Innovative Solutions & Support Inc (IA) Q2 2021 Earnings Call Transcript

Good day, and welcome to the Innovative Solutions and Support Second Quarter 2021 Earnings Conference Call and Webcast. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. 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, sir.

Good morning. This is Geoff Hedrick. Welcome to our conference call to discuss our performance for the second quarter of fiscal 2021, current business conditions and the outlook for the coming year. Joining me today is Shahram Askarpour, our President, and Rell 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 on file with the SEC and other public filings. Now I’ll turn the call back to Geoff.

Thanks, Rell. It was a stronger quarter: revenues were up, margins improved, cash flow was positive, and we achieved solid bottom line profitability. New orders were strong, and we ended up the quarter with a sequential increase in backlog. Over the past several years, we have been planning a strategy to establish a better balance of OEM and retrofit revenues, creating a more diversified set of products to reduce volatility and provide a broader foundation for our continued growth. These efforts continue to succeed. As the pandemic recedes, production contracts are now generating steady, predictable revenues from some of our largest names in aviation: Pilatus, Textron, and Boeing. Sales of our patented autothrottle continue to grow. Most recently, we announced that Textron has made our autothrottle standard equipment for another of their new planes, the King Air 260. Additionally, we’ve been shipping to their global network of service centers for retrofit applications, where the pandemic has slowed adoption. In this recent quarterly report, however, Textron indicated they expect the retrofit market to improve, which could open a significant market opportunity multiple times larger than that of the production market. The cooperation and relationship with Textron has been very strong and rewarding. We believe that we can develop additional opportunities across their product portfolio. The success of our ThrustSense technology in general aviation is creating opportunities in other markets, such as military, air transport, and several multiengine aircraft. We are currently seeing interest from far beyond King Air. One reason for this interest is that we have the only autothrottle with a lifeguard feature that is easily retrofittable. This appeals to owner-operators because it means they don’t lose revenue; they can use their aircraft and prevent loss of control. Currently, we are developing an autothrottle that will offer customers a simplified solution at a lower cost. This will allow us to penetrate the lower end of the market, which is substantially larger than the turboprop market we are currently serving.

Thank you, Geoff, and thank you all for joining us this morning. Looking at the second quarter, revenues were $5.1 million, up 5.9% from $4.8 million a year ago, primarily due to increased shipments of King Air Autothrottle Systems to our OEM customer. Gross margins for the quarter were 56.7%, improving as expected from 47.5% in the year-ago quarter and 52.7% in the previous first quarter. The improvement reflected reduced material costs due to product mix, partially offset by higher labor costs. Total operating expenses for the second quarter of fiscal 2021 were $23.4 million, up by a margin of 2.1% from a year ago and down 1.8% from the preceding first quarter of fiscal 2021. We continue to emphasize tight operating cost control; we believe current quarterly operating expense levels will be maintained for the balance of the year. Research and development expenses decreased from the year-ago quarter primarily due to a higher proportion of efforts focused on product development programs that were allocated to cost of sales in the quarter. Research and development expenses were almost 14% of quarterly revenues, reflecting our strong commitment to innovation and new product development.

Thank you, Rell, and good morning, everyone. The solid financial results that Geoff and Rell described are a testimony to our business model that focuses on both OEM production and retrofit opportunities, as well as the diversity and high quality of our customer base. This quarter demonstrated strong performance in our OEM production contracts, which have generally proven to be less sensitive to the influence of the pandemic. For instance, Textron recently noted that virtually every model of jet and turboprop they have is seeing strong activity. Interest in the acquisition of new jets is still largely driven by personal travel, but corporate aviation departments are starting to come back. This is encouraging news for our Textron business, and for our Pilatus PC-24 business as well. We believe these programs, as well as our KC-46 contract with Boeing for the US Air Force, will run for several years, offering a stable foundation of predictable recurring revenues from which to build. Just briefly, our development of a more easily retrofitted autothrottle is in progress; we are working on a single button, simple operation autothrottle that will allow for lower cost installation. The single button features a high-resolution OLED display that occupies minimal cockpit space. It can be installed in multiple aircraft with different cockpit layouts, and its generic nature will significantly reduce the time and expense of obtaining FAA certification on multiple platforms. Autothrottle remains a top priority of our research and development budget. The retrofit market is experiencing some weakness as the pandemic curtails travel, while also creating some degree of caution among buyers. Nevertheless, we are achieving retrofit success in the air cargo market, as the growth of online shopping continues to drive strong cargo conversion activity. Consequently, shipments of Flat Panel Display Systems for 757 and 767 remain robust. With many of over a thousand operational 757 and 767 still available for cargo conversion, we expect to see our Flat Panel Display business remain strong.

Thanks, Shahram. The second quarter was another quarter in which we achieved the objectives we believe best build shareholder value: growth, profitability, and positive cash flow. The second half improved sequentially from the first half, showing a solid start to the fiscal year. Backlog also rose—all signs of a healthy growing business. In the second half of calendar 2020, we distributed nearly $20 million in dividends, showing our commitment to rewarding our loyal shareholders. We remain optimistic about Innovative Solutions and Support's future, and we thank you for the ongoing support, encouragement, and participation today. Operator, please turn this over for questions.

Thank you. We will now begin the question-and-answer session. The first question will come from George Marema with Pareto Ventures. Please go ahead.

Yes, good morning, Geoff. Thanks for taking the call. A couple of things. So, I wanted to ask you about the new orders for Q1. Did much of this come from Boeing, such as cargo retrofits, or were they mostly OEM orders?

Let me have Shahram answer that specifically. But the distribution was generally more uniform than even we anticipated. Shahram, can you comment on those?

Sure. Yes. We received new OEM orders from Textron, Telarus, and Boeing. Additionally, we had strong retrofit orders from the cargo market.

Yes, in Q2, you said Q1.

Yes, the current quarter, yes, this quarter.

I think you meant Q2 of 2021.

What’s rewarding is that the demand from Amazon continues.

Yes, okay. Yeah, I just want to see how strong it was. Because I know on the OEM business, like the King Air is the only one to produce seven planes in Q1, but that’s their seasonal low quarter; it just goes up sharply from here into the fourth quarter. I’m talking about my calendar quarters now. But yes, I just want to see the flavor of the ordering there on how it came. Also, I was excited to see in your press release about your new low-cost product, which sounds like that is going to address the piston engine market, correct?

Yes, that's correct.

I’m sorry, what?

What we believe is the technology has turned out to be ideal. We were able to reduce our costs significantly and create a simpler, lower-cost installation. We see this as a broad application across many of the Textron product lines, and also very easy retrofits, significantly reducing retrofit time.

Wow. Okay. This new product can also be applied to platforms like the King Air as well?

Yes, you can install it in a King Air. What it allows you to do is operate the auto-throttle much more simply: there’s no need for setting complicated numbers; you just push a button on and off. It makes it much simpler to operate. The real advantage is that it will provide a very fast retrofit time.

Yes, well, I’m also excited about the piston market, because as you know, that’s a huge market.

About the P58; they made 8,500 of those, and they still have common problems with all twins that we have a solution for. We think it’s going to be a very good product for us and for Textron, who has been remarkably supportive. We’re delighted.

And about how long do you think until this becomes available on the market for retrofits and all that?

I would assume it will be soon. The actual day, I can’t specify. I mean, this is an engineering program; it’s mostly done. We are currently in the play test phase. But like everything, as soon as you give it a date, you risk slipping.

But you’re thinking 2021, though, it sounds like.

Absolutely.

Okay. In terms of the retrofits, what is sort of the cadence going on right now? And what do you anticipate? Well, I guess this new product will change the inflection on that you predict. What’s the current cadence of the retrofits?

It's a steady progression. As more and more people install it, they feel more comfortable, etc. But most importantly, remember: autothrottles were always considered a luxury feature. Our most recent product means that you can fly the airplane as you always did, while benefiting from a background safety net that effectively enhances engine and safety controls that have never been seen before. It is ideal for the pilot who wants to fly their airplane while also having additional safety features.

Okay, and how are – and my last question is in terms of supply chain issues with getting product components? Is that okay right now, or are you experiencing many problems?

We are monitoring a couple of choke points, but overall, I'm not overly concerned about the issues. We are currently able to produce and ship products, and we have inventory available as well.

So far, you’ve been able to make products and ship them, it sounds like...

Yes, we’re doing that now. Remember, inventory plays a role in our production capabilities, so it’s not a simple answer, but in general, that’s an accurate one.

Yes. Okay, thank you, Geoff.

Thanks.

The next one will come from Michael Frederick, Investor. Please go ahead.

Good morning, gentlemen, congratulations on the quarter and the new products. I have a question for you about the turboprop market. Are you guys finding that your auto-throttles are actually replacing existing FADEC-like auto-throttles that are on the marketplace?

No, you wouldn’t replace FADEC auto-throttle. Our auto-throttle incorporates FADEC-like attributes for protection against over-temperature, over-speed, and torque. It enhances safety controls and prevents the kind of horrendous damage that can occur with turboprops. This is why it’s important. Loss of control caused by slow airspeed can be catastrophic, and our auto-throttle has a patented feature that prevents that. Those are the strengths of our product, but we’re not looking to replace FADEC.

Okay. Okay.

Most existing turbofans are not FADEC systems. However, I can’t speak for turbo fans. It wouldn’t surprise me if a significant number of turbo fans out there are also non-FADEC.

Got it. Another question for you, Geoff, is on the new product. When we're talking about piston planes, like Cessnas and whatnot, there are different levels of pilot certification. Would the implementation of auto-throttle actually help accelerate a pilot's ability to move up that chain?

Actually, we don’t look at it that way. What we envision is that the system is primarily conceived to reduce the workload on the pilot, which is crucial. Even when you take the workload off, the pilot must still be prepared and capable of managing the aircraft manually. You don’t gain a significant advantage there. However, you will enhance safety features that are unique to our technology. We are the only ones providing proportional mitigation of slowing airspeed and loss of control.

Understood. And, Geoff, just ballpark, do you have any idea what percentage of the piston market consists of dual props, as opposed to just single prop planes?

Well, I can tell you there are an awful lot of piston twins.

Twins. Right. Okay. And that’s where you’re more applicable to the twins, correct?

No, we’re applicable to everything, even single engines. We started with the PC-12, and it performs exceptionally well there. It manages the aircraft in a way that most operators marvel when they see the aircraft take off, whether it’s a single or twin. The advantage we have with the twin is in patented loss of control protection. Historically, this has been an unresolved issue for many years, but we believe we have finally developed a viable solution.

Yes, you guys certainly cracked the code. Well, that’s all I have for you, Geoff. Congratulations. Hopefully, all this mania will get behind soon, and you guys will be back to full speed.

Yes, well, I appreciate that. We’re working diligently, and I’m proud of our team.

I know you do. I’ve been with you for a while. Well, keep going. Okay, take care.

Thanks.

This concludes our question-and-answer session as well as our conference call for today. Thank you for attending today’s presentation. You may now disconnect.