Earnings Call Transcript - ISSC Q1 2020

Operator, Operator

Good morning. And welcome to Innovative Solutions and Supports First Quarter 2020 Earnings Conference Call. All participants will be in 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 call over to Geoffrey Hedrick. Please go ahead.

Geoffrey Hedrick, CEO

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.

Relland Winand, CFO

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.

Geoffrey Hedrick, CEO

Thanks, Rell. The New Year is off to a 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 an 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 from both domestic and international OEMs. We are pleased to announce that an aircraft manufacturer 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 are 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 and value that will improve operational efficiency and safety. Finally, we continue to pursue new opportunities in all our commercial air transport, military, and general aviation markets. We see large potential demand in military and regional aircraft markets for our autothrottle. Our plan is to continue to pursue additional STCs on multiengine aircraft and retrofit markets 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 safety and reduce pilot workload. With the autothrottle STCs in both single and multiengine aircraft secured and the recent qualification of our VMCa technology, we believe autothrottle technology is positioned for very significant growth. Let me turn it over to Rell for a discussion of our financials.

Relland Winand, CFO

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 and 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 in 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 expenses are incurred as contrasted with 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 the year ago. The company remains in a strong financial position despite a very modest use of cash in the quarter, primarily to fund increases 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.

Shahram Askarpour, President

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 an 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 Geoff mentioned, as pleased as we are with our stronger quarters of revenue growth and profits, we are equally pleased with 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, 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 authorities 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 in 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 a 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 discussions 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 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, which 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 the 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 stream for a long time. Development and flight testing on the F5 flight 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.

Geoffrey Hedrick, CEO

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.

Operator, Operator

Thank you. Our first question comes from George Marema with Pareto Ventures.

George Marema, Analyst

I've a couple of questions. The first question on this new OEM. When are you expecting to start shipping on that?

Geoffrey Hedrick, CEO

In the next six to eight weeks.

George Marema, Analyst

Six to eight weeks from now, you will begin shipping?

Geoffrey Hedrick, CEO

Correct.

George Marema, Analyst

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

Geoffrey Hedrick, CEO

It will be formally announced to the industry in late spring of this year. We have been instructed by the OEM not to comment on it until the announcement is made. I apologize for this; we are not trying to be evasive. There is nothing particularly unique about the situation. We simply want to announce it together at the appropriate time, which is a few months away.

George Marema, Analyst

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

Geoffrey Hedrick, CEO

Well, there are a number of aircraft that would be helped by autothrottle, and it has just been an autothrottle that was readily installed in the existing aircraft. We have identified two or three targets that we are working on as we speak. We think that the military market is going to be a good and big one. Additionally, regional aircraft like ATR 42 and 72, which are twin-engine turboprops, have suffered from the same kind of loss of engine accidents, and our system has demonstrated that it can protect against that, preventing that from happening. So as a safety feature and to reduce pilot workload, it is compellingly attractive. We have multiple patents on the technology, so we're always cautiously optimistic, but we believe there's an opportunity. We just visited someone yesterday and talked about the program, and they expressed a great deal of interest. So we're optimistic in all three segments: military, commercial, and business jet.

George Marema, Analyst

On the autothrottle in 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...

Geoffrey Hedrick, CEO

We currently have two installations underway for commercial airplanes, both Pilatus PC-12 models. We are also working on the latest version of our King Air, which we expect to supply for its first commercial installation in about three months. Progress is steadily being made. We are continually refining the product; the twin-engine version has received certification for engine failure recovery, and we have made enhancements to its operations to handle rapid changes in airspeed. This ensures that it functions properly under catastrophic conditions and aids in recovery. It is a significant advancement and unique, as nothing like it has been achieved before in either commercial or military aircraft.

George Marema, Analyst

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

Geoffrey Hedrick, CEO

There are two things that are going to happen. Some of the OEMs have certified service centers throughout the world. That's already in progress to have them offering retrofitting services. 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 are the area we are in right now; we interact more generally with the larger aircraft. So we use FBOs and we expect to have upwards of 20 installations happening on a regular basis.

Operator, Operator

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