Innovative Aerosystems, Inc. (ISSC) Q3 2019 Earnings Report, Transcript and Summary

Good day, and welcome to Innovative Solutions and Support's Third Quarter 2019 Earnings Conference Call. [Operator Instructions] Please note, today's event is being recorded. At this time, I would like to turn the conference over to Geoffrey Hedrick, Chairman and CEO. Please proceed.

Good morning, this is Geoff Hedrick. I'd like to welcome you this morning to our conference call to discuss our performance for the third 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 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 also on file with the SEC, and other public filings.Now I'll turn the call back to Geoff.

Thank you, Rell. The company's third quarter results continue to reflect the cost controls and marketing refocus initiated at the end of the last fiscal year. The revenue increase this quarter and profit -- and we were profitable for the third consecutive quarter. Profits were also up sequentially, and we generated 28% of our revenue in cash, $1.3 million. Once again, each of the 3 market segments we serve, commercial air transport, general aviation, and military, contributed to our third quarter results. In addition, customer service revenue remains strong. The company's ability to have products that provide access to these markets remains the core strength of the company.Substantial revenues in the third quarter were generated from our general aviation PC-24 production and the retrofit programs for commercial air transport. In the military market, we continue production for the KC-46 program, and the Navy continues to evaluate our new air data computer for the company and -- we have developed for F-5. We believe that these programs, along with our steady maintenance activities, will provide a solid base of revenues over the coming quarters. In addition, the revenue and development expenses have been relatively constant at approximately 15% of revenues, a historical sweet spot. The company continues to implement its strategy of investing in fewer but more promising technologies and products. At the same time, we continued our optimistic outlook for our patented ThrustSense autothrottle, especially now that we've added a twin Turboprop STC to our portfolio.Just recently, our new ThrustSense autothrottle on the Beechcraft King Air twin engine turboprop was subject to a -- was the subject of an aviation international news feature. They found our autothrottle safety benefits compelling and noted how the engine better on especially during takeoff. They went on to further remark that many of the benefits of the autothrottling, concluding that great tool to help pilots concentrate on the flying of the airplane without worrying about power control. So industry authorities clearly understand its advantages. I believe the autothrottle provides the same level of protection, in many cases, as a [indiscernible] engine. And it offers engine protection from over temperature and similar costly maintenance issues.With the autothrottle system fully operational and certified, we've chosen to spend a little extra time refocusing on perfecting the installation procedures to make sure that it is simple and efficient. We want to support the marketplace, starting with the first installation, minimizing aircraft downtime. This extra preparation does allow us to -- allow owners and operators to install their autothrottle quickly and at a lower cost and, at the same time, strengthening our market penetration.Let me turn it over to Rell for a discussion of the financials.

Thank you, Geoff, and thank you all for joining us this morning. Revenue for the third quarter of fiscal 2019 was up 35% from a year ago to $4.6 million, our third consecutive quarter of revenue growth. We were also profitable for the third consecutive quarter. Revenues were primarily comprised of product sales, which includes approximately $1 million of customer service revenue, which has steadily increased over the last 3 quarters. The balance of the quarter's revenue was for engineering services.Gross margins for the third quarter of fiscal 2019 were 55%, an increase from 47% from -- in the same quarter last year. Margins in the quarter were essentially consistent with the second quarter of 2019. We believe the improvement in gross margin primarily reflects better leverage from increased revenues and the benefit of the workforce reduction implemented in the third quarter of fiscal 2018. Total operating expenses for the third quarter of fiscal 2019 were $2.1 million, down approximately $500,000 compared to approximately $2.7 million in the third quarter a year ago.Research and development expenses -- expenditures were down $300,000 for this quarter compared to the same quarter last year, while selling, general and administrative expenses were down approximately $200,000 for the third quarter of fiscal 2019 as compared to the same quarter last year. Each of these decreases reflect the impact of the third quarter fiscal 2018 workforce reduction. While 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 what we believe are more promising new technologies. In the quarter, we earned $124,000 of other income, primarily interest from our cash balances. We did not recognize any income tax expense in the third quarter of fiscal 2019 due to the utilization of tax loss carryforwards.We reported quarterly net income of $511,000 for the third quarter of fiscal 2019 or $0.03 per share compared to more than a $1 million loss or $0.06 per share loss in the same quarter a year ago. We believe that the company remains in a sound financial position. We generated a positive cash flow of $1.3 million in the quarter. And at June 30, 2019, we had $22.6 million of cash on hand with 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. Good morning, everyone. We achieved steady progress in the third quarter, both financially and strategically. It was our most profitable quarter of the year, and it was a period where we made significant strides in strengthening our position in all our end markets. As we continued to increase our organizational efficiency, we witnessed the result of our actions through increased strengthening of our cash position.Let me provide a little more detail on some of our ongoing programs that Geoff briefly reviewed. On PC-24 program, production continues to grow as demand for the utility management system is supplied Pilatus is keeping pace with the sale of what is one of the most successful new aircraft launches in the industry. Keep in mind that we believe Pilatus will be ordering a significant quantity of shipsets per year. However, we include only a small portion of this future revenue in our backlog. And we continue discussions with other aircraft manufacturers who have expressed interest in this UMS product.In our commercial air transport market, revenues continue to be generated from our Boeing 737, 757 and 767 portfolio of cockpit technology, both from existing and new customers, domestically and internationally. There has been a little tailwind here because we anticipate that by end of next year, support for existing CRT-based displays will end, making it more attractive for these airplanes to get our cockpit offerings. And this is where our MRO channels are becoming more valuable as we continue to have new service centers signing up as installation sites for our commercial and business aviation products.Relying on our dealer network to perform individual sales allows our internal sales force to focus on more lucrative opportunities. Since we have been manufacturing many of our commercial aviation products for years, they require little additional engineering and are, therefore, quite frequently, our most profitable products.In the military market, our production KC-46 program continues forward. Our engineering contract developed a new air data computer for the Navy and in the aircraft installation and product test support phase. The basic product is derived from successful air data computer we developed for the [indiscernible] and we believe this versatile product to have opportunities on other platforms in the U.S. and international military markets. In general aviation market, we remain excited about the potential of our ThrustSense autothrottle, where we now have single and twin engine STCs. Our strategy is to add optional features for the basic STCs, where each feature is essentially a new technology.More importantly, in contrast to the base autothrottle, the addition of these optional features is strategically designed to substantially enhance the autothrottle in the field. As we progress with additional certification of our King Air autothrottle, we will expand the certification base to allow us to take advantage of the full market potential for all King Air models. And as Geoff mentioned, we are also refining the installation process to reduce the cost and critical downtime of the aircraft. This is a deliberately planned and disciplined way to ensure a successful launch and to improve our long-term opportunities with this revolutionary product.On the PC-12, we're seeing increased interest in both full cockpit autothrottle conservation as well as individual stand-alone installation. We've done deliveries and we've completed installation of both configurations, not just within the U.S., but also internationally, which is very promising. The revenue growth and increased profits realized over the past several quarters are providing the time and resources we need to carefully plan and meticulously execute our autothrottle market entry strategy. Products is being made. The endorsements we have received from industry authorities like Aerospace International News and the welcome reception we are seeing from manufacturers, dealers and operators has us confident it is a large market for autothrottle, constant cultivation will bring it to fruition.Let me turn the call back to Geoff for some closing remarks.

Thanks, Shahram. Another quarter of consistent performance has enabled us to advance our autothrottle strategy at a pace to yield the greatest return. We are, in some respects, creating a whole new market. I am confident that we have the right product, a sound strategy and a strong team that will enable ThrustSense to achieve widespread adoption and we believe that it deserves. We recently heard that the certification authorities had completed a 2-year review of our unique safety feature that can prevent catastrophic loss of control of the aircraft when an engine -- with the loss of an engine. This is a breakthrough. And this prudent review by the FAA and other agencies has resulted in, I believe, an approval and an STC of this new feature -- I emphasize does not exist anywhere in the world today, this feature within the next couple of months. So it's an optimistic output, and we will be happy to answer any questions you have.I'll turn it back over to the operator.

[Operator Instructions] Today's first question comes from David Campbell of Thompson, Davis & Company.

We're having a good quarter. You almost made my estimate, you were close.

We worked hard at it, but I needed a new car.

Well, I wanted to ask you a little bit more about the revenue. First of all, the revenue in the quarter does not include anything from the autothrottle. Is that correct?

It does.

It does, yes.

It does have revenue?

Small amount.

Okay. And you've mentioned something about service revenue. I'm a little confused. Is that the same thing as product revenue? Or what exactly...

It's repair and overhaul. We have equipment that's been out in the field for 20 years now. And some of that equipment is being sent back in for refurbishment or repair. And the revenue from that now becomes significant because the amount of equipment has grown. There's a significant amount in service for a long period of time. And that provides a significant revenue to the company, continues to grow. And we've hired a new manager of that department, who's done an outstanding job. He had experience with OEMs like us so -- and other International OEMs. So he's doing -- I think, the operation is getting better and more productive.

Is it likely to be sustainable? I mean, is this something that's going to happen every quarter or just...

It tends to grow because as you build more equipment, the support of that equipment grows. For most companies that have been around for a while, it's a significant part of their profits. When I was at Smiths, we had a significant repair and overhaul facility that generated a significant amount of our revenue. Just to let you know, it's in -- so when you look at production, it's in that number. It's in the production number. But it tends to be almost $1 million a quarter.

It's in the production number?

Pardon me?

It's in the production number?

Yes.

Yes. Because...

There wasn't any engineering business in the revenue in the quarter.

Yes, there was some.

There was some, but you didn't...

It's been weighted primarily I think to the F5 program where we're still doing -- we're getting funded for modifications to our existing design.

So it was smaller than in previous quarters?

Yes, that's correct.

Our engineering is now more focused towards our own development of our own products now.

Great. So -- but it sounds like autothrottle is going to have more revenue in the future as -- based upon your optimism.

We're talking to a number of sources that have expressed interest in us supplying them autothrottles. Obviously, we don't want to discuss who they are or what they are, but it's premature. But we're chucked and we're excited about the recent FAA decision, which was a landmark decision. They did a great job. It was a tough analysis, but it's a profound change. If we can implement this, it has a -- as many have pointed out, it has the ability to save lives, and that's exciting in itself.

Right. Right. Now do you sell the autothrottle -- are you selling that through service centers, fixed space operators? Is that who you sell?

We're selling through FDOs. We expect to be selling it through OEMs as well. So we look to market -- the thing that has -- everybody has been waiting for has been this decision from the FAA. And it looks like it's imminent. So I'm excited about after 2 years of review, it's nice to see them finally finish up.

They've given you the certification to install it.

We have -- it's a nominal certification. But the thing that I'm talking about specifically is this loss of control. If the engine...

Okay.

If an engine fails and the speed gets too slow, the airplane just flips on its back and kills everybody on board. We've seen some examples of that recently, by the way. So the thought is this system will prevent that from happening.

Okay.

And a different certification, the fundamental certification for the autothrottle. The fundamental certification for the autothrottle is simply as somebody -- a system that controls the speed, the power to the engines and protects the engines from over temperature and over powered.

And the FAA is working on this certification...

They've approved that. That's already approved.

Right. But the other...

The other feature of this loss of control feature has never been done before. And so there was no certification background for them to have to certify it under. So they haven't developed all the background and extensive review to make sure that it was safe. And it appears that they've completed that review, and we expect momentarily some time the approval of the approach. And then we have to fly it and prove it. That's all. But we've been waiting 2 years to fly.

But you still have your King Air, you can use yours to practice on it.

We've tested already. I mean we've brought a lot of tests. And they've been very successful, very promising. But we -- and we now have to test it for the FAA, obviously. FAA has shown -- have been more than cooperative, but they're being very prudently -- very prudent. I mean, this is caution, and it's appropriate for a new technology, especially, this is -- we're trying to mitigate a catastrophic event, an investment that you really don't have much chance to recover from.

All right. The only problem is the King Air is not big enough to hold your new car.

You got that right. A guy that works for me that bought a trailer truck for -- and used it as an RV. And on the trailer truck, he had a smart pod tucked in the back of the tractor so he can drive around when he stops. I must have paid him too much money, I don’t know.

Our next question comes from Erwin at Goldman [ph], a private investor.

Geoff, you may remember me. I'm the old guy at the annual meeting, 96 years old.

I remember. Of course, I remember, you moved faster than I did.

All right. I had a lot of questions then, I have a lot of questions now. I'd like to start off with your employees. Number one, how many did we add in the quarter? And number two, are we hiring now?

We still continue to hire a few number of -- a few people. Because we don't have this urgent need, we're doing it in a carefully planned better way, hopefully getting better quality people. It's a tough environment around us. It's unemployment is nearing an all-time low. So there aren't a lot of people looking for jobs. So recruiting the right people is difficult. But there are -- we still find them, and we've had a few remarkable successes recently at it.

Okay. How many employees do we have right now?

55, roughly 7 -- no 7.

Okay. All right. You had 49, so you added 6. Okay.

And we have some consultants that we use. We use a lot of specialized consultants as well.

Next question is about Pilatus. Is that a public company? And if so, what's its name?

It isn't a public company and it's a switch company.

I know it's switch, okay. All right.

And it's not public.

Okay. Now about the Pilatus. What percentage -- about the sales to them, I'd like to know the sales in the latest quarter? And what percentage of our total sales that is? One would depend on the other. How many dollars? And how many units?

Well, honestly, we don't make any of that public. But we could tell you that it represented a significant portion of our revenue.

Yes, absolutely.

Significant, meaning more than 25%?

More, it can be a range. Yes, it's a little high, but...

I can't hear you.

That's the range, yes.

It's approximate. And we can't tell you exactly what it is because we don't release that.

Okay. Are your July sales through Pilatus more than they were in June?

We're not prepared to go into in the quarter.

That's a detail we don't address directly. The good news is we are on every production Pilatus PC-24 so this rate in which we deliver it during the year are not only dependent on what they deliver, but depending on how they stage their material. So there's periods of -- it's bumping. It's you have a lump and then you have nothing. So we don't define it because it's not representative of what's the consumption. What we do know is every airplane is built and delivered, we're on the airplane.

A couple of things which is public on that is that they plan on delivering 40 aircrafts in 2019.

How many?

40 for 2019 and 50 in 2020. Production's going to go up by 25% next year. A couple of years ago, they opened their books, they took orders for 84 PC-24s at $9.2 million. And back in May, they reopened the book at [indiscernible] base in Switzerland. They increased the price from $9.2 million, I believe, to $10.7 million. And they took a whole bunch more orders. So it's a very, very successful product that's being marketed by them.

Okay. The next question relative to Pilatus is how are they on paying their bills? And do they have a credit limit?

No. They're owned by Swiss banks.

Owned by a Swiss bank?

They're paying their bills. They're paying on time. No issue.

I'm sure it's a cooperation that stands on its own feet. Do you have a credit limit on them? Or a credit guarantee?

No credit limit.

No? Okay. And they have been paying their bills promptly?

Absolutely.

Okay.

And their revenues are over $1 billion.

Really? Okay, good. All right. Can you tell us something about the KC-46? That's military, isn't it?

Yes, that's correct.

And we can't tell you much about the KC-46 because it's military.

Okay. So besides those two, do you have any other customer who is over 10% of your sales in the last quarter?

No, no single one.

And we expect to get more OEM business. We are talking to a number of OEMs for different products. So we want to get a nice distribution, we're looking at expanding our OEM business that will provide stability in our revenues, more stability in our revenues while we pursue retrofits.

Okay. The last question I have is tell us all about whatever you can about sales efforts and interest on the autothrottle?

We can tell you that the industry, all the press has raved about the product, people that have installed it rave about the product. Our issue is simply trying to implement all of the technology that we developed but need to get approved additional features. And it's -- and we're getting close to that, and we're refining as we explained, the installation procedures to minimize the downtime which is if you own an airplane, you don’t like your airplane to be down. So anyway, the -- we don't expect to have any program in the near future that represents individually a very large percentage of our revenue. We will expect to have that distributed over a broad range of people and retrofit first.

You said something about the people who have had it installed. I didn't know there were any. How many installations have you made?

About 5 -- we have 5 and they're working fine and we were bringing it up slowly because we don't want to have problems. And we haven't had any problems to date. We're optimizing installation, which is critical. We're normalizing that installation. We're actually -- we're going into building harnesses that we never initially anticipated. But now we're doing it to provide consistency of installation. It's those kind of refinements that we're in the process of doing it, we're making improvement steps.

The next question comes from Charlie Pine of Van Clemens & Co.

Congratulations on another good quarter.

Thank you.

Thank you. We got -- we're working at it.

Most of my questions have been answered. So the last one, I guess, I would have would be probably for you, Geoff, and that would pertain to your discussion and the information that you had provided regarding what you're doing to, I guess, simplify the process for the auto thrust installs. How many man hours? I thought I read somewhere an article that discussed what approximate man hours of time it took to install the ThrustSense into a King Air. What do you anticipate? Where are you trying to get that number? What's your goal as far as getting that number to as far as the amount of man hours to do a typical kind of normal install for the auto -- for the ThrustSense?

It depends on the airplane, but for the Pilatus it's less than -- it's a single engine, it's less than a King Air.

Well, I guess, I was referring to -- I was -- I wanted to address the King Airs.

Okay. Well, the King Airs, we started out at 50, we believe we're down, we could get it down to 30. So that's what we're working at. We want to keep it as low as possible. Now that's to give you -- that's about -- that's 10% or 15% of what an autothrottle installation normally takes. So it's pretty remarkable. We want to get it down simply so that a person can bring their airplane and get it back within a couple of days completely updated and ready to fly away because anybody that owns an airplane hates to put it down, myself included so...

Got it. So just so that I heard that right over these kind of scratchy phone lines, you said it's -- you're currently at around 50, and your goal is to get it to about 30 hours.

That's correct.

All right. And then with these additional features that you're referring to above and beyond this certification for loss of control, could you elucidate 1 or 2 of these? And these additional features, what's the approval process involved in -- on those -- for those types of situations? What's the kind of lead times?

In summary as to -- the loss of control, obviously, I discussed is a major feature, and it requires FAA certification and review. And it's a long procedure for this because it was never been -- it still hasn't been done before. But the ones we're talking about now are minor modifications. And in some case -- in some cases, we can refer to them as a minor modification as simply submit the data to the FAA, but there's no test flying, other than our own, that's necessary. So these are primarily and, in fact, without exception right now, features that will enhance the operator's experience, but are not certification issues.

Okay. And lastly, can you refresh my memory again on what you expect so just sort of the kind of a plane vanilla cost of an install of the -- on a stand-alone basis without all the extra utility stuff, utility management systems, just the drop in ThrustSense into a King air, what you will be receiving on that again?

So right now, in the King Air, the -- what would IS&S receive?

Yes.

Just the installation cost. The MSRP at the dealer, the guys who are selling it.

Probably, it's about 75k on the King Air, okay? And it's about 65k on our jet roughly.

That's what I meant.

The installed through a dealer.

Okay. Please repeat that again. You said the MSRP for a dealer will be about $75,000?

No. Not for the dealer, for the end user.

End user MSRP installed is $75,000.

Installed? Okay. All right. For the King Air? Great. Okay. Okay. Roughly, great. Congratulations again, and looking forward to more to come and hopefully you get the next FAA decision as soon as you're alluding to.

It's really a breakthrough technology. It's never been done before.

The next question comes from [indiscernible].

I had a couple more questions on autothrottle. Most of my questions have been answered, but I wanted to drill down a little more on -- the way I understand this is you can sell the autothrottle by itself for this $75,000 sort of number or you could buy it as a package with your whole flight deck upgrade. Is that correct?

That's correct.

And then what would be your ballpark guess on percentages, like would 25% of people go for the whole upgrade or 75% or 10%? Or what sort of expectations do you guys have for a stand-alone versus a complete upgrade?

It depends on the aircraft, but I would say initially that the vast majority would just buy the autothrottle. We are finding strangely enough that the autothrottle attracts people into the dealer -- they get into the dealer and say, "Gee, I'd like to do the whole cockpit." So we're getting people that are doing -- especially when they have Pilatuses, we're getting cockpit upgrades. The King Air autothrottle that we now presently provide is one we certified in more advanced cockpits that people aren't going to tear out and put a new cockpit in. These are more later generation cockpits, advanced generation cockpits and probably on far more expensive airplanes. But there's thousands of them out there. So -- and in those cases, we're going to do not as many cockpits. We're going to do, primarily in the autothrottle -- but let me say the autothrottle consists of also providing a standby instrument, which is a combination instrument and an autothrottle. So we do provide some features, additional features in the cockpit.

And currently are your demand signal for this primarily coming out of retrofits? Or do you also have demand pipeline for putting it in new planes?

We're negotiating that right now.

And is -- given your new breakthrough on the safety features of this, is there any discussion at all with the FAA or about a mandate for this in small planes?

The FAA doesn't issue mandates remember. Their responsibility is fundamentally to make sure that whatever equipment is in the airplane is safe. So they do nothing more than evaluate how safe the design and implementation is. I will say that we got comments from one person at the FAA, who commented that they watched a person every 4 days and the things that we were doing which could then save lives. I was surprised that he said that and very appreciative of that. Anyway. That's the good news. The cockpit upgrades right now are primarily in the Pilatus, we may do a King Air, but right now we're focused on equipment that both go into existing installations.

And one more. Given the demand signals you're getting currently, can you help to give a little color or frame up the magnitude of this opportunity for 2020 and beyond, just to give some ballpark idea how to think about this?

I don't want to speculate on that, but I will tell you that there are multiple thousands of aircraft opportunities. If it's successful, we continue to work at it, try to keep the installation costs down, manufacturing cost down. And we would expect excellent penetration, especially if this is a life-saving safety feature potential, which we're not sure of yet, but we believe there's an opportunity for that as well.

So it sounds like you feel like given all the articles over the years and the big news about this, that there's probably a lot of pent-up demand for something like this, I would assume.

Well, I don't know if it had. But again, as I say don't get too enthusiastic until you cash the check for the equipment.

Our next question comes from Rick Teller [ph], a private investor.

Just two questions here. One is, since, I guess, the last conference call, there were -- there have been a couple of crashes of King Airs, there was one out in Hawaii and I think one down in Texas. Obviously, there's no reports yet probably from the National Transportation Safety people. But as far as you can tell, are either of those things that, perhaps, might have been prevented with your autothrottle?

Honestly, I really wouldn't want to speculate. I don't want to speculate on something that killed 21 people. I really don't. It is -- if we're fortunate enough to be able to do something, that's great. But I don't know the details of either of those crashes. I only have it third hand and wouldn't want to speculate on how our equipment would work so...

Right. Okay.

I'm sorry. I don’t -- I'm obviously evasive, but it's just -- I think it's appropriate that we don't -- we still don't have that KSP analysis of what happened. So for me to speculate whether we could do anything would be inappropriate.

Right. Okay, understood, no problem. The other question is this. A lot of King Air owners are using them for various commercial purposes rather than just as a private plane. I'm sure that the insurance expense for them is probably fairly high. I'm wondering whether you have yet made any attempts or plan to be in touch with aviation insurers to see if they would give a discount to King Airs that have autothrottle installed with the extra safety feature.

Your comments are very appropriate and well pointed. But yes, we have contacted the -- some of the insurance companies. Anything that reduces pilot workload is terrific. And yes, insurance is very expensive. So it -- I think, clearly, that's a feature that insurance companies would like, I think. But ultimately, anything you can do especially in a more complex airplane, anything you can do to reduce the pilot's workload is important. And we see this in a broad range of applications, not only in the King Air, but in the -- the same system is applicable to regional jets and a large variety of literally tens of thousands of aircraft that have no autothrottle that we could work with. So we see a large market. But look, it's very early in the stage. When our production rates are up, I can be a lot more bullish. And right now I'm being a little circumspect. I appreciate your interest. Thanks. We'll shut off today and look forward to having you join us next week.

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