Innovative Solutions & Support's (ISSC) CEO Geoffrey Hedrick on Q1 2017 Results - Earnings Call Transcript

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Innovative Solutions and Support, Inc. (NASDAQ:ISSC) Q1 2017 Earnings Conference Call February 9, 2017 10:00 AM ET

Executives

Geoffrey Hedrick - Chairman & CEO

Shahram Askarpour - President

Rell Winand - CFO

Analysts

David Campbell - Thompson Davis & Company

Operator

Good morning, and welcome to the Innovative Solutions & Support First Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. Geoffrey Hedrick, Chairman and CEO. Mr. Hedrick, you may begin.

Geoffrey Hedrick

Good morning. This is Geoff Hedrick. I would like to welcome you this morning to our conference call to discuss the first quarter fiscal 2017 results, current business conditions and our outlook for the upcoming year. Joining me today are Shahram Askarpour, our President; and Rell Winand, our CFO. Before I begin, I would like Rell to read the Safe Harbor message. Rell?

Rell Winand

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 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 than those discussed, including other risk 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

Thank you. The quarter experienced delays both customer-initiated as well as those of our own making, which resulted in a disappointing quarter. Despite the decrease in revenues, the increase are investment and product development. Our strategy is to internally develop proprietary new technologies. This investment in research and development is key to our future success and we'll continue to position ourselves to capitalize on opportunities being created by the impending NextGen mandates. Since adapting our strategy to focus on production sales, we have consistently generated a vast majority of our revenues in higher margin product sales and the quarter is no exception. However, this success is missed by lower volumes which are primarily the reason that the margins are down.

We remain committed to our strategy to concentrate our resources on developing proprietary new products to focus on production sales and to expanding our sales distribution channels. While we continue to make progress in each of these objectives, I am a little disappointed that we are not further along and that should improve as the year unfolds. For instance, we are very close to the receipt of the SPC on our Autothrottle. There is strong interest in the product and we are already taking orders from customers. Initially, we are focused on the PC-12 market, but with its great versatility, we can expect to seek certification to the number of other aircraft broadening the market and most immediately turbo fans.

The Utility Management System we developed for Pilatus is another proprietary product where we internally funded the development. Our UMS accepts over 400 signals and replaces 20 independent systems such as environmental controls, cabin pressurization and flat deployment, et cetera. Our open architecture design allows operators and owners to create and maintain their own software and hardware solution, which significantly reduces not only initial investment, but subsequent maintenance cost as well. It is already receiving broad interest throughout the industry which we hope will convert to new opportunities.

Orders for the quarter were up from the prior quarter and we entered the second quarter with an increased backlog. As the Autothrottle enters the market and we introduce the UMS to a growing group of interested OEMs, we believe we will continue to enhance our reputation as a provider of the industry's best per price performance products and create new opportunities for future growth.

Let me turn this back over to Rell.

Rell Winand

Thank you, Geoff, and thank you, all, for joining us this morning. For the three months ended December 31, 2016, gross sales were $3.8 million and net sales were $3.4 million, compared to first quarter fiscal 2016's net sales of 6.6 million – consistent with recent quarters, over 89% of our total quarter sales or production sales.

For the first quarter, gross margins were 46%. While individual production unit margins were in-line with historical levels, total gross margins were down that resulted to lower volumes that were available to spread across our fixed cost. As sales volume rebound, gross margin should approve. Although margins could vary from quarter to quarter result of changes in either product mix or volumes.

Total operating expenses in the first quarter were $3.1 million, a decrease of nearly $500,000 from a year ago. Although net sales in this quarter were down from a year ago, we maintained our strong commitment to research and development investment, which was almost the third of revenue this quarter and an increase of $150,000 from a year ago.

For the first quarter of fiscal 2017, we reported a net loss of $1.2 million or $0.07 per share. With the year ago quarter, we reported a net loss of $0.2 million or $0.01 per share. At December 31, 2016, the company remained a strong financial position with a healthy $8.2 million of cash-on-hand and no debt, although we did have a small cash outflow in the quarter. We believe the company has significant cash to fund operations in the foreseeable future.

Now I'd like to turn the call over to Shahram.

Shahram Askarpour

Thank you, Rell. Good morning, everyone. Since it has only been a short while since we last spoke, let me quickly provide an update on the progress achieved during that period. I would like to first reiterate Geoff's comments regarding our financial performance in the first quarter. In the quarter we increased our bookings by more than 20% from the previous quarter. While we had an increase in bookings due to the timing of the orders, certification delays, as well as customer delivery date changes, we simply did not realize the full financial potential revenue as we had expected.

Heading into the second quarter, backlog is up by nearly a third, compared to the beginning of the first quarter [ph]. With imminent new certifications, we believe we will sustain new order momentum heading into the rest of the year. Our focus is on developing new products to capture an increasing share of the demand for impeding NextGen mandates. We already have several products available to meet that need and as these products are a key to our future success, I would like to provide some additional insight.

The SPC for our new NextGen cockpit is in final stages of issuance at the FAA and we are already lining up initial customers. A launch customer is ready to install our equipment as soon as the SPC is issued. We are not only marketing this feature-rich cockpit directly through our sales channel, but also making it available throughout our growing MRO distribution network.

Many of these MROs have relationships with numerous customers that are owners and operators of PC-12 aircrafts. This cockpit includes the first Autothrottle product to market that we are targeting, allowing our new MRO partners ideally positioned to encourage users to implement the comprehensive upgrade only our NextGen system can provide.

As I previously mentioned, the Autothrottle is a first of its kind product that provides an unprecedented level of safety for [indiscernible] turboprop aircraft. With extensive innovative capabilities, we expect the Autothrottle to typically be integrated into our display system.

Our flight deck also includes many desirable NextGen features such as ADS-B in, ADS-B out, LPV and RNP capabilities as well as synthetic and enhanced version. While initially available for the PC-12, it has been designed to be incredibly versatile and suitable for broad range of aircraft. Most immediately, turboprops. We're optimistic about the prospects of this new product over the new few years.

I've also previously mentioned that we are now beginning to engage with the digital OEMs that have taken an interest in the Utility Management System we have developed with Pilatus on the PC-24 program. We are seeing interest and beginning to initiate dialog with OEMs that want to take advantage of the capabilities of utility management system and its numerous benefits to new aircraft platforms.

I'm certainly excited by this warm reception we are receiving from the OEM community. Our existing UMS program on the Pilatus PC-24 remains on course. Pilatus anticipates YASA certification for this brand new airplane this year. Our UMS reduces rate, power consumption, maintenance and operation expense by eliminating use of multiple computers traditionally installed in aircraft. We have had an incredibly smooth transition to this product from designing its volume production.

We are also making steady progress with our program to contract with new MRO distributors. They continue to offer an economical means to broaden distribution, both domestically and internationally. In summary, we have taken a disciplined approach centered on the key tenants of our growth strategy. We believe that this will enable us to have better control over our performance in the long term, which we believe is the key to building value for our shareholders.

I would now like to turn the call back to Geoff.

Geoffrey Hedrick

Thanks, Shahram. As you heard today, we continue to focus on new product development strategy and focused on production programs. In the short term, this may affect the volatility of the company, but in the long term will enable us to realize the value created by proprietary technology that we are developing.

I appreciate your interest today and I'm open for questions. Operator?

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from David Campbell of Thompson Davis & Company. Please go ahead.

David Campbell

Good morning, everybody. I'm sorry for your production delays in the first quarter. Were those delivery delays – will that be made up in the second quarter? Did the company simply delay deliveries for a period of time and then you will make it up in the second quarter, which would leave you with better-than-expected revenues in the second quarter? And were those delays with more than one customer or just one customer?

Geoffrey Hedrick

No. It was a couple of different customers, but specifically, the roll out of our Autothrottle certification was delayed and that has impacted what we expected to be a significant number of sales in this past quarter. My experience tells me you never are able to make it up quite as much as you would like. Certainly not immediately. So, over the next three or four quarters, I would hope and expect that we'll make it up because we got to keep the customers satisfied. But it was a combination of customers that wanted to change their configuration and other cases where our certifications were delayed coming out of the FAA.

David Campbell

And those certifications, are still not have been approved?

Geoffrey Hedrick

That's correct, but we expect them shortly, I guess is the answer.

David Campbell

Assuming those FAA approvals come, you should see some sequential improvement in revenues?

Geoffrey Hedrick

That's for sure. We're obviously focused on getting our revenue up to the point where we can achieve our initial forecast. It means we have a gap to recover over the next three quarters.

David Campbell

And Shahram mentioned the distributors that you're working on. Could you please explain these distributors? Who are they? Are they fixed-based operators? What are they?

Shahram Askarpour

They're mainly MROs. They provide two service – one is that they provide distribution network for us as well as they do installation and some level of product support to our customers. We've kind of put more emphasis in utilizing that sales channel now for over a year now and we're actually now beginning to see sales coming through those channels.

David Campbell

And are they global, or just in the United States?

Shahram Askarpour

Some of them are global, international and we may be pulling out some announcement in the near future with regards to some names, but right now, I'm not at [indiscernible] to disclose.

David Campbell

And what do these MROs do? Are they doing this for other equipment manufacturers?

Shahram Askarpour

Typically, yes, they do. Although one of the MROs that we're working on, it seem to be strictly working on our installation of our equipment. In some of these areas that they specialize in, really, there's no other manufacturer that provides the solutions that we do.

Geoffrey Hedrick

An MRO is a maintenance and repair facility. What they'll do as an example, they'll take an aircraft, some 5-7, or 6-7 or 3-7 passenger and convert it to a cargo airplane. They've done a lot of them. They'll do modifications and there's MROs over the world – people like Lufthansa Technik is a very large one and a number of them here in the United States. So a carrier as an example, as a carrier like FedEx move by passengers, 757s and have them converted to cargo. And in that conversion process, we can now offer them a cockpit upgrade that can be installed at the same time.

David Campbell

Right. Were there any revenues from this in the first quarter?

Geoffrey Hedrick

Yes.

Shahram Askarpour

Yes.

Geoffrey Hedrick

And to be clear on the certification, the FAA, the reason there was in part of delay is that this Autothrottle is the first of its kind for a turboprop. There's no standard specification for Park-23 [ph] aircraft. So they're working on their own approval process internal to get it through. It's not anything wrong with the flight test or anything, it's just simply that it's completely new and it has to be addressed appropriately.

David Campbell

Well, it certainly have a lot of potential, particularly in the cargo conversions. You see what Atlas Air is doing for Amazon and some of that is cargo conversions.

Geoffrey Hedrick

We're doing the Amazon airplanes.

David Campbell

Right. So it looks like your biggest potential is in some of that cargo conversion work?

Geoffrey Hedrick

We see a number of areas of pretty substantial potential. In the hundreds of millions as opposed to 10 and 20 million kind of thing. We're optimistic, but in the short term, it's been problematic.

David Campbell

Right. Okay. Well, I haven't had a chance to look at the actual numbers, but it sounds like with your backlog up, we should see some benefits of that in the next two or three quarters.

Geoffrey Hedrick

Our backlog needs work and it's got to get up. We hope than when the certifications come through, that the dam will break and expect reasonable level of bookings that we anticipate. But we got to work at every day and we've made some moves that we're optimistic about and hope to come up with some announcements in the near future.

David Campbell

Does the backlog depend on SEC approvals? Does the backlog include orders without SEC approvals?

Geoffrey Hedrick

Yes. What we're talking about, the things that are being held up right now are FAA approvals that are pending and they're very close to being...

Shahram Askarpour

But they're not in our backlog.

Geoffrey Hedrick

But they're not in our backlog. Nothing goes in our backlog unless it's hard and regular – now we have a hard PO, in fact a deposit or a pending deposit.

Shahram Askarpour

But that's not in the backlog.

Geoffrey Hedrick

And it's not in our backlog. Well, it won't be in our backlog until we get the certification and get it done.

David Campbell

Okay, well, thank you very much.

Operator

[Operator Instructions] Since there are no more questions, this concludes our conference for today. Thank you for attending today's presentation. You may now disconnect.

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