Good day and welcome to Innovative Solutions and Support Second Quarter 2020 Earnings Conference Call and Webcast. 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, Chairman and Chief Executive Officer. Please go ahead sir.

Good morning. This is Geoff Hedrick. Welcome this morning to our conference call to discuss our performance for the second 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 would 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.

The coronavirus pandemic is reshaping the way we live and work including the lives of our many dedicated employees of IS&S. As the business deemed as essential, we have managed to safely keep our operations open to meet our obligations to our customers, which includes markets that are vital to the nation's safety and security such as the military, as well as cargo air carriers, who are playing an increasingly crucial role in getting medical supplies that are needed throughout the country.And we recognize the challenges early on. We took aggressive steps to protect the health and well-being of our employees, our families, our customers, and our partners, as well as immediate and remedial actions to minimize the impact to our business.The results of these efforts have been rewarding. All 100% of the IS&S team members have complied with the new safety procedures and have come to work, my personal heroes.These past three months resulted in a quarter-over-quarter revenue growth and the sixth quarter in the last seven in which we have generated sequential revenue growth. We generated strong cash flow and has one of the strongest quarters of new business backlog has increased to nearly $10 million highest in years. The margins were impacted by period cost fluctuations in the quarter. We expect them to rebound the prior levels in subsequent quarters.We will deliver production -- we will deliver production quantities of our Autothrottle to the OEM this quarter, which would represent the second major OEM contract in the general aviation market. The Autothrottle has been six years in development, culminating with the FAA Certification of OEI upset protection and adoption into a major OEM production.The general aviation market and Autothrottle, we believe provides an excellent, excellent opportunity and further inserts us into a market both in terms of…

Thank you, Geoff and thank you all for joining us this morning. Revenues for first quarter -- for the quarter of fiscal 2020 were $4.8 million, a 15% increase over second quarter of 2019 reflecting increased product demand, as well as increased customer service revenue, which was over $1.2 million in the quarter. There continues to be engineering revenue associated with the F5 development contract.Gross margins for the quarter were 47.5%. That is down from last quarter as well as a year ago due to product mix, an increase in warranty costs and higher labor expense as we stamp up ahead of future production demands. We fully expect margins to return to levels recently achieved as these expenses normalize.Total operating expenses for the second quarter of fiscal 2020 were $2.2 million, down from the first quarter and little change from a year ago, so that normalized expenses remain relatively stable despite the revenue growth we are experiencing.Research and development expense was up slightly from a year ago reflecting an increase in the amount of internally funded R&D which is expense as incurred in contrast is funded R&D which is charged across the goods sold. With the wind down of the F5 development contract, funded R&D has been significantly reduced.Selling, general and administrative expenses were essentially unchanged, as we work hard to keep cost under control.Interest and other income added $75,000 to the bottom line this quarter, which is a little less than last quarter, mostly due to the decrease in interest rates. Due to loss carry backs we recognize the $309,000 tax benefit in the quarter. A loss carry back resulted from the Coronavirus aid released an economic Securities Act or CARES Act which has been signed into law. The CARES Act amends the net operating loss provision, allowing for the carry back of losses to each of the two taxable years preceding the taxable year loss.We reported quarterly net income of $438,000 or $0.03 per share more than doubled the same quarter a year ago as well as sequential improvement from $332,000 or $0.02 per share in the first quarter. So the first half of the year, net income is more than twice that of the first half of fiscal 2019.The company remains in a strong financial and generated positive cash flow of $500,000 from operating activities in the quarter. At March 31, 2020, we had $22.6 million of cash on hand and no debt. We believe that 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. It certainly has important, exciting and challenging first six months. As Geoff explained, and as an essential business, we have remained open over the course of Pennsylvania's shelter in place director.Our first priority was the safety and health of our employees. So we acted swiftly to enact a plan that met and went beyond Federal and State guidelines, while maximizing the productivity of our workforce.Additionally, production crews during the month of April, were split into two different shifts, with each shift, one week on, one week off, but paid for both weeks. Although, short term productivity was reduced as a result of measures taken, we believe the overall results of this quarter will not be significantly impacted.We are currently meeting our delivery deadlines, and in fact, we are now hiring to staff up to meet the increasing production requirements.As heard from Jeff, we expect to start shifting production overthrow units over again, this order. This is an encouraging endorsement of our Autothrottle technology from a leader in the general aviation industry.As we have mentioned in the past, the ability to incorporate VMCa mitigation in our Autothrottle provides a tangible competitive advantage to twin engine aircraft. And it seems OEMs want to capitalize on this advantage by incorporating the technology into the new production aircraft.It offers a great selling point to prospective buyers as it offers potentially lifesaving rollover protection for twin engine aircraft. And VMCa mitigation technology is a standard part of our Autothrottle.We have been in fact anticipating an influx of orders throughout production orders and while it may not be a year of big Autothrottle shipments. It is shaping up to be the beginning of a ramp up, we believe a significant potential.Once again, quickly reviewing the program's, driving current results.…

Thank you, Shahram. Well, current conditions make it particularly difficult to forecast future sales with a real degree of certainty. We're confident that the prior progress we've achieved today has positioned as well to prosper over the longer term.I want to turn it over the operator for lines for questions-and-answers now. Thank you.Thank you. We will now begin the question-and-answer session. [Operator Instructions]And the first question will come from David Campbell with Thompson Davis & Company. Please go ahead.

Hey, good morning, everybody.

Good morning. How you doing?

Thank you for all the good news.

We're happy to give to you. It's been a good time. It's an interesting time.

Yes. It surely is.

Especially with a massive downturn in commercial air transport, I guess, is down 95% hard to believe. We just sent somebody out to Wichita. I think he said, there were only about 20 people on the airplane. Although, he said, -- on the one of the flights, there was a woman that was in completely wrapped in plastic with whether her wrist and ankles taped and ventilating for breather.

She didn't want to take any chances.

But what it speaks to interestingly enough is there's a hell of a lot more interest in flying from in charters and business jets, where you could control number one, the people that are going to be on boarding the airplane with you. And number two, you don't have 100 people show as an example, we had some friends down in Palm Beach, with charter of and eight passenger citation to bring them back up. And when the price was distributed among the eight passengers, was about the same as our first class ticket.So it's interesting that we may even actually see a strengthening in that market. We're delighted that we've established our sort of foot in the door. Just by the way, David, I did some looking, if I look at the three production programs, what we call the ongoing OEM type production programs, their revenue at the end of next year, will be equal to some street programs will be equal to our revenue last year -- total revenue last year, and that'll be in just those three ongoing programs. So it's -- it's a problem. It looks very promising. The problem is we're on -- on spectacularly successful

Yes. I know that. Thanks for the comments. I just wanted to ask a sort of technical question about the taxes. The CARES Act provided us some tax benefit in the second fiscal quarter. Well, that's the only quarter though, will the third quarter go back to the normal tax rate?

Right. I mean, yes, the effect of the Cares Act and going forward is in the past quarters, we have done well. We really haven't had any tax expense. So I don't expect that expense.

The truth is David, this quarter, this past quarter attended to mitigate the periodic fluctuations in period costs. So what kind of level goes out this coming quarter, they will be there, but we expect it upturn in both volume and margin. So it will all balance out for a change. It works with us rather than against us.

So assuming there's pre-tax income in the third and fourth quarters, there shouldn't be any charges for taxes?

Yes. Yes.

Okay, great. Well, what about the rest of the business? The flat panels growth in the cargo conversion market that's likely to continue because the passenger market will probably stay down for some time. And they'll be using these passenger planes for cargo.

So very good. That's a very, very accurate observation, David. The reality, I mean, think of it, you're an airline or a carrier, and you got a whole hell of airplanes, specifically five sevens and six sevens, which you don't need now because no -- there isn't anybody to carry and I don't expect to have large markets for several years, because people, myself included might be apprehensive about going to Europe or traveling.So it's going to be down those areas redundant, so the obvious thing is that you convert to package carriers. The other thing that we've learned in this last three or four months is that people rely far more heavily on Amazon and alike. And you can even see deliveries in that area, the online ordering, I understand has gone up by about 25 or 30% just in the last, and I expect that people are getting use to it. I certainly I’m getting use to it.Very nice. So we can probably expect more and more and take a look at the aggressive action that Amazon which was to essentially build their own fleet of airplanes, I mean, obviously, they’re -- a lot of them are on charter, but they’re committed to that -- to the Amazon operation. And I think they’re over 80 now, and it’s very reasonable that they could be up to several hundred committed cargo aircraft, and they all would be converted from five sevens, six sevens presently in service.

It's amazing to me that these five sevens and six sevens all have old technology…

Well, they -- defensive five sevens, six sevens at the time, it was very advanced. That was the good news. Literally, there are other airplanes that were in production at the same time, the three sevens and five sevens really were analog airplanes were the five sevens, six sevens were substantially a sort of a digital airplane. So they were a transitionary airplane and that's -- and so they’ve got a lot of life schedule and they’re a very efficient way of moving cargo. The six seven has a lot of box space to move a lot of packages.

Right. Thank you very much, and good…

I’ll tell you -- when you look at deliveries now, I was looking something this morning, and they say, you can't well deliver it in an hour. Why would you want to start your car and drive to the store, wearing a mask. I mean, I want to do that. So anyway, I'm sorry to get carried away. You go ahead.

No. I'm just saying thanks for the comments. And thanks for doing such a good job, building the business. And I'll talk to you soon. Thank you.

Thank you for your support. Go ahead.

[Operator Instructions] Our next question will come from Michael Frederick, investor. Please go ahead.

Good morning, everyone.

Good morning.

Good morning. Hey. I have a question, a follow-up question from the last call. You haven't been able to announce the new OEM partner yet. Is that been pushed way back? Or is that still on schedule for maybe the next quarter?

The simple answer is I don't know.

Okay.

Up to the…

I mean, we have obligations under agreements that don't allow us to divulge certain things. And that's all. And there's nothing very dramatic about it to be blunt with you. And it doesn't really affect our business in any way. But you're right. It is a little odd, I would say.

Yeah. And I’ll be honest with you…

Hopefully, understand that it is odd. And don't come to their senses, we’ll see.

Yes. And I'll be honest with you; it's not really hard to figure out who it is, but anyway.

But I…

Yes. I won't say any more. But anyhow, another question I had for you. You said that you had three OEM programs. Is that the PC-24, the tanker and the new OEM? Are we talking about? Or just two OEMs…

Yes. Yes. That's exactly what it is.

Okay. Okay.

No, that's exactly what it is. And they're all solid programs. Obviously, the tankers solid, the PC-24 has been a spectacular success as an airplane, they keep raising their brakes, and we're adapting our manufacturing to accommodate as much as double the rate. So we're stronger. And the third the OEM that we don't talk about is quite frankly, we couldn't be more pleased with their cooperation and support and the realization that this is a significant safety feature for their aircraft and will be unique to them for that aircraft in the world, a real lifesaver, so.

That's fantastic. That's fantastic.

It’s nice -- we've got good pointers. And I think the prospect of a lot of business.

Great. Great. So you -- just real quick, you had said that you thought that by the end of next year that the three OEM programs would exceed, you say, last year's revenues?

That's right.

Okay. So, all right. Great, great. And then one --- yes, and then one quick -- one more quick question. The backlog, so for something to make in the backlog are we to assume that that's something that's going to be delivered and what the next two quarters or what's on the qualification and…

I don’t think interim that. It's just remember the backlog really doesn't reflect all the potential business as an example. Any OEM make may agree to put their equipment basic on the airplane, let's say standard. They’ll only give you purchase orders for the next 20 years, they only release purchase orders and over a six-month period separately. Boeing did it kind of a double standard, they will release a six-month group of, so the only thing we ever see in our backlog are those that six-month period. The total -- if you took at the total over the next 10 years of the program would be obviously orders of magnitude larger.

Okay. But to make it the backlog, you're essentially saying you need a purchase order?

These are orders with a defined payback schedule. Is that right? Its sound right, yeah.

And ballpark, I mean, how much time we’re talking about that. Although, we delivered over how many months?

I can't answer that. I don't know.

All right. Okay. Okay. All right. Well, guys, great report. Just doing great. Appreciate it. Take care.

Thanks for your support.

Our next question will come from George Marema with Pareto Ventures. Please go ahead.

Hey, good morning, guys. That was a fantastic new order number today. To follow-up on that. Approximately out of this new orders, how much of this was new OEM Autothrottle business versus the retrofit markets? And just in general, how is the retrofit market for the auto sense, Autothrottle performing

Well, the business for the Autothrottle is starting to really blossom now. We're getting a lot of interest. We -- so we've been doing PC-12 and now we're doing King Air as well. So the retrofit opportunity is orders of magnitude larger than the OEM business. To gives you some idea, there's probably in just one airplane, there's a total market of over 5,000 opportunities, so that's huge. And we're looking at other airplanes that we're working on now where they built over roughly dying 1,000 of the airplanes.And this Autothrottle has gone from being a cruise control to a lifesaver and a multi-engine airplane. As you're aware of the Addison, Texas scenario that we saw on the news, where the airplane just generally roll-on over on its back and into the warehouse is not enough, sadly an uncommon terminal scenario. Our system has been certified to prevent that.

Right. Are you guys in discussion with additional OEMs on this autosense Autothrottle?

Yes, we are.

Okay. So on the new orders, I'm assuming that some of that is from the Autothrottle business, correct?

Look it’s all very -- no, this is also happening in the last couple months. So refining and trying to understand what is your means as relevance? It's, I think, premature, I think we have to kind of say things are maturing well. In light of the pandemic and all the other crap that's been going on. We're pleased -- just think about it under pretty adverse conditions, we were able to expand our business and grow it toward the future. If we could just keep our heads down and work hard. Hopefully, we'll keep that going.

Okay. As you look out into the back half of this year into next year, do you expect the gross margins in terms of product mix to sort of stay in this normal zone you've had in the last couple years or and do you see any longer..?

It will go up. There are bunch of fixed costs associated with them. Obviously building and things like that, that don't need to be expanded and therefore the gross margin should go up. Remember, I do remember is that been around a while, the year that we did over $60 million returned $18 million in profit and cash, 30% net after tax. I don't expect to do that again, but that gives you an idea of how sensitive the margins are to volume.

Okay, already. All right. Thank you.

Thank you.

Our next question will come from Roger Goldman [ph], Investor. Please go ahead.

Thank you. Good morning. And I'm an investor. You guys knew my dad, who was a long-term investor and he died a couple of months ago and now my sister and brother and I are investors and thank you very much for the good results and a good report. A quick question about your cash. Are you guys getting in the banking business? That's a theoretical question, of course, but you got a lot of -- you got a lot of cash on the balance sheet and questions, are there any interesting opportunities out there to do something with it in a low interest rate environment?

Well, we're looking at that. I'm reminded about two seconds. It was serendipitous, that in a time when the Federal government felt that it had to loan money to the industry to keep it alive. And so they would have cash flow and wouldn't go out of business. Our business is needed and had that reserved in place. So I will make any apologies for.

No, I wasn't expecting you to.

And one other thing. Yes, we're going to look at how we best use that. The company has now transitioned into a position, we believe that will generate cash ongoing in the future and that will change the equation. So, we will look at that. I would…

I mean--

The company and I always enjoyed your jazz. If I remember right, he was 95, but I still remember him saying to me, I got a third of my net worth in you guys, so get going.

That's right. But he died peacefully with all his marbles in January and basically told me, I'm the Executor basically told me don't you dare sell that stuff.

He is a good man.

Yes, thank you. Thank you.

How old was he?

97 with all his marbles.

97 with all his marbles and he came in the [indiscernible] from Jersey?

That's correct. Well, hopefully runs in the family. Anyway, thank you so much. By the way, I wasn't asking for anything specific in terms of how you use the cash except there's going to be lots of bargains out there. Asset values of a lot of companies are going to be dropping and cash becomes King as you know in this environment, having to those--

And we obviously are mindful.

I'm not asking you to disclose anything, but just wanted to comment on it.

Roger, I think we're okay. Trust me, we discussed it constantly.

Okay. That's good enough for me.

What are you doing with the money? So anyway…

Now, okay. Well, I'm looking forward to meeting you. We're in Palm Beach in the winter and actually, your comment about chartering is spot on. That's how we're getting North.

It's a sensible way to do it.

Yes.

[Indiscernible] and you actually don't even have to land in Philadelphia International in fact…

Well, we're going to fly right into Westchester.

If you are in the right kind of airplane, you can land in Westchester and places like that with...

Actually, we're going right into Westchester.

You know our plans here?

Where?

Westchester, New York HPN or Westchester PA.

Okay. Well, I'll come visit you.

Where you in New York or Pennsylvania?

No, we're summer in Western Massand winter in Palm Beach.

Okay.

Pretty good life.

Yes. I grew up in Westchester County. Anyway, you have a good day.

Okay.

And we're doing our work and you enjoy with your family.

Great. Well, thank you and the best is yet to come.

Bet you.

The next question will come from Steve Rudd with Blackwell. Please go ahead.

Hi, guys. First, I'm very grateful that you are coming into work and organizing things as well as you have. And happy to hear everybody's voice on the call. We talked about the delivering production quantities of Autothrottle this quarter and if I remember correctly, the units can rent up to $50,000 per units, so how many units are we talking about for this quarter?

Couple of dozen.

A couple of dozen?

Yes.

Okay. So that would be then a significant impact on revenue.

I hope so.

Okay, all right. That sounded different than what we had and my numbers are about…

To be honestly, I'm great. I'm just really pleased that we're that our customer has committed themselves in such a terrific way. It's been a hold of good partner and the program is starting along exceedingly well. They're even -- the simulators for the aircraft are even and being built as we speak. And they'll be training people within a couple of months. So the program is moving along very well.

Okay. So the incremental revenue could be as much as $1 million or more?

We don't really, we're not going to estimate that.

I was just trusting my math.

The best thing we can do there's a lot of a lot of moving marbles right now.

All right.

We're trying to keep them together.

Okay.

We're just focused, we'd like to explain what we think is general opportunities and we'll work hard to try to make the best out of realizing those opportunities.

Okay. Fair enough. I didn't note that our gross margins were 47.5% I think they run higher on Autothrottle, so that incremental -- those incremental sales, I'm assuming our sales, we take a base of $4.8 million for this quarter, we're going to be running up higher than that with a given that our margins in Autothrottle are a bit higher than that. It should be average gross margin of greater than 47.5 for this for this quarter we're in.

Honestly, when you get in gross margins in the 45%, 50% range. You don't want to expect a hell of a lot more you can get them and we've had times that were over 65%. But if you try to run a business with that as a target, you're probably not going to grow the business very fast. So it's -- the last density of the curve, it's sort of disappears when you get into those levels.

Okay. That makes sense.

The only people that you can maintain those kind of margins is Heidi Fleiss.

All right. I won't take -- I won't go for that too much more in a Me Too movement and I'm not among those who are Me Too in any negative way. So let's talk about the Care Act, remarkable comment. Let's talk about the Care Act. What is the magnitude of the benefits that we're going to get on the tax benefit because I somehow that blew past me.

Yes, the biggest benefit was for us was just the carry back. As you remember, we’ve signed into law a year ago or so, you couldn't carry -- the change in law was carry back losses you can only go forward. So this new March, whatever the exact date was late March, but it allowed companies to do is to carry back losses. Now, for us since we're a fiscal two years, I mean, I assumed the point was cash, right?

Correct.

So you file it. If the company can get some cash carry the loss back and is another way of funding some company, so that's the benefit we received from it. Now we just..

What's the dollar amount that we should expect to get back as you're talking for refund, right?

Yes. Is about $309,000 refund.

Okay, very good. And we get to take that in from an accounting point of view, do we then take that into income or it gets, we have to restate the prior years, what happens with that?

No, no. It’s a now thing, so in our Q2, you'll see a tax benefit of $309,000 in the P&L.

Okay. So that'll give us, from the just a number point of view, it'll give us a nice presentation, just to that point. Very good. The new order number that we had for, that was stated in the press release, is it I take it as corrected. None of that new order number is Autothrottle or does it include that the roughly two dozen that we just talked about or what amount?

It doesn't include.

It doesn't include it

It does include. I'm sorry, say it again.

It doesn't include Autothrottle.

Okay. So it includes the unit's we just chatted about?

Yes.

Okay. All right, terrific. Listen, all of you take good care of yourselves and your employees and hats off to you. You're in the business of saving lives and we really, really appreciate what you're doing.

Thank you for your support.

I guess that wraps it up. Thank you for your attention today. Thank you for coming and thank you for supporting our company.

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