FLYHT Aerospace Solutions Helping China Control Its Weather

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About: FLYHT Aerospace Solutions Ltd. (FLYLF), Includes: BA, COL, ERJ, HON, THLEY
by: Sergio Heiber
Summary

FLYHT Aerospace Solutions is the only company that offers a real-time satellite-based flight recorder communication system.

Chinese legislation mandates satellite-based communication on each plane.

FLYHT Aerospace Solutions has already won contracts with almost half of the Chinese Airlines.

System sales turn into 30-year recurring revenue.

FLYHT Aerospace Solutions also offers real-time in-air weather information and monitoring of engine and airframe.

Intro

FLYHT Aerospace Solutions (OTCQX:FLYLF) (FLY on TSX) is a Canadian company that offers software as a service ("SAAS") solutions for airlines and to a lesser degree to the military. Their products address the three major hurdles that airlines strive to overcome; legislation, weather, and maintenance.

The company is experiencing a huge opportunity in China and potentially can exploit similar conditions in other countries. After the company sells its hardware, it enjoys recurring revenue for the life of the plane. Planes typically stay in service for 30 years. That means 30 years of profit margins above 75%. The company also offers other real-time weather and maintenance monitoring services that no other competitor can match.

Legislation

The coastline of China has high frequency towers, but the vast interior of the country lacks infrastructure and will have to rely on satellite communications in order to meet CCAR 121 R5 requirements. China is determined not to ever lose where a plane is. China has mandated that by the end of this year, all airplanes flying within their airspace have the capacity to interphase with airline operation centers every four seconds.

FLYHT is currently the only company offering real-time satellite black box connectivity. In the event of a crash, their system provides instant black box information as well as the location of the crash.

I was unable to find any other company offering real-time satellite black box connectivity and wanted to find a source other than the company to confirm this is true. Robert McWhirter, President and Portfolio Manager at Selective Asset Management in a recent Bloomberg interview said that FLYHT is the only company that offers real-time black box satellite connectivity and that the Chinese law makes it mandatory for planes to have satellite communications. So, how big is this opportunity for FLYHT in China?

China is expected to be the leading aviation center in the world within the next three years. Boeing (NYSE:BA) expects that China will add more than 7,000 new planes in the near future. FLYHT has won contracts with 23 of the 57 Chinese airlines and expects to win more as the deadline nears to comply with legislation. The U.S.-China trade war should not have an effect on FLYHT as they have personnel and operations in China.

One of FLYHT's existing customers, AirAsia, recently announced that it was acquiring hardware and services for an additional 100 planes, bringing the total to 190 planes. AirAsia has an ambitious new plane schedule and is expected to continue to be an active customer but that is just the tip of the iceberg for FLYHT's opportunity.

FLYHT hasn't won a contract with one of the big four Chinese airlines yet. The next few months could bring about a major win from one of the big fish Chinese airlines. That is a very large addressable market for FLYHT in China alone, but there's potential in other areas as well.

Similarly to China, Australia, most of Asia, South America, and Africa offer vast territory that lacks infrastructure and would have to rely on satellite communication for black box connectivity. It's not just China that's adding planes. The global outlook is that almost 50K new planes will be added over the next 20 years.

The International Civil Aviation Organization - ICAO is a United Nations agency made up of representatives from governments and companies from 192 nations, specializing in best practices for safety and reliability. The new ICAO standards for tracking aircraft go into effect in 2021 calling for autonomous distress signal tracking at 1-second intervals and timely recovery or availability of flight recorder data. FLYHT is the only company able to deliver immediately available flight recorder data which exceeds ICAO requirements but would put carriers in compliance with ICAO standards for availability of flight recorder data.

ICAO is also attempting to address the pollution caused by aircraft by capping carbon dioxide emissions. Effective January 1, 2021, airlines will need to limit the emissions of flights to the average of their 2019-2020 levels. Most countries have voluntarily signed on, and the U.S., China, and the European Union have ordered that airlines begin monitoring their emissions. FLYGHT offers real-time information to help airlines monitor and improve fuel efficiency.

Weather

FLYHT acquired the assets of Panasonic Weather Solutions ("PWS") in 2018 from U.S. based Panasonic Avionics. The assets are FlightLink for aircraft tracking and alerting, Air Map for flight planning, and Tropospheric Airborne Meteorological Data Recording ("TAMDAR") sensors for communicating through Iridium satellites. TAMDAR provides real-time onboard weather data and offers FLYHT a new revenue stream.

The PWS acquisition was completed at no monetary cost to FLYHT and includes a partnership agreement with Panasonic that ends on March 1, 2020. The two companies agreed to complete ongoing FlightLink and TAMDAR programs. FLYHT will receive a $3.3 million subsidy from PAC. The subsidy amount is subject to adjustments depending if the results of certain agreed upon thresholds are exceeded or not met. The acquisition doubled FLYHT's revenue as well as doubled its higher margin SaaS revenue and brought with it new customers including AirAsia who has equipped all of their planes with TAMDAR.

TAMDAR isn't the only board weather monitoring system. The U.S. National Weather Service, Southwest Airlines, and others have their own weather monitoring systems which are used in conjunction with weather balloons to provide data. Weather balloons are sent up from various locations once or twice a day. Capturing weather data from airplanes adds much more to the database. More data results in more accurate weather prediction. China is actively seeking weather data in order to control its weather and could legislate mandatory weather monitoring on all aircraft.

Maintenance

The company's primary product is the Automated Flight Information Reporting System ("AFIRS"). AFIRS data is transmitted via the Iridium satellite network to its UpTime in the cloud ground-based server and then to the customer according to their respective specifications. In this video, CEO Tom Schmutz describes how the system works as well as what he envisions for his company.

CEO Schmutz mentioned that using FLYHT's real-time analytics saves money, but there's no explanation of how in the video and I could not find any info on this question on the company website. I believe that the cost savings are in time and replacing preventive maintenance with as needed maintenance.

Airlines need to keep their planes running smoothly as continuously as possible without wasting time in the repair shop. By analyzing real-time data, replacement parts could be waiting at the next airport on an as needed basis, thereby reducing plane downtime. Currently, most planes go through scheduled maintenance based on collected data. Real-time monitoring will save airlines money by not replacing parts that are in good working condition and by providing service only when needed.

A report from competitor Honeywell (HON) revealed that almost all of the responders to their survey expect to spend at least half a million dollars per plane on connected airplane technology and a vast majority in this group named maintenance as their number one concern.

Business Plan

Initial hardware sale leads to installation and recurring revenue on data services and licensing. Sales contracts are usually for five years and renew automatically throughout the life of each plane. Planes have an expected usage of thirty years. As the company grows, it will establish long-term predictable fat margins in the above 75% range.

FLYHT is a micro-cap company competing against giants such as Honeywell, Rockwell Collins (COL), and Thales (OTCPK:THLEY) but comes well armed with the only real-time airplane diagnosis and satellite black box communication system and over 90 Supplemental Type Certificates ("STC") for different aircraft types. FLYHT also has numerous patents including patents to stream black box over satellite in Canada, China, and the U.S. and pending elsewhere.

It would not have been possible to monitor airplane engines by satellite a few years ago. Satellites were not capable of processing the massive amount of data that this will generate. Bandwidth improvements now make FLYHT's technology possible and pave the wave for strong growth forecasts for the Connected Aircraft Industry.

Financials

FLYHT has historically lost money until it turned profitable in the fourth quarter of last year and the first quarter of this year. In the first quarter this year, the company reported 27% organic growth stemming from record AFIRS unit sales which were almost half of total sales for last year. 22 of the 48 sold were in China.

Q1 2019 Q1 2018 Variance
SaaS 2,405,232 1,043,030 1,362,202
Hardware 2,374,901 1,566,270 808,631
Licensing 377,760 626.962 (249,202)
Tech Services 183,859 82,049 101,080
Totals 5,341,752 3,318,311 2,023,441

Source

SaaS revenue doubled as a result of the acquisition. Hardware gain was organic. Licensing fell due to what management described as seasonal reasons during the recent conference call at which time it was also revealed that more news is coming to support evidence that licensing revenue will improve this fiscal year. Technical services is the initial point of sale and product installation. This has been the lumpy side of the business, but growth in this area is a signal for upcoming growth in the other areas as installed product is turned into recurring revenue. There are currently 325 AFIRS units and 225 TAMDAR units generating monthly recurring revenues according to the recent quarterly report.

Further info from the report indicates that the company has about $2.7 million in cash, $2.7 million from an innovation low interest loan, and $3.3 million from the PAC subsidy. There are also convertible debentures issued in July last year that mature in April 2021. The conversion price is $1.30/share. Forced conversion occurs when the common shares trade at or above $1.80 for 20 consecutive days. If the common shares trade above $1.90 for 20 days, the warrants issued with the debentures can be exercised. Conversion of the debentures would not raise any money but would clean up the balance sheet. Warrant exercise would net the company about a million dollars.

It does appear that the company is well funded to maintain its operations, but there may be the need to issue shares going forward in order to expand and meet demand should sales pick up.

Risks

Risks include the ability of the company patents to protect against competition offering the same services in the future. The cost savings of predictive maintenance must prove to outweigh the cost of buying the system which costs between $70K and $100K. Competitors offer predictive maintenance products but without real-time communication. These systems are cheaper and have lower maintenance costs. Real-time satellite communication exceeds ICAO standards and is not mandatory to meet these standards. Will airlines voluntarily exceed ICAO standards? I read the risks section of the last quarterly report and encourage the reader to do as well.

Conclusion

FLYHT offers solutions to the three main concerns that airlines strive to conquer; legislation, weather, and maintenance. The company's systems provide solutions that exceed current and pending legislation as well as standards.

I like the established foothold in China which should expand greatly as additional airlines are captured and Chinese airlines expand their fleet. The 30-year recurring revenue from the sale of their hardware has the potential of taking this company from its current micro-cap status to large-cap status but that's a long way away. China is the opportunity now and we need to see how well FLYHT captures their addressable market opportunity there. It's off to a good start and I'm optimistic of continuing success.

I write about small cap stocks and welcome discussion.

Disclosure: I am/we are long FLYLF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.