Good morning, and welcome to the Innovative Solutions & Support First Quarter 2014 Earnings Conference Call. All participants will be in listen-only mode. (Operator Instructions) After today’s presentation by management, there will be an opportunity to ask questions. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Mr. Geoff Hedrick, Chairman and CEO. Mr. Hedrick, the floor is your sir..

Thank you, and good morning. This is Geoff Hedrick, Chairman and CEO of Innovative Solutions & Support. I'd like to welcome you this morning to our conference call to discuss first quarter fiscal 2014 results, current business conditions and our outlook for 2014.

Joining me today in our Exton headquarters is Shahram Askarpour, our President; and Ron Albrecht, our CFO. Before I begin, I would like Ron to read our Safe Harbor statement.

Ron?.

Thank you, Geoff, and good morning, everyone.

I would like to remind our listeners that certain matters discussed in the conference call today, including 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, than those discussed, including other risks and uncertainties reflected in our company's 10-K, which is on file with the SEC.

I'll now turn the call back to Geoff..

Thank you, Ron. In the first quarter, we’ve reported revenues of $11.1 million or a 70% increase to the first quarter of fiscal 2013. Net income was $1 million or $0.06 per diluted share, up about 300% from the $318,000 earnings or $0.02 per diluted share in quarter one of 2012.

The revenue growth was attributable to an increase in shipments of various products to the significant progress achieved in our engineering development programs. Product sales grew 42% compared to the fourth quarter of 2013, up 63% from Q1 last year. Gross margins improved to 34%, up 25% or seven points from last quarter.

Continued expense management grew net income faster than revenues. We achieved these results while investing 37% of revenue in product development. The recent reorganization and strengthening of our leadership and manufacturing organization contributed to the improvement in production volume in this quarter.

Our increased productivity enabled us to provide a required manufacturing support to our Engineering Development programs. We anticipate at the completion of these development programs will result in new orders of an estimated $90 million over the long-term OEM production. This is in addition to our current backlog of $87 million.

In addition, we expect FAA certification and the start of production of several of these programs will attract additional new customers.

Our growing portfolio of products includes Flight Management Systems, GPS centers and other NextGen air traffic control products with industry leading ease of retrofit continues to offer the industry’s best performance for price value.

As a result, our customer base includes some of the world’s largest commercial air transport and business jet operators, both domestically and internationally, foreign and domestic military. We continue to develop advanced technologies and improve the performance reliability and efficiency of increasingly sophisticated new and existing aircraft.

Our object is to capture a greater share of an expanding addressable market by increasing the functionality of our products to provide state-of-the-art technical solutions at a very competitive price.

Given the slower start to the year and our healthy backlog, we’ve remained optimistic that fiscal 2014 will be another year of increased revenues and earnings. Let me now turn it over to Ron for a detailed description of our financial performance..

Thank you, Geoff and thank you all for joining us this morning. For the three months ended December 31, 2013, company reported its eight consecutive profitable quarter. For the quarter, revenue was $11.1 million, up 70% from revenue of $6.5 million in the first quarter of fiscal 2013.

Company reported fiscal 2014 first quarter net income of $1 million or $0.06 a share compared to net income of $318,000 or $0.02 per share in the same quarter a year ago. Products sales including Flat Panel Display, Air Data and other hardware and software sales accounted for approximately 70% of total revenues.

The other 30% of first quarter revenues of $3.4 million resulted from customer support of our product development programs. Gross margins in the first quarter were 34%, down from 46.5% a year ago, but up nearly 7% sequentially from 27.2% in the fiscal 2013 fourth quarter.

Compared to the preceding quarter, margins reflect the increased product volumes. Over the course of this year, we expect to complete the engineering divestments in several of these product development programs at which point they will transition to higher margin product sales.

Total operating expenses in the quarter were $2.4 million, down from $2.7 million a year ago; the decrease was primarily attributable to $200,000 decrease in spending on internally funded research and development.

However, the combined spend on customer supported and internally funded engineering development was approximately $4 million or 37% of revenue.

Selling, general and administrative expense in the quarter was $1.7 million, down from $1.8 million in the first quarter of last year and also down sequentially from $1.8 million in the fourth quarter, principally because of the adjustment to lower an accrual related to the settlement of legal matters.

As a percentage of sales, SG&A was 16% in the quarter. As revenues have increased, the underlying level of SG&A expense has remained relatively stable over the last four quarters and we do not expect those expenses to increase appreciably in the near-term.

We reported first quarter operating income of $1.4 million, an improvement of over $1 million compared with $385,000 of operating income we reported in the first quarter of last fiscal year.

For the quarter, we provided taxes at 29.2% rate, a rate which we expect to remain in effect for the full year, unless Congress reinstate the fired R&D Tax Credit. Net income for the quarter was $1 million or $0.06 a share; this net income compares favorably with both the first and last quarters of fiscal 2013 at $318,000 and $155,000 respectively.

Earnings per share of $0.06 in the first quarter compared favorably with the first and last quarters of fiscal 2013 of $0.02 and $0.01 respectively.

Operating activities used $223,000 of cash in the first quarter, primarily related to the timing differences between expenditures on customer supported product development programs and related receipts from those customers and unbilled receivables grew as a result. These timing differences will reverse as these programs reach contractual milestone.

Company ended the quarter with almost $16 million in cash on hand and remains debt free. We believe that we have sufficient cash to fund operations for the foreseeable future. During the first quarter, we collected the entire $760,000 pre-Bankruptcy receivable from American Airlines.

I should mention that, following a competitive process, the audit committee of the company’s Board of Directors voted unanimously to engage Grant Thornton LLP as the company’s new auditors, effective January 18, 2014.

As a result of one of its periodic reviews, the audit committee concluded that Grant Thornton would better serve the company’s requirements at its present stage of development.

The transition to the new audit firm delayed the earnings release and conference call as Grant Thornton spend time reviewing the company’s accounting metrics, internal controls over financial reporting and financial results for the first quarter.

For the fiscal year ended September 2014, we expect increased sales and generate profit, which would represent our sixth consecutive profitable year. The transition of certain programs from their development through their production phases should improve margins.

Now I’ll turn the call over to Shahram Askarpour for further comments on market conditions and operations.

Shahram?.

Thank you, Ron and good morning everyone. For the first quarter, revenues increased significantly, both from a year ago and sequentially from the fourth quarter. The first quarter revenues also exceeded our targeted long-term growth objective.

This growth resulted from increase in product shipments and customer support of our product development program. In anticipation of over 20% increase in annual revenues year-over-year and manufacturing support to engineering programs, we’ve restructured and strengthened the leadership in our manufacturing organization.

Although, we felt it might take a quarter or two to see improvement, first quarter results reflect our progress in productivity and efficiency. In the past, we demonstrated an ability to manage rapid production increases with quarterly production as high as $19 million.

We believe that we can maintain an increased level of output that we achieved this past quarter to support our growth strategy. Also during this quarter, we made excellent progress on all of our product development programs, several of which are nearing completion.

Among our more significant accomplishments, we obtained STC for both the Auto Throttle and Standby Display for the Eclipse aircraft. Development on this program has progressed to the point that we are shipping Eclipse E550 production units. We have delivered and upgraded Boeing 737 Classic aircraft to the National Nuclear Security Agency.

The airplane is now in customers’ position and is undergoing flight testing in advance of final specifications. With respect to some of our other development programs, during the first quarter, we produced the first batch of pre-production order for the Pilatus PC-24 business jet aircraft that we used for aircraft and qualification testing.

We also delivered a fresh shipset for aircraft integration on the Foreign Military C-130 transport program. The KC-46 tanker is in the midst of a lengthy qualification period, followed by support of customer flight testing.

The MD88, MD90 upgrade programs for Delta Airlines is progressing well and we anticipate the receipt of FAA certification this year. Our contracts with OEM customers consist of agreements to provide engineering to develop products and to be the sole-source manufacturer of the related product once development is complete.

During the next two years, we expect the current OEM development programs to transition from engineering to production. At that point, some of the approximately $90 million of anticipated sole-source OEM production contracts will begin to add to the potential revenues already included in our backlog.

As an example, once this development certify, we have a contract to furnish the aerial refueling control display unit to the roughly 180 planned KC-46A aircraft. Our backlog does not contain any of that potential future revenue that we expect to stretch over a decade or more.

Revenues from the product sales from these OEM contracts should enable us to achieve margins consistent with our historical performance. As we discussed during the last quarter conference, the product development programs have placed the requirements for additional resources.

We are currently outsourcing a significant amount of Engineering Development work to cope with this demand. We expect that the same level of outsourcing and engineering expenditure will be required for the remainder of this year to complete some of the major programs in hand.

As of December 31, backlog is a healthy $87 million down only slightly from $91 million at September 30, 2013. We continue to add backlog through new orders, which totaled $7 million during the first quarter of fiscal 2014.

In summary, in the first quarter, we increased production to a highest sustainable level through improved productivity, so that we can both increase our production volumes and support our new product development initiative.

As a result, we grew revenues in excess of our long-term objectives, expanded margins, and grew earnings at a greater rate than revenues. Current backlog, delivery schedule and increased customer support of our new product development efforts have created the demand that we expect to increase revenues this year compared to fiscal 2013.

As we complete our product development programs and transition to production, we continue to expand our product portfolio and increase market recognition of our performance for price strategy. Our production revenues for the first quarter grew by 42% compared to the fourth quarter of fiscal 2013.

We are beginning to see improvements in gross margins and operating profits as a direct result of increased production volume; these improvements provide us with optimism as our strategy sounds and increases our confidence that we are in the right path to continue to achieve meaningful growth this year and beyond.

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

Thank you, Shahram. For the fiscal year ending September 30, 2014, we expect to report our sixth consecutive profitable year with sales, operating income and net income all of which expect to increase compared to fiscal 2013.

This year should be a transition year with revenues from production volume increasing as Engineering Development completes and products received FAA Certification and enter production. Our number one focus is on execution.

We need to continue to improve our productivity and efficiency to optimize the value of our development and production opportunities. In order to continue on our momentum, we anticipate investing 30% to 35% of our revenue in research and development as we continue to expand our product portfolio into new markets.

That benefit from our performance and price strategy. This ability to deliver results in the near terms while investing in long-term is a formula to create value for shareholders. We are fortunate to have customers who partner in share in the cost of that development. Operator, I’d like to open the call for questions..

Yes sir. We will now begin the question-and-answer session (Operator Instructions) the first question we have comes from David Campbell of Thompson, Davis..

Good morning everybody..

Good morning David, how are you?.

Good, thanks. Thanks for the excellent first quarter results.

However, I assume from your comments that, everybody has made that quarterly revenues will not increase 60% in the rest of this year, is that a good assumption?.

I don’t know yet..

Yes, that’s true..

That would be more than I was assuming in my previous workouts..

We are pleased that we are starting to make the transition to a business that we are used to when I am planning. We’ve made some good moves and Shahram have done some great work in redirecting and restructuring the organization. We have been fortunate with good business, so now the question is just to focus on the business and as I say, execution..

You mentioned Shahram that you had $7 million of new orders in the first quarter.

I assume that means $7 million of more engineering modification contracts?.

None of those were [indiscernible] mainly production..

Those were full production?.

Yes..

Okay.

But you are not supposed to get more production orders until the engineering contracts are over, so how?.

You get production orders from existing products..

Existing products, we’ve had around for 20 years..

We still sell Air Data Equipment, we still sell Altimeters, we still sell Display for 57/67 and then those are all production orders, that’s great stuff..

Great, great..

Those are great orders..

Okay.

So Shahram I think you mentioned that the engineering workload will be continuing at the two other balance of this year, does that mean at the first quarter levels which were that will have $3 million or $4 million?.

We don’t expect it to increase. We expect it to be around that, just maintain that level of engineering. We have a fair amount of product development going on right now and some of which are – we have not spoken about it, but we believe that it’s us only required, so we can sustain our over 20% growth year-after-year.

And because of that, we are going to continue with this level of engineering at least through the end of this year, but as our production grows, what we will see is that we will see improvements in our gross margins and profit, because we don’t plan to grow the engineering expenditure beyond what we’ve seen in the first quarter..

I understand, but you did say that the FAA approval or STC Certification for the MD88/90 work will come during this year, but the production phase I thought was starting in late April?.

Again, I don’t want to go too much into the details on that contract, but we anticipate some shipments prior to the final receipt of the final certification..

That was good, that’s probably for testing of the equipment or testing the aircraft with the new?.

And simulate things like that..

Okay, then the PC-12 those in recent article about the PC-12 upgrades with new engines, I assume that your new contracts or your new to equipment for the PC-12 there is that anything do with the new engines or is it a separate program?.

No, actually the company that does the engine upgrades on the PC-12 and they also do propeller upgrades for the PC-12 as we partner on them on some of the upgrades, but it’s not tied into our display system. Some people choose to do them both together, other people choose to do one or the another..

But the new display systems have laid and you’d begin deliver those yet?.

Yes, we’re delivering those. Our first customer in that is the U.S. government and we have been delivering those to them..

Okay.

You mentioned the Eclipse and you said the Eclipse 500 production partnership, its 550, isn’t?.

That’s right. Eclipse 550 will actually start shipping production units for them..

Right, right and that you’ve got STC approvals on those?.

Yes, sure..

Right..

That’s the TC that Eclipse has to do on the 550. 550 is going to be a tax verification done by Eclipse, but what they are doing is that they are taking our STC and converting it into TC and then they going to start shipping airplanes to their customers. So we’re in the process of doing that with them right now..

Ron, my revenue forecast looks a little low for fiscal 2014, I don’t think the earnings are but because of the heavier revenues from engineering contracts, but it looks a little low?.

Well, refresh my memory on your forecast..

Well, my forecast was $38 million in revenues for the year..

Okay..

That looks low..

We hope it is, but I would also remind you that we don’t have 100% of that order coverage yet, so about $38 million, we probably do right..

Yes..

So right now, I would suggest that we see what happens in next quarter, everything looks very good, but what we don’t want us to do is, overreact a good news, we’re very pleased with the performance and we think we’re going to continued to do very well and we will keep everybody updated with progress on the order book and product development..

Yes, I don’t really think that my earnings here that for estimates, but revenue seem to be? So I am just, if we continue to integrate this much in EMD engineering revenues?.

Engineering is always when you growing a 25% or so, it’s very hard to be precise with what it because you’re growing so rapidly one instrument can make a big difference in the revenues..

I do, I have question about the C-130s.

There was an article that the, there is a dispute in the Congress about upgrading the C-130 cockpits and I was wondering if that’s not a problem for you?.

That’s a problem for Boeing because that distribution is about whether they want to spend $17 million on airplanes and our Boeing do that ample upgrades or go to people like us for a fraction of that..

Dispute was the air force wanted to head with the upgrades so called air program, aircraft modernization program. That was brought by everybody including the Joint Chiefs of Staff was taken out of the budget by the military and put back in by the Congress.

It is the cost we’re running almost $15 million to $17 million for the upgrade when its price competitively in the marketplace it’s about $1 million. So needless to say it’s difficult to justify and that’s the biggest problem.

We expect something like $2.5 billion or $3 billion coming up with the technical solution that’s so expensive that it makes it virtually impossible to do. So that’s why we have received a number of orders starting the upgrade of the cockpit by a number of the services independently, because they don’t have $17 million on upgrades of their aircrafts..

Do you have the alternative to the expensive Boeing solution?.

Pardon me..

Do you have the alternative to the expense Boeing solution?.

It alternative, I agree with you. I mean but nobody is using the Boeing solution yet. It’s not a Boeing issue, it was unfortunately when you have a large development program like that, I think is growing, growing, growing.

I’m sure Boeing did what they were asked to do and what they ended up with something that in view of the cutbacks in the budgets and just there is no money for that and that’s not uncommon..

Yes, all right, but doesn’t sounds like anything that I heard you..

We are running out of money and what we’ve a much more cost effective solutions it’s good news for us..

All right..

I will remind you, I started the business in 1988. Everybody told me the last thing you don’t want to do is get into the military, because there is no military budget.

At the time I concluded that if there was no money, the first thing that would be cut would be new procurement of new weapon systems, but I turned out to be right and the retrofit that we ended up building the business on we are very successful. So when things get cutback, people get very serious about getting best value for money.

When you don’t have much money to spend, you end up being very frugal..

You said that actually, as you complete deliveries, initial deliveries of displays to Delta for the MD88 and MD90 program that that may promote that may contribute to additional orders from new customers for commercial aircraft?.

That’s correct. We believe virtually every program that we work on today results in an expanded market opportunity, because we consciously select programs to go after that leverage us into an expansion of our market offering..

And why is that, because the commercial operators want to actually see the operation of the Display Units before they….

That’s always to Display Units, if the total solutions and the performance that we offer..

Right, I know it’s more than Display, but the potential new orders come because they want to actually see the new equipment working?.

Think about it. What would you do if you spend $100 million, you probably like to see what color of the plane was.

So I mean it is what we’re able to demonstrated by an installation is the fact that the equipment works well that everybody is happy with it and then it gives other people the idea that they can do the same thing pretty cost effectively and that’s how it sort of builds.

We are fortunate to have a customer like Delta whose technical and business savvy is industry standard as you know they were airline of the year or internationally, it’s an amazing success story..

I’d like to fly them, but they are doing okay. Those MD80 drive me nuts, but anyway that’s another theory, but thank you very much. I appreciate the help, keep up the good work in being so efficient..

Thank you..

(Operator Instructions) the next question we have comes from Scott Lewis of Lewis Capital Management. Please go ahead..

Good morning. Thanks for the taking the call and congratulations on the very nice quarter..

Thank you..

My question is about the 737 program.

Now that you’ve moved a long a little bit, can you talk about the prospects for the market there?.

So we have a fair amount of interest, both internationally as well as within the U.S. for that solution. Again the key is to finalize the certification and we believe once that’s finalized, you have other customers who are interested to procure that solution..

Okay.

And do you have a timeframe in mind for getting the final certification?.

It’s within the next two months..

Okay, super.

And then my second question relates to the back-up display that I believe is going in the Eclipse 550, but that can go into other aircraft, right and are you having success selling that into other models?.

It was sold through Delta Airlines for their MD88, MD90, it’s going into the C-130 platform and we are seeing a significant amount of interest from various OEMs with helicopter as well as fixed wing aircraft as well as other airline operators that they want to use this standby for their regional and air transport fleet..

Okay.

So I assume when you consider lot of volumes through that product, does the gross margins get better and better?.

Absolutely. When you look at like the gross margins, I mean we’ve increased our production revenue this quarter and we saw a significant increase in the gross margin for sole-source production..

Understand we are fortunate to have customers who are willing to partner and sharing the cost of product development. There is no intention to make a big profit of engineering development. We are not in the engineering business. We are fortunate to have customers who will help us in the development of these products.

The gross margins are effected directly by production where we have intrinsically a very large available gross margin in all of our production products. So as we transition into more and more production, we are just a core of our business. Our gross margins will grow accordingly..

Okay, super, well, congratulations on….

Looking at our historical gross margins, there is not much difference than they were eight years ago. We used to have gross margin in the 60% range..

Okay. Well, let’s hope we see it back in the 60% range when August production begins..

Remember, we are not focused so much on gross margin. We are focused on earnings per share which is what we are interested in doing mostly and we’ve always had that discussion. If we get gross margins as we’ve talked about, 50%, we will be delighted..

Okay, super. Well, it’s nice to see it all coming to fruition all these years of R&D, keep up, good work..

Okay, thank you very much..

Next we have [indiscernible]..

Good morning gentlemen..

Good morning..

Good morning..

Good morning.

My question was about the and I am sorry, I tuned about 15 minutes late, so I don’t know if you touched on it or not, but on the FAA and whether or not you guys think it’s going to be any movement on the priority landings at certain airports that might really help you guys with the uptick in getting some of this equipage into some of these other airlines?.

The FAA is interested in what we are doing. In other words, directly interested, because with Delta, the required navigational performance will enable far more traffic to manage the same aerospace and they’ve taken a great interest and a very cost effective solution to NextGen air traffic control, so in short is, yes..

Okay and I mean I realize there has been some early adapters here with these things and I’m sure that their patience is getting a little bit short with the FAA because they’ve obviously done some upgrades that they are really not able to take advantage of, do you think there is enough pressure they can generate to speed-up this process, because I think I read a few weeks ago that like New York had put a new policy and where they were actually going to be slowing down the [indiscernible] traffic?.

Well, they may slow it down. What will happen is that inevitably the equipped aircraft will start getting priorities and as the equipped aircraft get priorities, the other aircrafts will slowdown and the incentive to put the equipment on will grow very quickly..

Okay..

And that’s what happen with reduced vertical separation, so a similar situation where they got priorities going over the North-Atlantic when they were RVSM equipped and they didn’t take people very much time to figure out that they want to do that quickly..

Sure..

And put the equipment in the airplane, but the only reason you put equipment in the airplane in the long-term is to so that you can make the equipment more effective and more efficient and that’s with this equipment does period..

Sure.

And it does appear that even outside of any sort of FAA, NextGen deadlines that the equipment you’re talking about that has a market as soon as what has a market right now, but a much bigger market that the time were the FAA actually starts to take advantage of these equipments, correct?.

Well I think it’s a cat and mouse a little bit.

What you have got to do is, you have to have a enough equipments on the aircraft to have a buyable RNP procedures, precision procedures into the airports and when that number of equipments exists, then they will offer priority to those aircraft with that equipment, it’s the same thing happened in New York, virtually you couldn’t get into certain airports without the RNP equipments.

Initially you’ve got preference for treatments and it’s certainly for 10 minutes or 20 minutes, it inspires you to get the right equipment quickly..

Absolutely.

Do you guys have any thoughts on a timeframe where they going to start to amp that up a little bit more?.

I have no idea..

Okay..

I’m trying to guess what the government is going to do is very tough to do..

Sure..

I already know is that is inevitable, because it’s absolutely required and so the best thing we can do is keep working at it and working hard. Our equipments we hope would be in by the time that equipped demand comes, our equipment should be very easily installed and very competitively practiced..

Great, thank you gentleman..

Thank you..

Since there are no more questions, this concludes our conference for today. First we’d like to thank the management team for your time and we thank you all for attending today’s presentation. At this time, you may disconnect your lines. Thank you, have a great day everyone..

Thank you..