Innovative Solutions and Support, Inc.

Welcome to the Innovative Solutions and Support Fourth Quarter 2020 Earnings Conference Call and Webcast. All participants will be in misnomer 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 telephone keypad. To withdraw your question, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to Mr. Jeffrey Hedrick, Chairman and Chief Executive Officer. Please go ahead, sir.

Good morning, this is Jeff Hedrick. Welcome to our conference call to discuss our performance for the fourth quarter and fiscal year 2020, the current business conditions and our outlook for the coming year. Joining me are Sharon Askapour, our President, and Rel Winand, our CFO. Before I begin, I'll ask Rel to read the safe harbor message.

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 10-K, which is on file with the SEC, and other public filings. Now I'll turn the call back to Jeff.

Thank you, Raoul. Several years ago, I announced we would change our approach to the market by focusing on only products that are technologically driven performance and price advantages. I am pleased that our operating performance during this challenging period appears to validate our change in direction. The fourth quarter had a strong finish, resulting in a year-over-year, quarter-over-quarter, and sequential growth. Our revenues increased 31% from a year ago. The quarter full-year revenue growth was 23%. Fiscal 2020 was our second year. consecutive year of strong growth, of increasing profitability, solid cash flow, and while strengthening the underlying foundations of OEM production contracts and recurring revenue that support our continued success. Based on this performance, our cash on hand and our confidence in continued success In September, the board of directors declared a special $0.65 per share dividend. We were able to achieve these results while protecting our employees, partners, and customers against the pandemic. While its impact today on our business has been minimal, safety precautions have now become a routine part of our operators' commitment to ensure a safe and a healthy work environment. We announced last quarter that Textron had awarded us an OEM production contract to supply our ThrustSense autothrottle with lifeguard protection on the new King Air 360 twin turboprop. In November, Textron celebrated delivery of its first feature craft, King Air 360 turboprop aircraft. More recently, Textron announced that the thrust fence autothrottle is standard equipment on the new King Air 260. Delivery is scheduled to begin in the first half of 2021. We are pleased to be working with Textron and are grateful for the support through the certification and moved into production. They are a strong supporter of our technology. The IS&S autothrottle is the first among a list of 360 upgrades mentioned in their King Air 360 promotional material. Textron joins two other major OEMs to feature IS&S products as standard equipment on their production aircraft, joining Pilatus PC-24 UMS and Boeing's KC-46 tanker as major OEM contracts of prospectively significant duration and value. These contracts offer a growing base of long-term recurring revenue as expected for the last years. We are supporting Textron in looking into opportunities for the Thrust Sense workload reducing features on their other production platforms. We are grateful to see that the Service Center organization has positively pursued the significant retrofit opportunities of thousands of King Airs currently in service. Consequently, we are working with Textron to ensure Our production levels meet the service center's demand for auto-throttle and help promote the availability of this potentially life-saving technology to King Air's owners. The restaurant also has a base for expanding beyond the general aviation market. You'll look at the military aircraft and air transports and multi-engine aircraft as well. In addition, we are finding that the public publicity surrounding our ThrustSense has created interest with other OEMs. Our potentially life-saving FAA-certified one-engine and operative upset protection is a compelling differentiator that multi-engine operators are now very interested in. We are optimistic that the contracts with Textron support the wide adoption of a technology that not only improves air care performance, but can provide unparalleled safety. Precipitated by our King Air business, we have hired a sales and service support representative stationed in Wichita. He will support our present business at Textron and explore new business opportunities in the region. We are working with Textron Worldwide Service Organization, supporting autothrottle retrofits. Our autothrottle programs director is successfully addressing large military opportunities and air transport markets with very encouraging results. We continue to recruit sales and support personnel for our growing business demand and for thrust sense, autothrottle, and lifeguard protection systems. In addition, September of 2020, we announced the FAA had certified our synthetic vision installation and autothrottle upgrade for the Eclipse jet. The Eclipse was the first aircraft in which we developed an autothrottle, and we are pleased to be able to offer owners the ability to upgrade the airplanes with our latest features. The ongoing growth of online shopping continues to fuel the increase in the number of 757s and 67 aircraft being converted to cargo. This has generated increasing demand for our flat panel display technology. Engineering and development work completed, we ship our upgrade for U.S. Navy aerodated computers for the F-5 in the fourth quarter. We are now marketing international customers for the F-5. Let me turn this over to Ralph for some financial results.

Thank you, Jeff, and thank you all for joining us this morning. Looking first at the fourth quarter, revenues were $6.3 million of 31% from $4.8 million a year ago. and generated a 39% increase in operating income. This was the fastest quarterly rate of growth in this fiscal year. Growth this quarter was almost entirely in product and customer service revenue as we completed final engineering on the US Navy F-5 Air Data Computer Development Contract, and we shipped the entire production order in the quarter. Gross margins for the quarter were 55.8% down from 59.5 in the year-ago quarter, with a decrease attributable to product mix, higher warranty, and material costs. Also, this quarter we had limited engineering development revenue, unlike the year-ago quarter, which yielded strong margins. Nevertheless, margins remain in line with the historical averages achieved over the years. Total operating expenses for the fourth quarter of fiscal 2020 were $2.3 million, up from $2 million in the year-ago quarter. This modest increase in expense reflects the addition of resources needed to support the company's 30% revenue growth rate. Research and development expense was up over the year-ago quarter, reflecting a shift to more internally funded R&D, now that the customer-funded F5 development contract is completed. R&D was approximately 11% of quarterly revenues, which is consistent with our strong commitment to innovative and new product development. Selling, general, and administrative expenses were up about 8% from the year-ago quarter, again, primarily due to the need to add resources to support our increased business activity. For the quarter, we generated operating income of $1.2 million, or approximately 19% of revenue. Other income was down from the year-ago quarter as interest rates decreased. We reported quarterly net income of $1.2 million, or 7 cents per share. Looking at results for the year, total revenues were $21.6 million, up 23% from $17.6 million for full year 2019. The company reported fiscal 2020 net income of $3.3 million, or $0.19 per share, increases 74% and 73% respectively from net income of $1.9 or $0.11 per share for fiscal 2019. The company remains in strong financial position. We generated over $2.2 million of positive cash flow from operations in fiscal 2020, of which $1.6 million was generated in the fourth quarter, and had $12.6 million of cash on hand at September 30, 2020. The company is debt-free. In September, the Board of Directors declared a cash dividend in the amount of $0.65 per share, or approximately $11.2 million, which was paid on October 1, 2020. The dividend appears as an accrual on the September 30, 2020 balance sheet offset by a corresponding restricted cash. We believe that the company has sufficient cash to fund operations for the foreseeable future. Now I'd like to turn the call over to Sharon.

Thank you, Ralph, and good morning, everyone. The fourth quarter was our best sales quarter of the fiscal 2020. and put a fine point on our second consecutive year of top and bottom line growth and strong cash generation. More importantly, it was a year in which we secured our third OEM production contract with a Tier 1 manufacturer, Textron. King Air 360 and King Air 260 Our new aircraft that will feature our ThrustSense autothrottle as standard equipment join our ongoing OEM contracts with Pilatus and Boeing. These OEM contracts, we are building a solid foundation of recurring revenue that should last for years. Let me also quickly reiterate what Jeff mentioned earlier. generated this strong growth and profitability and successfully executed on the King Air contract while implementing new safety policies and procedures that have kept all of our employees safe and productive as well as protected our partners and customers. The King Air 360 program is just ramping up with the first production aircraft delivered to a customer last month. The King Air 260 is scheduled for delivery in the first half of 2021. We have been shipping process units to Textron since third quarter and expect orders to naturally follow the anticipated increase in production over time. In addition to shipping units for installation on the King Air 360, we are also shipping units to Textron for distribution to the service centers where they have been used for retrofit installations. As Jeff mentioned, the retrofit opportunity is much greater than the forward fit, with about 5,000 Kingaires currently in service, which we estimate represents about a $300 million total addressable market. At this point, we are certified for retrofit and the Beechcraft can get 300 series equipped with Proline Fusion avionics, and the Proline 21 equipped Beechcraft can get 200 series. Other variations of this STC are being pursued with some imminence. We are consequently also shipping autostravels to our installation partners where it appears many King Air owners take their aircraft for service. Both organizations are aggressively marketing the retrofit. In fact, we are opening an office in Wichita to not only promote the product, but also support Textron. The relationship with Textron is going well and provides a solid foundation from which we expand our auto travel market. only horizontally across King Air platforms, but other OEMs as well as the military. We are in conversation with manufacturers of both twin turboprop, twin jet, and multi-engine aircraft with regards to our autotravel. Potentially life-saving nature of trucks and multi-engine aircraft is a feature in which virtually all OEMs have an interest. In September 2020, we announced that the FAA had certified our synthetic vision installation and overall upgrade for the Eclipse jet. This installation marks ISSNS's first upgrade directly to Eclipse owners and involves substantial pre-orders. Eclipse owners now have the benefit of significant functional upgrades and ongoing product support directly from the partnership with IS&S. I will now briefly review some of our ongoing programs. DC24 program has essentially reached steady state production levels. We expect to ship close to 50 ships in fiscal 2021 to support their current production rate. This program remains highly successful. Elatus is very satisfied with our performance This program, we believe, is expected to continue to run for many years, offering a predictable, stable, recurring revenue stream. Dynamics in the commercial transport market are also essentially unchanged. Their cargo delivery services continue to convert Boeing 757 and 767 planes, including upgrades to our flat panel displays. Where we once contracted with large installers, we are now doing more direct sales to carriers, which has proven much more successful. There remains over 1,000 operational 75 and 767s that are still in need of retrofitting, with an even larger number of 737s yet to be updated. Development work for the U.S. Navy A-5 data computer was completed, and we delivered production units for the U.S. Navy fleet, retrofit in the fourth quarter. This was a highly successful program, and we are now turning our attention to foreign military, which also fly the F-5, and would be a large new market for this versatile product. Our KC-46 program with Boeing is one of our three OEM production contracts, it continues to make steady contribution to our recurring revenue and profitability. New orders in the fourth quarter of fiscal 2020 were over 3.4 million and backlogged as of September 30, 2020 was 3.6. Bookings for the full year were in excess of 19 million. Keep in mind that backlog at the end of Any one quarter is not necessarily indicative of future business activity, as we generate a good portion of our revenue from customer service and intra-quarter book and ship orders. The ongoing pandemic has had peripheral effect on our sales and marketing activities, limiting our ability to personally meet with customers and prospects, causing some complexity working with the FAA, which is operating on the work-from-home directives. In balance, we do not believe the pandemic has or will have a significant impact on our business and are excited about the prospects of our portfolio of our products. Let me turn the call back to Jeff for some closing remarks.

Thanks, Sharon. The growing success of our auto throttles strongly suggests that this strategy is creating real value for both our customers and for our stockholders. We're entering a new fiscal year with momentum for two years of strong growth, solid balance sheet, and a portfolio of products that are receiving enthusiastic market reception. We see a great opportunity. Thank you for your ongoing support and encouragement. Thank you to the audience today. I'll take the questions as required.

Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. And the first question will come from David Campbell with Thompson Davis and Company. Please go ahead. Good morning, David.

Hey, good morning, Jeff, Rell, and Haram. Thanks for having such a good quarter. I just wanted to ask you, Rell, about what you assume, what I should assume for a crude tax rate in fiscal 21. I would say... Will there begin to be tax accruals?

Yeah, there'll be some expense, but it'll be lessened because we still have some NOLs and some R&D tax credits, so I would use... I'm estimating use like a 5% effective tax rate type of thing.

Okay, thanks. Thanks. And Jeff and Sharam, were any of the... Shipments to the King Airs, were any of them for some OEM and some retrofits or all retrofits?

One OEM, both. A lot of OEM, actually. 20-odd OEM shipments. Obviously, the airplanes haven't come off the line yet. And then a very rapidly growing demand in retrofits.

but no retrofit revenues yet.

Actually, Textron did an installation in Australia on a retrofit on using our Orotron.

We've had a number of them. We've had, you know, there are local service centers. They have a huge network of service centers throughout the world. And the very encouraging thing is they are very aggressively promoting the autothrottle retrofit. So it looks better almost every day. It's very good.

So you expect those revenues to increase in fiscal 21?

Very much so. We believe that the growth is going to be exponential.

All right. Right. This quarter, this December quarter, we'll have the usual seasonal downturn. Is that correct?

Maybe. Maybe we'll do a little better.

Okay. Well, thanks for answering the questions.

We're trying to do better. We're trying to keep a more stable and straight growth. Look, the operation is good. It generates cash. every day virtually. It's excellent. It's profitable, and as our volume goes up, it becomes more profitable, not only because it covers all the fixed overheads, a lot of which affects the present profitability. So we're very optimistic about the future. We're very pleased about Textron's interest and support in our products and see a large retrofit opportunity Listen, we're already delivering 5, 7, 6, 7 systems to another very new demand for package carriers. So, I mean, business is coming up. And when you consider the other effects of pandemic, most of aerospace companies have been struggling. We've done really well.

Well, you're doing a great job. Thanks for all your help.

If I do what I'm hoping to do this coming year, then it will start looking a lot better. I think we're fortunate we have a very good product that is very producible. We've got a great customer. All of our customers are outstanding. We're very fortunate with that. So we just keep working at it. You know, every day I get up and – As the Marines say, kick ass and take names.

Well, thanks a lot for answering the question. I've got to get off the call, but I appreciate all the work you're doing. Thank you. Happy New Year, Ken. Thank you.

Once again, if you have a question, please press star then one. The next question is from Roger Goldman, a private investor. Please go ahead.

Good morning, all. And first of all, thanks for a great quarter and a great year. Validates my late father's trust in you, as you know. And my sister and I are much appreciative. I also want to acknowledge the fact that the last quarter and the last year of history, but it sounds like you guys have set the company up for fabulous growth in the future that without being Pollyanna, could make the past look like small potatoes. So congratulations on that. My question, as it usually is, goes to the use of cash. We've got a company with no debt, with solid operating profit, and even after the dividend, a fair amount of cash on the books. Any thoughts of either an acquisition or a small regular cash dividend that I think would have a great impact on the stock price.

It's a good question. Some of that I can answer.

No, I know you can't. I know you can't.

But it's a reasonable question, absolutely. Look, we know we generate a lot of cash, and our interest is we're operating the business, not for us to look at cash that doesn't generate any income at all. I mean, I personally have cash accounts they're paying interest in pennies. We have no interest in doing that anymore. If we can reasonably invest it in other things, we're doing some automation on the floor and CapEx kind of things. We are actually looking at dividends on a long-term basis because we believe the business itself will generate cash on a regular basis, and that we... believe that our stockholders can make good use of cash. So we're very conscious of that. That's what precipitated the 65 cent. And yes, we continue to look at it, especially in light of what might be changes in taxation policy.

Exactly. Yeah, that's all I can ask for. And again, Well done. You guys are doing a great job of positioning this company for the future.

We miss your dad. He was always fun. He's a good guy.

Well, thank you. We miss him, too. We miss him, too. But I'm hoping after COVID, Jeff, to come on out there and meet you guys and spend some time. So I look forward to it.

Ladies and gentlemen, this concludes our question and answer session. I would like to turn the conference back over to management for any closing remarks. Thank you. It appears that our management line is inadvertently disconnected. So we thank you everyone for joining today's presentation. The call has been completed and you may now disconnect. Take care.