little bit of detail on essentially the damage that is done to these engines and the cost associated with fixing things right now. I’m trying to get an idea of the general value proposition of this upgrade.

Well, there is a lot. Obviously, the turboprops, we’re talking about a new engine. Install is probably $1 million. If you over-temperature an engine and you’ve got to do a hot section, you’re talking several hundred thousands of dollars to do it, and that’s just over-temperaturing for a very short period of time. A hot start – you’d have to do a hot section. It will vary. I guess the cheapest thing you can do is a borescope for $20,000 to $30,000. The most expensive is $1 million. And that’s on a cheap engine. On a good engine, an air transport engine is at $10 million or $15 million. So it varies a lot. Protecting the engine is critical. In some case, it’s just – remember even inspection takes the airplane out of service for some period of time. So it has real advantages, and that’s why people have paid [a lot of time and effort] significantly more for what’s called FADEC, or full authority digital engine controls. We provide the same kind of protection without – on conventionally fueled engines.

Okay. And then Geoff, give me an idea of what is the normal life cycle of a PT6 engine.

I mean I can’t – I’ll tell you a little data that I know as I think in one of our airplanes is 3,500 hours and they’re actually pushing into 4,000. But if you have a hot start, all bets are off, obviously. So it depends a lot on the engine. They’re anywhere from – I don’t think they’re any – above 3,000 as a turboprop. I guess some will go up to 4,000 or 5,000. They’re pretty damn reliable. They’re remarkably reliable but they’re extremely sensitive to temperature. And you over-temperature by even 10 or 20 degrees, you can [just see] real damage.

Okay. Okay. So I mean – so obviously, the ThrustSense does – is a tremendous value proposition for these owners. Another question I had for you was in the third quarter of last year, you guys at least briefly mentioned the idea potentially this becoming something that would be carried by OEMs or maybe even engine manufacturers. Now engine manufacturers, obviously, there’s one engine manufacturer. But can you provide any – maybe outlook on the idea of where you could see this going? Could it potentially be something that’s part of an actual new aircraft?

Yes. But we can’t talk about it. But obviously, we’re looking at that. Honestly, I don’t want to discuss it.

Okay. Got it. Got it. And on the rollout, you had said that just on the last questions that you were not in a hurry or that you weren’t pressed for basically time on this. I wanted to just get a little bit more detail on that. Is that simply because you’ve got plenty going on? Or is it the idea that the MROs, they’re filled up with NextGen work? Or is there any – can you provide a little more detail on what you mean by that?

Well, a couple of things. First of all, we want to get installation time down as far as we can because as a former personal airplane owner for 35 years, nothing annoyed me more than I have to lose my airplane even for a day, just a day, didn’t have access to it. And you – so we really want it to be a very minor disruption to the owner for this installation. That’s number one. Number two, the other issue I’m talking about is we have [a rule on time, 4:00]. This started – starting to respond to some of the actions we took last year. We’re seeing the company making money. We’re generating – generated almost $1 million in cash last quarter. And so we’re in a reasonably comfortable position where we don’t have to run a fire drill to keep ourselves alive. And we’re going to use that time in a planned and disciplined way to improve our long-term opportunities.

Got it. Got it. And just a couple – a quick – other quick things. Any idea what the next STC is going to be? Is that going to be more of the King Air series or another turboprop?

I’m not sure. I don’t know. I mean we just – every time we won’t get disturbed, we’re pleased. Honestly, the FAA – it was easy to go up in an industry and complain about the federal services, the administration services making it difficult for your business. In this case, it’s not to the case in general. I mean the ways are appropriate sometimes. As much as I don’t like them, I have no idea what the next one would be. But with anytime, a lot will happen, another one within a month. It’s a surprise, right?

Okay. Good. I...

That’s behind the door. That’s behind door number three.

All right. I look forward to it. Okay. One more quick question. On the KC-46, obviously, that’s a major rollout by the military. I’ve never been able to kind of get an idea of really how significant that is to you folks in terms of revenue, the part you’re providing. Is that a significant cost item? Or is this more like a lead into other things?

I mean it’s a good-sized program but it’s not significant to our revenues.

Okay. Okay.

It’s very good. We’re very happy and it goes on for a very long period of time in a very predictable way. And it’s a very good program. Is it make or break divisions one way or the other? No. But it’s a wonderful opportunity and we’re delighted with it.

All right, gentlemen. Well, thank you for your time and continued success.

The next question comes from Mr. Irwin Goldman [ph].

You guys may remember me. I’m the old guy who was at the meeting. I would like...

I’m the only guy who was at the meeting.

A few questions. Number one, you had commented then that you were hiring and you were looking for about 11 people. So you let me know about that one, how that went. I’m also very interested in knowing, in the last two quarters, how did the sales break down, percentage-wise, among the three leading customers. And my third question is, what, if anything, to the old Eclipse company? Is there any movement there? And does that look like they’ll be back producing and using some of our services and merchandise? Okay. Go.

Do it.

So with regards to the hiring, the – I think we’ve hired like six or seven people so far since the meeting, and we continue with our hiring efforts. And with regards to the Eclipse, they will not be building new aircraft. Right now, they’re in bankruptcy court. And whether they will emerge or not remains to be seen. Our agreement with them to – that we would supply equipment to Eclipse customers only through them, it’s – will soon be, yes, completed and we will have the opportunity to direct market, upgrade to that, lead out – move it to [another] aircraft. With regards to the revenue, Rell can address it.

Yes. For the revenue, for the six months, it’s pretty much even breakdown between general aviation, which is primarily Pilatus and the 757/767, which is – you have basically an MRO, a big MRO is throwing a lot of stuff over that term. So between the two types of industries, it’s almost 50-50 but approximately.

Then Pilatus has become the number one sales area.

Of any one, yes, of any one customer.

Okay. Okay. That’s all. I don’t have a lot of questions today.

Thank you, sir.

You have good questions. And we’re delighted. And I – and you remember what you said to me when you left at the annual meeting. I think about that almost every day.

With no further questions, this concludes our question-and-answer session. And the conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.