Innovative Aerosystems, Inc. (ISSC) Q1 2020 Earnings Report, Transcript and Summary

Good morning. And welcome to Innovative Solutions and Supports First Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.I would now like to turn the call over to Geoffrey Hedrick. Please go ahead.

Good morning. This is Geoff Hedrick. I'd like to welcome you this morning to the conference call to discuss our performance for the first quarter of fiscal year 2020, current business conditions and our outlook for the coming year. Joining me are Shahram Askarpour, our President and Relland Winand, our CFO.Before I begin, I'd like Rell to read the safe harbor message. Thanks.

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.

Thanks, Rell. The New Year is off to good start with our fifth consecutive quarter in which we generated revenue growth quarter-over-quarter. Revenues were comprised primarily of product sales and customer service revenue, both of which carry attractive margins, which led to our 58% gross margin in the quarter, down only slightly from peak margins achieved last quarter.I'm pleased that we continued growing the business, while maintaining healthy margins. Last quarter as I mentioned was the best quarter in new orders for more than two years, and I am quite pleased to announce last quarter's orders were also very strong. We once again finished the quarter with a backlog that was greater at the end than it was at the beginning.In addition, we also have production contracts that extend over a number of years and we believe have promised additional revenue not reflected in our current backlog. The largest of these was a very successful Pilatus PC-24. We have previously disclosed that they intend to increase their PC-24 production by 25% this year. This has been a remarkably successful aircraft program, maybe one of the most remarkably successful that I've seen in many, many years.We remain pleased with the financial results we have been recently reporting, but some of our most significant recent project progress is not reflected in our current results. Most recently, we were awarded a Supplemental Type Certificate for the revolutionary protection system against catastrophic loss of control with one engine inoperative. The milestone achievement was followed by our first agreement with aircraft manufacturer to supply our ThrustSense Autothrottle as standard equipment on new aircraft production.They reflect, we believe, a market interest to quickly adopt the technology, not only in a targeted retrofit market but in the OEM market as well. Authorities suggest that one engine -- loss of control accidents are responsible for multiple catastrophic accidents annually, and our VMCa control system will mitigate or if not totally eliminate this condition. Originally developed for the retrofit market, our autothrottle is receiving interest in both best domestic and international OEMs.We are pleased to announce that an aircraft manufacturer that intends to include our autothrottle as standard equipment in their new aircraft production. Between the retrofit and aircraft manufacturer systems that have been certified, we believe our potential market opportunity is very large and growing. Therefore, we were undertaking a number of actions to help accelerate the adoption.First, we're working on means and methods to reduce downtime required for installation, an important consideration in any retrofit application. Second, we continue to refine and enhance the product, adding new features that add functionality, value that will improve operational efficiency and safety. Finally, we conclude -- continue to pursue new opportunities in all our commercial air transport, military and general aviation markets.We see large potential demand and military and regional aircraft markets for our autothrottle. Our plan is to continue to pursue additional STCs on multiengine aircraft and retrofit market with existing large fleets. We're also looking to expand our OEM business, some of the aircraft that we are targeting in these markets are much larger, and we feel our autothrottle can provide a meaningful improvement in aircraft’s safety and reduce pilot workload.With the autothrottle STCs in both single and multiengine aircraft secured and the recent qualification of our VMCa, that is the loss of engine -- loss of control problems, that’s what VMCa technology. And the award of the OEM agreement, we believe autothrottle technology is positioned for very significant growth.Let me turn it over to Rell for a discussion of our financials.

Thank you, Geoff, and thank you all for joining us this morning. Revenues for the first quarter of fiscal 2020 were $4.5 million, a 13% increase compared to the first quarter of 2019. The majority of revenues in the quarter were generated from product sales, primarily general aviation in military, as well as the steady level of customer service revenue. The small amount of engineering revenue we earned this quarter as compared to the first quarter of 2019 reflects the completion of the F5 development contract.Gross margins for the quarter were 58%, up from 54% a year ago. Gross margins reflect an increase of first quarter revenue from product sales and the growth of our high margin customer service revenue, margins also reflect the leverage obtained when we increase volume across our fixed overhead.Total operating expenses for the first quarter of fiscal 2020 were $2.4 million, up from $2.1 million in the first quarter a year ago. Research and development expense increased from a year ago. This reflects an increase in the amount of internally funded R&D for which is expense as incurred in contrasted funded R&D, which expenses are charged as cost of goods sold. With the wind down of the F5 contract, funded R&D has been significantly reduced.Selling, general and administrative expenses were up 230,000, primarily reflecting the increased investment in sales and marketing. In the quarter, we earned $96,000 of other income, $79,000 of which was interest income. Due to tax loss carryforwards, we incurred no income tax expense in the quarter. We reported quarterly net income of $328,000 or $0.02 per share, more than double the $139,000 or $0.01 per share over year ago.The company remains in a strong financial position despite a very modest use of cash in the quarter, primarily to fund increase in receivables and inventory associated with our steady growth. At December 31, 2019, we had over $22.2 million of cash on hand and no debt. 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. In the first quarter, we continued to achieve steady progress towards our short-term and long-term goals. In the near-term, we had another quarter of top line growth and a doubling of our profits.Longer-term we witnessed two important developments that we believe will result in the success of ThrustSense Autothrottle, and STC from our patented VMCa technology and our first contract with an OEM that intends to make our autothrottle standard equipment on production aircraft. As Jeff mentioned, as pleased as we are of our stronger quarters of revenue growth and profits, we are equally pleased of what these two recent developments mean to our future opportunity.So let me first provide a little bit more color on each of them. We believe our VMCa mitigation technology is the first of its kind of, and with it having been evaluated and approved by three different departments within the FAA. We believe also that our STC has been validated as the de facto standard for this catastrophic loss of control mitigation feature. We have already discussed how independent evaluations by leading aviation authority have lauded the product in various aviation trade publications.So relative to competitive products in the market, the ability to incorporate VMCa loss of control prevention and our autothrottle provides a tangible competitive advantage. The award of an agreement with an aircraft OEM that intends to make our autothrottle standard equipment on their production aircraft has been announced.Due to the nature of our agreement with the manufacturer, there is little more we can share with you about this agreement at this time other than what was previously announced. Nevertheless, we believe that having been chosen by an OEM as standard equipment for production aircraft is further market validation of our autothrottle value. We are also in discussion with other aircraft OEMs to include ThrustSense as standard fit into their production aircraft, as well as retrofitting their existing fleet.In the propeller market, there are a great number of multiengine aircraft, ranging from smaller part 23 pistons to larger air transport part 25 turbofan aircraft, as well as numerous multiengine turbofan aircraft that would benefit from our VMCa technology in both military and commercial markets.On the aftermarket side, we have been pursuing markets through certified installers and MROs. We are also pursuing large military fleets through approved integrators and military installers. Meanwhile, our strategy is to pursue the larger OEM opportunities directly through our own sales organization. We anticipate autothrottle production orders and installations will start this fiscal year. This will be the beginning of what we believe is a ramp up that has significant lead potential to increase future revenues.Just quickly reviewing the programs driving current results in the PC-24 program has been running at a steady level that we believe should approximate 50 Pilatus aircraft this year. Again, this is a long-term contract, which we believe will span multiple years and generate demand for thousands of units only a fraction of ultimate value is in our backlog.In the commercial air transport market, we are experiencing steady demand for our Boeing 757 and 767 portfolio of cockpit technology. We expect that the revenues from the air transport side of the flat panels will stay at current levels for the near future at least. And since many of these are close to off-the-shelf products, these sales can generate nice margins.In the military market, our production KC-46 program continues forward. This is an ongoing program, which we believe will provide a continuous revenue streams for long time. Development and flight testing on the F5 flight data -- data computer is now complete. The company has now received the expected additional engineering contract to enhance the design assurance level of the unit. Additionally, we anticipate receiving a production order contract for the U.S. Navy in the near future. We also believe this product has the potential to be sold to foreign militaries as well.Backlog is up again from last quarter and revenues from backlog continue to be supplemented by steady demand for customer service, intra-quarter book-and-ship work and the contribution from long-term contracts where only a fraction of the total contract is reported in committed backlog. New orders represent the mix of commercial, air transport, military and general aviation programs.As we glance back at the recent challenging years where we invested significantly in the ThrustSense Autothrottle development and initial certifications, we are pleased to begin to see the results of that business.Let me turn the call back to Geoff for some closing remarks.

Thanks, Shahram. I attribute these results to our disciplined commitment to better leverage our core technologies and innovation in our designs in both the commercial, general aviation and military markets. After a strong fiscal 2019, we're entering the year with new momentum and new wins. We remain cautiously optimistic. We're obviously excited about our autothrottle program, and we believe this program over the longer-term, can generate expanding acceptance so that as it proceeds the growth will approach an exponential growth rate. But we are being cautiously optimistic, as I said, about our current projections. We still will have to work to ensure that we can provide our customers with the high quality and reliability on which we have built our reputation.I'll turn it over to the operator for questions and answers.

Thank you [Operator Instructions]. Our first question comes from George Marema with Pareto Ventures.

I've couple of questions, the first question on this new OEM. When you guys expecting to start shipping on that?

In the next six to eight weeks.

Six to eight weeks from now you will begin shipping?

Correct.

And are there any -- is there any commentary regarding like the how many planes they make a year, or a little bit what the size of operations?

It’s going to be formally announced to the industry in the late spring of this year. So we have been asked by the OEM not comment on it until the announcement comes out. And that's the reason why -- I'm sorry about this. We're not trying to beat -- there is nothing unique about the situation. It's just simply we want to announce it together at the appropriate time and that's a few months away.

And then on the comments you made regarding military segment. I didn’t quite catch all that. What are the -- were you talking about a military opportunity for auto sense or something else? Could you elaborate a little bit more on that?

Well, there is a number of aircrafts that would be helped by autothrottle and it just has been an autothrottle that was readily installed in the existing aircraft. We have one that can be -- we have a number of opportunities that we have identified. It is simply a question of adapting our actuary into the airplanes. We have got two or three targets that we are working on as we speak. And so we think that the military market is going to be a good and a big one. In additional, the regional aircraft like ATR 42 and 72, these are twin engine turbo props, have suffered from the same kind of loss of engine accidents and our system has demonstrated that it can protect against that, prevent that from happening.So as a safety feature and to reduce pilot workload, it as a compelling it’s compellingly attractive, we have multiple patents on the technology. So we're always guardedly confident but we think there's an opportunity there. And we were just visiting somebody yesterday and talking about the program, and they expressed a great deal of interest. So we're optimistic in all three segments, military, commercial and business jet.

On the auto sense, on the retrofit market, can you give any commentary on what's happening currently in the first part of 2020 with that? Are you shipping now and what…

Well, we have two installations going on right now for airplanes in the commercial lines. They're both Pilatus PC-12. We have a King Air. We're looking at -- we're just about to finish the latest version of our King Air and we'll be supplying that for the first commercial installation, I would say in about three months. So it's building momentum. Right now, we keep refining the product, the twin engine product has now been certified for the loss of engine recovery, but we've enhanced its operations so that it will accommodate very high rates of change of the air speed. So that they’re under catastrophic conditions, it still works and provides recovery. It's very good. It's notably unique. It's never been done before by any airplane, commercial or military.

Have you had feedback from the MROs on their outreach to the market on this?

There is two things that are going to happen. The OEM -- some of the OEMs have certified service centers throughout the world. And that's going to be -- that's already in progress to have them offering for retrofit. It's a large number of aircraft of all kinds that will be serviced by these service centers. And then we deal with the FBOs; FBOs because this is the area that we're in right now; MROs we deal more generally with the larger aircraft. So we use FBOs and we expect to have upwards to 20 totally as doing installations on a regular basis.

Our next question comes from Rick Keller, a Private Investor.

Two things with reference to what you said in your opening remarks. One is that you're still working to reduce the downtime. I recall in the last conference call that you were holding up any possible installations pending you're developing these new methods. How long do you think it would be before you think your installation message will be kind of let’s call it standardized enough that you can say, okay, this is good enough to go with?

No, we're there. But we’ll continue to improve it. But right now the installations that are going on now follow the profile we develop and it was very good. Our effort is to try and get this thing down to a couple of days, so that the owners don’t have to tie their aircraft up for a week or two anybody knows an airplane hates to give it up even for a day. So that's why we're doing it this way. Also it increases the number of units that can go through the modification places. If it takes a week you can do fewer per week, that's simple.

And one other thing you mentioned, you said that you are also trying to improve the product by adding new features. Are these features things that will have to go through a process with the FAA to get approval, or are they kind of smaller things that you can just add one without having to do substantial testing?

Most of them are small enough so that we can get a change to an existing STC, and not go through a long re-certification process. Other features may or may not be so significant that they'll need re-certification, but we're moving in both areas very quickly. And quite bluntly that FAA has been extremely cooperative. They're still being very prudent but there is no -- we are not experiencing any delays from working on it. They work on it immediately. So we couldn't be happier.

[Operator Instructions] Our next question comes from Michael Fredrick, a Private Investor.

I had a question about the process of getting the ThrustSense included in a new plane with the OEMs. Is that something that also requires an FAA approval like the retrofit market? Or if it’s going in during production, is there a different process to getting that accepted?

Well, I mean the Supplemental Type Certificate allows an OEM to install the equipment in phase and on the line and ship it. So that's -- it can be used as to support production in early stages. Ultimately, the OEMs don’t want to do a type certificate as opposed to a Supplemental Type Certificate and he’ll take the Supplemental Type Certificate and submit it to the FAA with an application for a type certificate for that exact model and the same installation. So it’s two different situations but in either case, it doesn't hold up the OEM’s ability to deliver product.

And when you’re talking about using ThrustSense on these larger military type planes. With the per unit cost of the item go up on a larger plane, or is it a relatively standard cost across the board?

Well, on a larger airplane, it's going to be more – obviously, more involved. So you can be -- you can figure that the price is going to go up. I mean, there are four engine airplanes that we can do and it's not an issue, but it would sequentially go up almost proportionally the number of engines. It's hard to -- but in general terms, a bigger airplane takes more equipment, longer distances, all of those things and therefore, it's going to be somewhat more expensive.

And I know that there's a huge number of planes in the piston market. Is it eventually, will this product be available for the -- on a price scale low enough for these smaller piston type planes?

Yes. The system is remarkably adaptable from the very low end all the way up to the high end. I owned piston airplane 35 years. So I'm acutely aware of what it cost. And by the way, none of those are cheap.

I'm using a relative term, and I guess that's it. Thanks guys.

Our next question comes from Mike Heberg with Axiom.

Is it realistic to expect that at some point the NTSB might make a recommendation to the FAA to mandate the autothrottle for commercial applications because of the safety nature?

I don't know whether -- honestly, I can't project that. They obviously mandated to us which was -- but there was a lot of support from them, from the Congress on that as well. I think what's going to mandate is if you think about it, if your airplane has it and your competitors don't, why would you want to fly in an airplane that if you got too slow with an engine out, it's just rolls on its back unrecoverable and kills you. I mean that's -- if you own an airplane is $5 million or $10 million or even $1 million, why would you want -- not want the equipment to do it. And I think aircraft manufacturers are very reasonable. I mean they really just -- when they know that something is safe, it helps the safety, I don't think they hesitate finding a way to put it on their airplanes. So whether it's mandated or not, I don't know.

Has there been any discussion with insurance companies to insure aircraft operators?

I think that's a very strong way to do it. And contacting insurance companies is obviously very smart, because when they do fail it is a pretty ugly conclusion, there's not too many survivors. So in anyway the only reason it hasn't been done before is it never existed before. I think based on our experience to-date the manufacturers are very interested and are being very expeditious about implementing it.

As we have no further questions, this will conclude our question-and-answer session, as well as today's call. Thank you for attending our presentation. You may now disconnect.