Innovative Solutions & Support Inc Q1 FY2021 Earnings Call

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

Thank you, Geoff, and good morning, everyone. I would remind our listeners that certain matters discussed in the conference call today, including new products and operational and financial results for future periods, are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially, either better or worse from those discussed, including other risks and uncertainties reflected in our company's 10-K, which is on file with the SEC and other public filings. Now I'll turn the call back to Geoff.

Thank you, Rell. We managed to maintain revenue growth, bottom line profitability and positive cash flow in the first quarter of our fiscal 2021 in spite of the pandemic's impact on our industry. Although on a balanced mix, retrofit and OEM has somewhat mitigated the impact of the COVID pandemic on our business. However, the exponential growth in our autothrottle has been impacted but the slower and steady expansion in demand is resulting in promising revenue growth. This was our third consecutive year in which our first quarter revenue and operating income increased from the previous year's first quarter. In addition, we finished this quarter with a backlog that was greater than the end of the quarter. And we have achieved these results while maintaining our commitment to implementing precautions against COVID-19 that we seek to ensure the safety of our employees, suppliers and customers. Reflecting our continued confidence in the business, in December, the Board of Directors declared a special $0.50 per share dividend, together with a $0.65 dividend declared in September, we returned nearly $20 million of our cash to the shareholders over the second half of calendar 2020. As a result of our strong cash flow, we remain in excellent financial condition with significant liquidity and no debt. We have, however, expanded our access to capital by opening a credit line with our bank, making that available if we need it. Since speaking to you several weeks ago, we continue to make progress on our strategic initiatives. Flying Magazine, a leading aviation industry publication has just awarded IS&S one of its 3 prestigious annual awards for their 2020 Editors' Choice Awards, along with SpaceX and Garmin. These highly anticipated and distinguished awards are selected by their senior editors based on the products that have the greatest influence on safety and technology and aircraft operations. With Textron, we announced that they offered our ThrustSense autothrottle as standard equipment on the new King Air 260, further expanding our product revenue from Textron. All of our OEM contracts are expected to generate recurring revenue of significant value over the next few years and all of these contracts are with some of the most respected names in the industry, Textron, Pilatus and Boeing. In addition to their direct impact, these relationships are creating additional growth opportunities. In the case of Textron, we are jointly capitalizing on their global network of service centers where they are and we are promoting the autothrottle benefits. We will go on toward next month to 5 of the service centers at the beginning of the month, with presentations by their Chief Test Pilot and our product support maintenance group. The retrofit market is much better than the OEM opportunity right now. We are making progress working with Textron to more broadly adopt our technology across their product portfolio. The success of our ThrustSense technology and the general aviation market is creating opportunities in adjacent markets, such as military, air transport and several multiengine aircraft. In addition to the steady recurring revenue generated from these contracts, there remains strong demand for our legacy products with our long-term customers. A recent introduction of the synthetic vision and Autothrottle Upgrade for the Eclipse Jet is seeing steady demand. The new ownership has committed to refurbishing and upgrading used aircraft and are preparing to place sizable orders on new cockpits for those airplanes. The strong growth of online shopping and the decrease in air passenger miles has made the 757 and 767 aircraft a choice for cargo carrier conversions. We have delivered several ship sets of 767 flight decks to Amazon, which is creating their own fleet expansion.

Thank you, Geoff, and thank you all for joining us this morning. Looking at the first quarter, revenues were $4.9 million, up 8% from $4.5 million a year ago, reflecting an increase in King Air Autothrottle Systems sales and growth in the flat panel display revenues arising from the ongoing conversion of 757 and 767 aircraft to air cargo planes. Gross margins for the quarter were 52.7% compared to 57.7% in the year ago quarter. This is primarily attributable to an increase in direct costs as we staff operations to efficiently meet the demand of both increase in production programs under contract and the increasing demand for air transport retrofit services. Warranty expense also increased in the quarter. Margins remain in line with historical averages and can be expected to expand as we leverage our fixed investment through revenue growth anticipated over the balance of the year. Total operating expenses for the first quarter of fiscal 2021 were $23.3 million, down marginally from a year ago and basically unchanged from the preceding fourth quarter of fiscal 2020. Operating expense control remains a priority, and we do not believe they will rise much further from current operating levels over the balance of the year. Research and development expense decreased from the year ago quarter, reflecting increased product development programs that were allocated to cost of sales in the quarter. Research and development expenses were over 12% of quarterly revenues, which is consistent with our strong commitment to innovative and new product development. Selling, general and administrative expenses were up marginally from the year ago quarter. Note that first quarter operating expenses reflect the increase in staff brought about by steady growth as well as the one-time costs typically incurred in the December quarter, such as our annual audit. This increase was partially offset by reduced marketing show expenses as a result of COVID-19. For the quarter, we generated operating income of $232,000, a marginal increase from the year ago quarter. We reported quarterly net income of $240,000 or $0.01 a share as compared to net income of $328,000 or $0.02 per share in the year ago quarter. This decrease in net income is due to a reduction in interest income this quarter, reflecting the decreased cash balance and lower interest rates compared to the year ago quarter.

Thank you, Rell, and good morning, everyone. Continuing the trend in the first quarter that now stretches back over the last couple of years, we grew revenues, generated a profit and were cash flow positive. These results reflect the growth of recurring revenues from OEM production contracts, ongoing demand for our legacy products and the growing aftermarket upgrades of ThrustSense products. This also reflects the diversity of our markets, high-quality of our customers, which include some of the most respected brands in the industry. This focus on working with the best in the business on both new and existing airframes and technology has proven to be a formula for success. While our Pilatus PC-24 ongoing KC-46 contracts have been underway for some time, our Textron King Air contracts are beginning to ramp up. Initial units, including those ticketed for simulators, have been shipped with the King Air 260 not scheduled for delivery until later this year and the new version of C-90 to follow. We are not at full run rate production volumes. Textron has noted, that they delivered 18 King Air 360s in the fourth quarter. And as Textron sales production rates increase, we will follow suit. The larger opportunity in the King Air market is the approximately 5,000 aircraft that are currently in service. We estimate the retrofit market to be a $300 million opportunity. The versatility and performance of our autothrottle is enabling us to look at growth potentials across all our markets, including commercial air transport, general aviation and military. For instance, we are in conversation with manufacturers of both twin turboprop and twin jet, multiengine aircraft regarding our autothrottle, not only in the business aviation market, but in the military and other markets as well. While some of these discussions have slowed down due to the pandemic, the interest is real and the potential is exciting. As always, it's encouraging to receive further recognition for our ThrustSense Autothrottle from industry experts, such as the recent Flying Magazine Editors' Choice Award based on products that have the greatest influence on safety and technology in aircraft operations. Briefly reviewing some of our ongoing programs, the PC-24 program has been highly successful, and we expect aircraft delivery rates to remain at a steady level.

Thanks, Shahram. The fiscal year is off to a solid start, with revenues up, continued profitability and strong cash flow. We have rewarded our shareholders with nearly $20 million in dividends in the second half of calendar 2020, and it is our intention to continue to build the business to create even greater value for our shareholders in the long term. Thank you for coming.

Thanks for your comments today, and for doing a good job despite the pandemic and its impact on your company. I also want to thank you very much for the special dividend in December. That was well needed by the Campbell family, thank you very much. I'm hopeful revenues in coming quarters will begin to reflect the optimism that you have in your various products and services. So I'll continue to estimate probably more earnings than I should. But one of these quarters, I expect your optimism will produce some meaningful profits. If you have any problem with that, please let me know.

Listen, I'm the first guy that wants to have more profit. Remember, I'm the largest shareholder in the company. So I want to have lots of profits. I'm with you. Keep up the good work.

Well done, team, very nice quarter in spite of all the headwinds and very optimistic. Geoff, I have a question about battery-powered airplanes. There's a lot of attention being given to battery power as the future of aviation. There are any number of incredibly well-funded start-ups who are already flying these airplanes with delivery expected in the next 2 years. Have you looked at playing in that market? And if so, how?

The quick answer is no, we haven't. We would like to see the market develop a little more definitively. My judgment is that it's terrific. You can do a lot of things with electric motors that you can't do with any other propulsion means. One of the ongoing challenges is finding a source of energy to power the motors, which is difficult. The latest attempts to use hydrogen in a new way to generate sufficient energy look promising. It's important to note that a battery doesn't become lighter as it discharges, meaning you're carrying a lot of weight. It's similar to carrying a full load of fuel during landing, and that's not ideal. This adds complexity. In terms of timelines, I can't say for certain, but it might take about 20 years. I reminded Shahram that we've been promised fusion energy for 30 years over the last 70 years. It will happen eventually, but I don't know when. In the meantime, we remain focused on conventional demand. There are many aircraft, especially interested in our autothrottle. We're pleased with the recognition from Flying; it was notable that they chose SpaceX for landing that booster, which is remarkable given that NASA has struggled with it. This is a significant achievement. Additionally, Garmin did an impressive job implementing auto land in a small airplane. We believe we could achieve auto land in a larger airplane if there's demand. The FAA informed us that they lose 100 to 200 people a year due to upset accidents. The certification work we're doing today is expected to save lives, which I find humbling. It is also encouraging for the business.

Can you talk to me a little bit about the twin jet market you had mentioned in the comments? I know that previously, prior to ThrustSense, you had already developed an autothrottle for the Eclipse, and that going forward, would you be looking to use ThrustSense in the twin jet market? And what advantage do you have in that market over the existing players that are already there?

The most significant aspect is our patented Vmca upset protection. The incident in Addison, Texas, where an airplane with 13 people crashed, underscores the importance of our equipment in preventing such tragedies. This technology is unique and has been effectively addressed for over a century; we successfully patented it and implemented it. Textron demonstrated visionary leadership by integrating our system into their airplanes swiftly. We take pride in our partnership with Textron and see substantial market potential. We have received inquiries from approximately 5,000 aircraft beyond the King Air interested in installing our autothrottle. A key differentiator for our autothrottle is that it is truly retrofittable, unlike typical systems that require extensive modifications or new engine installations. Our technology not only safeguards the engine—whose overhaul costs range from $750,000 to $1 million—but also helps prevent situations that could lead to catastrophic loss of control. Our latest version allows for these safeguards to be implemented without removing the aircraft from service, which is a remarkable accomplishment. We believe this retrofit can be achieved without impacting the aircraft's revenue.

That's great. So Geoff, regarding the twin jet market, I know Addison was focused on the King Air, particularly concerning the autothrottle on the Eclipse. Will ThrustSense be suitable for other twin jet models, or will there be a different version of autothrottle you will be promoting in that sector?

No, it will be very similar, if not identical. We are, as we speak, in talks with another manufacturer. One way of doing this is to say you have a turboprop and a turbofan. The turbofan is what we think of as a conventional jet airplane. Like the Eclipse had turbofan engines. And we are looking at other airplanes as we speak that use turbojet engines, and the same safety features we offer the turboprops, we now offer the turbojets. The reason we were so attractive in the turboprop market is that there was virtually no autothrottle for the King Air, which has 5,000 airplanes out there and no autothrottle. Because it was a very difficult thing to do due to the way the controls went out to the engines, left an enormous amount of slack and problems with the control system. We were able to fix that. So we have a unique solution and hopefully, we'll continue to show interest from a broad range of people in the industry.

Okay. Good, good. Other question, Geoff. Can you talk to you about what's going on with the FAA right now? And like you just said they're doing a work-from-home program. Do you have pending applications with them right now that you're still waiting to hear from them on?

Yes, we have quite a bit going on. Our ACO in Boston has performed exceptionally well, even though they usually face challenges. Despite working from home, they've made significant efforts. In some ways, remote work has been beneficial. In the past, we encountered situations where we waited a long time for responses from individuals, but our FAA has been very responsive. I want to acknowledge their strong performance without tempting fate. I believe that in two to five years, about 25% of our key employees will be working from home. This represents a valuable pool of experienced, talented individuals who are eager to stay engaged without the need for relocation. We are actively working to leverage this resource. I've held my last three Board meetings virtually, which has improved our efficiency and allowed us to conclude meetings earlier. While we do miss the personal connections, our focus remains on productivity. Boston has managed this shift very effectively, and their performance has been outstanding.

Do you have applications that are beyond Textron that are currently in with them?

Yes. A significant part of our success comes from a strong partnership with Textron. They understand the benefits of implementing our technology on new aircraft and acted quickly. Importantly, there are over 5,000 existing aircraft in the market that can utilize this investment, which is relatively modest compared to the cost of the airplane, and it brings substantial savings in maintenance and potentially enhances safety. We're optimistic about the interest we're receiving from operators of larger, four-engine turboprop aircraft who are asking us to develop an autothrottle system for them. Additionally, we're currently exploring similar requirements with various military aircraft.

Okay. One more question, Geoff, and I'll let you run. Just briefly touch a little bit more on the COVID impact. It sounds like this is more affecting the rollout of the retrofit market in the autothrottle. Does this have to do with the idea that you can't actually visit people in person and they can't actually take the plane up and try things out? Can you just kind of give a little bit more color on what the hurdles are here to getting all of that going?

I'm not an expert on this, but let's discuss a few of the issues. We have situations like COVID. If you own an airplane, you likely aren't flying as frequently as you used to. However, it's interesting to note that there's a growing demand in the small jet market. For instance, some of our friends are leasing or renting planes to travel to Florida because they are at risk and haven't received their vaccinations yet. We're seeing this trend increase. On the other hand, for those looking to upgrade, people are more focused on basic health and safety rather than flight testing or travel for demonstrations. This situation affects demand and limits our interactions with customers. For example, we have a customer who's interested, but I can't visit him, which restricts our ability to showcase our airplane. These issues may seem subtle, but they are widespread and have a significant effect. Thank you for your time and attention today. If you do have questions, you can always call Rell, and we'll get an answer for you. Thank you again for your interest and your investment.

Thank you. The conference has now concluded. Thank you all for attending today's presentation. You may now disconnect your lines. Have a great day.