Hey, and welcome to the Innovative Solutions and Support second quarter 2019 earnings conference call and webcast. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your touch-tone phone. To withdraw your question, please press star and then two. 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.
Good morning. This is Jeff Hedrick. I'd like to welcome you this morning to our conference call to discuss our performance of the second quarter of fiscal 2019, current business conditions, and our outlook for the coming year. Joining me today are Shahram Askarpour, our President, and Rael Linnain, our CFO. Before I begin, I'd like Rael to read our safe harbor message. Rael?
Thank you, Jeff, 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 10K, which is on file with the SEC and other public filings. I'll turn the call back to Jeff.
Thank you, Rael. Company's second-quarter results continue to reflect the cost controls and marketing refocus initiated at the end of last year. Both revenue and backlog increased, and we were profitable for the second consecutive quarter. In addition, the business generated $900,000 in cash. Each one of the three market segments, commercial air transport, general aviation, and military, contributed to that improvement. This quarter, we generated revenue in all three segments, and we generated revenue in both product and engineering contracts. Retrofit programs for commercial air transport and general aviation PC-24 production primarily drove the second-quarter sales. The highly successful Pilatus PC-24 jet program is in full production, and we believe a steady stream of order will be received over the remainder of this year and years to follow.
Our general aviation sales included sales of our new PC-12 NG autothrottle, PC-12 Classic full cockpit upgrades with autothrottle, and the sale of our UMS product to multiple OEMs. In the military, we are completing our work on new air data computer development contracts. Test units have been delivered to the Navy for their evaluation and testing. If testing proves successful, we believe that the Navy will proceed into the production phase of the order. As I discussed on the last earnings call, we are focusing our resources on fewer, more promising opportunities. This focus shows an improved productivity and shorter development cycle times. We continue to remain optimistic in our outlook for our patented ThrustSense autothrottle. We believe that the ThrustSense has broken new ground, especially in the twin-engine turboprop market.
Several days ago, we announced the receipt of a STC for the ThrustSense autothrottle for retrofit in the King Air. The ThrustSense autothrottle provides engine protection like the most advanced jets and is a full regime autothrottle for takeoff to landing, including go-around. ThrustSense computes and controls power levels, which are designed to reduce pilot workload, and which we believe brings a new level of convenience and safety to King Air owners and operators, which are, I think there's something like over 10,000 airplanes out there. We're applying the ThrustSense autothrottle into other applications that show great promise. We are aggressively marketing the autothrottle, focusing on what we call its ability to provide fourth-dimension control of the airplane. Market interest and awareness is now increasing for what we believe is a compelling combination of safety features and low installation costs.
Let me turn it over to Rael for discussion of the financials.
Thank you, Jeff, and thank you all for joining us this morning. Revenues for the second quarter of fiscal 2019 were $4.2 million, a 13% increase from the second quarter of 2018, and our second consecutive quarter of revenue growth for fiscal 2019. Product sales comprised approximately 88% of total revenue, with the balance comprised of revenue related to engineering services on the F-5 development contract. Gross margins for the quarter were 56%, an increase from 44% from the same quarter last year, and also a sequential improvement from the first quarter of 2019.
We believe the improvement in gross margins reflect better leverage from increased revenues, reduced direct material costs, and the benefit of the workforce reduction implemented in the third quarter of fiscal 2018, as well as more profitable pricing on the engineering contract. Total operating expenses for the second quarter of fiscal 2019 were $2.2 million, down $600,000 compared to approximately $2.8 million in the second quarter a year ago. Research and development expenses were down $400,000 from this quarter compared to the same quarter last year, while selling and general and administrative expenses were down approximately $200,000 for this quarter compared to the same quarter last year. Each of these decreases reflect the impact of the third quarter fiscal 2018 workforce reduction, as well as some variability between quarters due to expenses such as accounting, legal, and other.
While R&D spending is down from a year ago, a shift in our strategy has enabled us to improve the productivity of our spending by investing in fewer, but we believe are more promising technologies. Income tax expense for the second quarter of fiscal 2019 was $8,000 due to the utilization of tax loss carry-forwards. Income tax expense for the second quarter of fiscal 2018 was $200,000 due to change in the valuation allowance. We reported a quarterly net income of $202,000, or $0.01 per share during this quarter compared to the same quarter a year ago, we incurred a net loss of $1.3 million, or $0.08 per share. We believe that the company remains in a strong financial position and has generated positive cash flow in the quarter. At March 31, 2019, we had over $21 million of cash on hand and no debt.
We believe the company has sufficient cash to fund operations for the foreseeable future. Now I'd like to turn the call over to Shahram.
Thank you, Rael, and good morning, everyone. Over the past three months, we have continued to make steady progress across the organization, and for the second consecutive quarter, posted increase in our key financial metrics. Narrowing our developmental efforts, employing more aggressive sales and marketing initiatives, and implementing tighter cost controls have made us a more focused, efficient organization, and we are operating at a high level. Consequently, the second quarter was as successful as the first quarter, and we are seeing steady increase in our revenues and profitability. Much of the quarter's revenues were in our commercial air transport segment from flat panel displays for the Boeing 757 and 767. Encouragingly, these are orders for our portfolio of existing cockpit technology, which require little additional engineering and are therefore quite frequently our most profitable products.
As Jeff mentioned, the Pilatus PC-24 is one of the most successful new aircraft launches in the industry. As a supplier of the aircraft's utility management system, shipments are keeping pace with the sales as Pilatus is ramping up to full capacity. Keep in mind that although we believe Pilatus will be ordering a significant quantity of ship sets per year, we only include a very small portion of this future revenue in our backlog that reflects orders for delivery within two quarters. We're also experiencing increased interest from other piloted and optionally piloted aircraft manufacturers for the UMS products. The military market, the KC-46A program, continues to enjoy steady production. As mentioned last quarter, we are looking at some additional opportunities with Boeing's international military customers. In addition to product sales, we're also generating profitable engineering revenues in our military segment.
Our contract to develop a new air data computer for the U.S. Navy leverages our experience from the A-10 air data computer. Our development costs and time have been minimal compared to other development arrangements where we are not as familiar with the technology. We see interests for similar military air data computers for other platforms in the U.S. and international military market. Echoing Jeff's sentiment, we believe our greatest current opportunity is in the general aviation market with our ThrustSense AutoThrottle. Having recently received the STC for the King Air, we now have a baseline STC that we hope will open the door to a market of what we believe to be over 5,000 variable King Air aircraft. To capitalize on this opportunity, we continue to roll out our comprehensive marketing plan and strengthen the underlying infrastructure needed to ensure the launch is a success.
The manufacturers, installers, MROs, and others with whom we have been conducting demonstrations, have been impressed with our ThrustSense AutoThrottle technology. As mentioned last quarter, we have made deliveries of both the standalone and cockpit AutoThrottle configurations, and we are optimistic that activity will grow as more installations are performed. The addition of a twin-engine version to our product portfolio as the result of the groundbreaking ThrustSense product as we believe, helped to overcome the daunting challenge of getting a twin-turboprop autothrottle approved by the FAA, and paved the way for what should be easier thrust certification of additional piloted and optionally piloted aircrafts. I would note the $5.3 million in second quarter's orders and the $5.5 million in March 31st backlog as recent high water marks that further affirm the steady progress that has been the goal of our recent strategy.
I would also note that we have several long-term production contracts on which we book only the most immediate orders. The broad-based improvements we have achieved across our commercial air transport, military, and general aviation markets is an encouraging endorsement of a more focused strategy. We believe the new products rolled out and under development offer even greater promise for continued progress. Let me turn the call back to Jeff for some closing remarks.
Thanks, Shahram. Steady progress achieved in the second quarter is an encouraging sign that our end markets are improving and our strategy is on target. Interest is growing in our advanced flight deck, the unique autothrottle, and utility management systems, all of which deliver what we believe is industry-leading price for performance and the responsive to ever-growing needs for improved safety amid new or impending tighter regulations. I am very pleased with where we are as an organization, as productive and focused as ever. In conclusion, I appreciate your attention today, and we'll open up the call for questions.
We will now begin the question and answer session. To ask a question, you may press star then one on your touch tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star and then two. At this time, we will pause momentarily to assemble our roster. Okay. The first question comes from David Campbell, please go ahead.
Hi, Jeff. Hi, Rael. Hi, Shahram.
Good morning. Good morning.
Thanks for hitting my estimates for the quarter.
That's amazing.
Yeah, I know, it's amazing. That doesn't happen very often. You hit my estimates. Congratulations.
Thank you.
Shahram, you talked about the commercial aviation. It sounds like you got some new business there. I imagine the 767 business is coming from some cargo conversions. I'm a little confused where the 757 business is coming from. Can you elaborate?
That again, some of that is from existing customers.
In light of recent situations, 757 continues to be an attractive airplane.
You're upgrading their flat panel display. That's what you're doing, right?
That's right.
Correct.
In the seven-
In the Boeing 757, because as of next year, end of next year, there won't be any support for the existing equipment. It's important for them to do the modifications of the airplanes.
How about the Boeing 767s? Am I right that most of those are the cargo conversions?
Similar situation.
Mostly they are, yes.
We have a stronger position on the 57, as you know.
We're also selling to some of our existing airline customers as well internationally, as they add to the fleet.
Right. Well, it sounds great because everything seems to be clicking at the same time, with the commercial aviation going up, and the King Air business hasn't started yet, right?
Not really. It's just about to start, and we see real promise in that. It's a huge market. If we do our job right, we'll do very well. The product works great.
You'll be selling those to fixed base operators. Is that what you do?
We're already doing that, and we're showing them to all kinds of people right now. Remember, It's ranging from a piston turbo, a piston airplane all the way up to a conventional turbofan jet. It's really quite a remarkable product line.
Right. Does this fight with China over the trade disputes have any potential for your company?
I guess there's obvious uncertainty with China. If you think about China, they're pragmatic business people. They do business with us because they have to, and because we provide the best product for the money. My opinion is, if you do your job correctly, you should still be okay. Obviously, consumer products have a different problem. In our case, to the extent that we sell our standard product and are not involved in trying to share technology and things like that, we're delighted to be able to work with China. It's a great opportunity. It's a great market.
Overall revenues for the rest of this fiscal year, would be appropriate to slowly increase them on a sequential basis from where you were in March?
Yeah, we see a ramp up. Yes, you can see it in our backlog, obviously, as it increases. Our sales should follow accordingly.
We expect, we hope, a nice steady increase.
Yeah.
That's what we hope we see, and we're certainly planning on it, and the backlog obviously reflects what we think we're going to be shipping. Although we don't talk about targets for the sales, you can see the backlog has gone up, and consistent with the backlog going up, you'll see our revenues for the quarters go up as well.
Well, I was estimating a backlog of $5.5 million at the end of March, that's what happened, right?
That's because you estimated it, we said. You should have estimated it more. If you'd estimated six, we would've had six. We didn't know what to do.
Well, congratulations. Thanks again for doing so well.
Thanks for your support all these years. Appreciate it, David.
Oh, yeah. I'm going to continue supporting. Thank you very much.
I'll see you.
The next question comes from Charlie Pine of Van Clemens & Co.. Please go ahead.
Hi, good morning. I'd like to congratulate you all on more good progress in the second quarter.
Thank you.
Thank you.
Excuse me. I have a few questions. They primarily would be addressed on the recent STC that you got for the King Air. I guess I was slightly surprised. I had been anticipating that from some of the earlier comments in the prior call that it didn't sound like that you were going to be able to get the STC until sometime this summer. Was that incorrect, or did something just kind of happen that actually moved it up a little bit more?
First, let me ask you, is that good or bad?
No, that's very good.
Okay. Look, it was actually sort of a strategic deployment. The autothrottle for the King Air has a bunch of optional features, and each one of those optional features is a new technology, which I've had a number of people comment about trying to get their head around it, try to understand it. What we chose to do is get the fundamental autothrottle system with the actuators and control of the engine and safety features all fully operational and certified, and we did. Now we can add additional features on for additional protection, and they're all, by the way, optional features that you pay for. They're going to be incrementally added over the next couple of months.
What that gave us is, first, allow people to start installing sooner than we had hoped, and ultimately, we'll get the same total penetration in the end, or in fact more, but we'll be able to get started much earlier. Does that make sense?
Yes, it does. Thanks. Let me follow up on a couple other things. First of all, just as far as overall, as far as getting the STC, it was a long wait, but better late than never.
It was a tough one. It had never been done before. The pioneer always is the guy that gets the arrow. The guy at the head of the line usually gets shot. It was a tough road. The certification authorities were being difficult, unfairly difficult. To the contrary, they were all enthusiastic about the product, and we actually had some of them saying that 200-300 people die every year, and we're going to save their lives. That's an amazing thing for them to say. They went through the hard work of making sure that it was right, and it was tough, and at times it was painful for us. In the light of other problems, I'm sure they had their own distractions. I got no complaints at all. I think it's just unique.
The people who are certifying it are used to saying, "Well, yeah, okay, I can do that because in the past I've done this, that, and the other." That wasn't the case, it had to be all new. We're grateful and delighted that we got through it.
Well, I'm very happy, and I'm sure everybody that's been sticking it out for this amount of time as you've gone through the process is also pleased at finally getting across the finish line. I'd like to have you explain a little bit of a distinction I'm having a bit of problem with. Jeff, you mentioned in your prepared remarks that there's over 10,000 planes for the King Air, and then Shahram, you said that it was 5,000 King Airs. What number should we really be using to model on.
Talking about operational, addressable market and non-addressable, et cetera. The 5,000 or 6,000 number is probably the more conservative numbers.
Okay. 5,000 to 6,000 for the addressable market.
That's only on a King Air.
That's on a King Air.
Jeff mentioned 10,000. He was including PC-12.
Okay. All right. Okay, thank you for clarifying that.
Sorry about that.
I guess I'd like to ask what would be a sort of natural follow-up. How soon do you believe you could start to recognize some meaningful revenue on the King Air autothrottle installs?
Well, I'll tell you what we're doing. In part because we have a little bit of breathing room, we want to make sure that the installation is simple and fault-free. That's going to take us doing several installations with our team in place to make sure that we've got it optimized. I want it foolproof. So we're going to spend a little bit of extra time in focusing on the installation and some of the optional features that we talked about, and be able to have a complete package and not rush it into the marketplace. We learned that from one of our OEMs, who showed better judgment than I have, by moving their airplane production deliberately into volume in such a way that they didn't end up with fire drills at the end of the line.
Do you think that there's a possibility that you could start to see some meaningful revenue in your fourth quarter, or do you think it's more probable that it will start to show up in-
The simple answer is, we're not sure. The reality is that if we get lucky, the installation kits work well, we don't have any big problems, we could get installations and revenue in the fourth quarter. If not, it'll be the first quarter of the following year.
Okay.
I think honestly, for the first time, we don't have to rush into this, that I think is going to pay off very handsomely in the future. The simple answer is I'm not sure. There's a chance. It's the last quarter or the first quarter.
Okay. Well, we've waited this long. Another few months isn't going to
I just want to get it in airplanes and get it flying and not have problems in the first installations. I want it to be smooth. Whatever it takes for us to do that, we're going to do.
I'm just kind of curious, how many partners are you working with as far as on the installation side of it right now?
How many what? Partners or-
How many of your partners, MROs and other field operators, are you working with right now on the installation aspect?
I don't know the actual number, but we have a significant number of service centers that are signed up for that installation. What we want to do is refine the installation, put it in a video format so that the mechanics all over the country, for that matter, all over the world, have a reference document that they can look at and know exactly where every wire. It's not the equipment in the airplane, that's the easy part. It's the wiring and how you attach it to the other systems in the airplane, and that's critical, obviously. Those are the things we're refining. We're making sure that wire lengths of as much as 20 feet are accurate within one inch or two. Those are the kinds of things we need to do.
Okay. All right. Well, great. Well, thanks for answering those questions, and, once again, congratulations on finally getting the STC and also for the continued return to profitability in the business. It's very gratifying to see again.
Thank you very much. I'm a little embarrassed to realize that I'm being complimented on doing what I said I would do when I said I would do it. I thought that's what I was supposed to do.
Yeah.
I had a director who ran Boeing's engineering department for many years. He said his boss told him that integrity was doing what you said you would do when you said you would do it. I'm going to try to do a better job of that.
Well, stay at it, Jeff. We appreciate it. Thank you.
The next question comes from Mr. Michael Frederick. Please go ahead.
Morning, gentlemen.
Morning.
Morning.
Morning. Some questions on ThrustSense. I wanted to have you provide a little more color on not just the safety end of it, but the engine protection portion or the value proposition of the engine protection end of it. Maybe provide a little bit of detail on essentially the damage that is done to these engines and the cost associated with fixing things right now. I'm trying to get an idea of the general value proposition of this upgrade.
Well, it varies a lot. Obviously, the turboprops we're talking about, a new engine install is probably $1 million.
Okay.
If you over-temperature an engine and you got to do a hot section, you're talking $several hundred thousands to do it. That's just over-tempering for a very short period of time. A hot start, you have to do a hot section. It'll vary. I guess the cheapest thing you can do is a bore scope for $20,000 or $30,000. The most expensive is $1 million. That's on a cheap engine. On a good engine, an air transport engine is $10 million or $15 million. It varies a lot. Protecting the engine is critical. In some cases, just remember, even inspection takes the airplane out of service for some period of time. It has the real advantages. That's why people have paid, on other kinds of engines, significantly more for what's called FADEC or full authority digital engine controls.
We provide the same kind of protection on conventionally fueled engines.
Okay. Jeff, give me an idea of what is the normal life cycle of a PT6 engine?
I'll tell you the little data that I know is I think in one of our airplanes, it's 3,500 hours, and they're actually pushing it to 4,000.
Okay.
If you have a hot start, all bets are off, obviously.
Got it.
It depends a lot on the engine. They're anywhere from I don't think they're any above 3,000 as a turboprop, and I guess some of them will go up to 4,000 or 5,000. They're pretty damn reliable. They're remarkably reliable. They're extremely sensitive to temperature, and you over-temperature by even 10 or 20 degrees, you can do some real damage.
Okay. Obviously, the ThrustSense is a tremendous value proposition for these owners. Another question I had for you was, in the third quarter of last year, you guys at least briefly mentioned the idea of potentially this becoming something that would be carried by OEMs or maybe even engine manufacturers. Engine manufacturers, obviously, there's one engine manufacturer, can you provide any maybe outlook on the idea of where you could see this going? Could it potentially be something that's part of an actual new aircraft?
Yeah, but we can't talk about it, but obviously, we're looking at that.
Okay.
Honestly, I don't want to discuss it.
Okay. Got it. On the rollout, you had said that, just on the last questions, that you were not in a hurry or that you weren't pressed for basically time on this. I wanted to just get a little bit more detail on that. Is that simply because you've got plenty going on, or is it the idea that the MROs are filled up with next-gen work, or can you provide a little more detail on what you mean by that?
A couple of things. First of all, we want to get the installation time down as far as we can because as a former personal airplane owner for 35 years, nothing annoyed me more than to have to lose my airplane even for a day.
Okay.
Just didn't have access to it. We really want it to be a very minor disruption to the owner for this installation. That's number 1. Number 2. The other issue I talk about is, do we have a lot of time? Look, our business is starting to respond to some of the actions we took last year. We're seeing the company making money. We're generating almost $1 million in cash last quarter.
Fine.
We're in a reasonably comfortable position where we don't have to run a fire drill to keep ourselves alive. We're going to use that time in a planned and disciplined way to improve our long-term opportunities.
Got it. Just a couple other quick things. Any idea what the next STC is going to be? Is that going to be more of the King Air series or another turboprop?
I'm not sure.
Okay.
I don't know. Every time one gets issued, we're pleased. Honestly, the FAA, it's easy to go up in an industry and complain about the federal services, the administration services, making it difficult for your business. In this case, that's not been the case, in general. The delays are appropriate sometimes. As much as I don't like them. I have no idea when the next one would be, with any kind of luck, we'll have another one within a month.
Okay.
It's still priced, right?
Well, thank you. Okay, good.
That's behind door number 3.
All right. I look forward to it. Okay, one more quick question. On the KC-46, obviously, that's a major rollout by the military. Never been able to get an idea of really how significant that is to you folks in terms of revenue, the part you're providing. Is that a significant cost item, or is this more of a lead into other things?
It's a good-sized program, but it's not significant to our revenues.
Okay.
It's very good. We're very happy, and it goes on for a very long period of time in a very predictable way, and it's a very good program. Is it make or break the business one way or the other? No. But it's a wonderful opportunity, and we're delighted with it.
Got it. All right, gentlemen. Well, thank you for your time and continued success.
Thank you.
Thank you.
The next question comes from Mr. Irwin Goldman. Please go ahead.
Hi. Hi. You guys may remember me. I'm the old guy who was at the meeting.
Hi, old guy who was at the meeting.
A few questions. Number one, you had commented then that you were hiring, and you were looking for about 11 people, so you will let me know about that one, how that went. I am also very interested in knowing, in the last two quarters, how did the sales break down percentage-wise among the three leading customers? My third question is, what if anything, to the old Eclipse company, is there any movement there, and does that look like they will be back producing and using some of our services and merchandise? Okay, go.
You do it.
With regards to the hiring, I think we have hired six or seven people so far since the meeting. We continue with our hiring efforts. With regards to the Eclipse, they will not be building new aircraft. Right now they are in bankruptcy court.
Yep.
Whether they will emerge or not remains to be seen. Our agreement with them, that we would supply equipment to Eclipse customers only through them, will soon be completed. We will have the opportunity to direct market upgrades to that fleet of over 250 aircraft. With regards to the revenues.
Yeah. For the revenue, for the six months, it's pretty much an even breakdown between general aviation, which is primarily Pilatus, and the 757-6, which is, you have basically a big MRO has done a lot of stuff over that term. Between the two type of industries, it's almost a 50-50 split, approximately.
Pilatus has become the number one sales area.
Of any one? Yes. Of any one customer.
Okay. That's all. I don't have a lot of questions today. Thank you so much.
All right. Thank you, sir.
You have good questions, we're delighted. You remember what you said to me when you left the annual meeting. I think about that almost every day.
Okay. Thank you.
Thank you, sir. All right.
With no further questions, this concludes our question and answer session. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.