Welcome to the Innovative Solutions & Support First Quarter 2016 Earnings Conference Call. [Operator Instructions]. I would now like to turn the conference over to Mr. Geoffrey Hedrick. Please go ahead, sir..

Good morning. This is Geoffrey Hedrick, I'm CEO of IS&S. I would like to welcome you this morning to our conference call to discuss the first quarter fiscal 2016 results, current business conditions, and our outlook for the upcoming year. Joining me today are Shahram Askarpour, our President; and Rell Winand, our CFO.

But before I begin, I would like Rell to read our Safe Harbor message..

Thank you, Geoff and good morning everyone.

I would 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 and other public filings.

Now, I’ll turn the call back to Geoff..

Thanks, Rell. This quarter's results shows our progress transitioning the business and redeploying our resources to capitalize on market opportunities. I'm pleased to report that revenues have grown compared to previous quarter with quarterly revenues of 6.6 million doubling those in the fourth quarter of 2015.

Over 90% of the first quarter revenues are from production contracts which have been historically more profitable. Orders in the first quarter were 12 million, the best of new business in more than a year. The majority of the new orders also being production contracts.

Focus on new production contracts help lift gross margins to over 50% while the bottom line was impacted by increased legal expenses and trade show marketing expenses we believe are fundamental financial performance in the first quarter reflects our historic ability to drive profitability through efficient operations.

During the quarter we maintained our commitment to internally funded research and development, we generated cash from operations and strengthened our overall financial position. Production program's generated 18 million of our new business in the last six months.

We continue to increase our sales and marketing efforts in new territories and internally funded new product research and develop. The result has increased or input [ph] across a wide variety of opportunities in all our key markets military, commercial and BizJet.

Most of our recent orders are for next gen equipment which we see as reflective of owners and operators recognizing the cost and safety advantages of our cost effective solutions that provide them with the latest technology.

And as indicated in the last quarter an increasing portion of our new business opportunities are arising in markets which we have previously had a limited presence including Europe, the Middle and Asia where our superior price performance proposition is motivating buyers.

We're excited about the opportunity to build on momentum experienced over the past couple of quarters and to return IS&S to a period of renewed positive growth earnings and cash flow. Let me turn it over Rell for a detailed description of the financial performance..

Thank you, Geoff and thank you all for joining us this morning. For the three months ended December 30, 2015 revenues totaled 6.6 million essentially flat from a year ago but up over a 100% on a sequential basis from 3.1 million in the preceding quarter.

In the first quarter product sales were 5.9 million or more than 90% of total quarterly revenue reflects a steady transition to a higher proportion of product revenues as expected. As a result of this product mix shift gross profit was up over 20% as margins in the first quarter rose to over 50% from approximately 41% in the same quarter a year ago.

While margins can still vary from quarter to quarter as a result of product mix shift as well as volumes in general. We do anticipate overall better margins this year compared to fiscal 2015 based on current backlog and production schedules.

Total operating expenses in the first quarter were 3.6 million, selling, general and administrative expenses were 2.7 million in the quarter. SG&A includes increased legal expenses compared to the first quarter of fiscal 2015. SG&A was 1.9 million in the year ago quarter.

The additional legal expenses from the ongoing legal matter are expected to continue at approximately higher levels for the next quarter or two beyond which we are unable to proceed with any certainty what our expenses might be.

R&D expense for the first quarter was 932,000 up from 655,000 a year ago reflecting our commitments to internally funded new product research and development as well as the de-emphasis of customer funded engineering contracts. For the first quarter the operating loss was 309,000 and the net loss was 215,000 or a penny per share.

At December 31, 2015 the company has $16.3 million of cash on hand it's essentially unchanged from the end the fiscal 2015. As we generate $57,000 of cash from operations in the quarter. The company is debt free.

We believe the company has sufficient cash to fund operations as well as fund any and all of this potential legal expenses for the foreseeable future. In January 2016 the company renegotiated an agreement with the customer whereby 1.3 million of unbilled receivable and our obligations associated with certain product levels were canceled.

The bids [ph] expense related to the impairment of the unbilled receivable is recognized in the company's September 30, 2015 audited financial statements.

In addition as result of the changes to the agreement we also anticipate recognizing an approximately 1.2 million positive impact to the statement of operations in the second quarter resulting from a reversal of 1.2 million in associated liabilities consisting of deferred revenue and contract loss approval [ph].

Shahram?.

Thank you, Rell. Good morning everyone. As it has been just over a month since our last call, let me very briefly provide an update on the progress achieved during the first quarter as well as our current strategy and plan.

As you have already heard from Geoff and Rell, the 6.6 million of revenue the first quarter shows a reversal of the negative revenue trend experienced through 2015.

Progress being made towards our objectives to diversify our revenue streams both from a customer and geography perspective, to focus on production revenues by leveraging our growing portfolio of existing products and to continue to develop new products that capitalize on the market sensitivity to price per performance.

When we last spoke a little over a month ago, you had booked just over $10 million of new orders in the first quarter. At the end of close of the first quarter, orders actually totaled over $12 million. Bookings were geographically and end-user diversified.

We’re experiencing a higher degree of success in foreign markets that are especially sensitive to the price performance value proposition.

As we’ve increased our internally funded product research and development budget, we have rolled out several new products that are focused on the growing demand of next gen technology such as the situational awareness and improved navigational capability.

Among the internally developed products recently introduced is our new generation flight check feature in the patent pending. PT6 [indiscernible] trial announced at the [indiscernible] where we continue to receive encouraging interest from aircraft OEMs and installs.

Our product development effort continues to be focused on opportunities in large fleets not only those on which we have had success such as the Boeing 737, 757 and 767 but others as well.

An important element of our new products strategy is to develop technologies that integrate the existing IS&S products to deliver highest standards of performance in a total solutions package.

For instance the Boeing 737 FMS, the IGNS and the auto trial are designed maximize aircraft safety and situational awareness then coupled with our flat panel display systems. [Technical Difficulty] product has been seamlessly integrated with our Eclipse display system.

So whenever an operator orders either of these products the order can grow into a larger total solution sale where it is paired with other IFMS products most frequently of flat panel display systems. Backlog at December 31, 2015 was 13.3 million, the highest since June 2014.

Because backlog is primarily comprised of production components, contracts we anticipate completing most of this backlog in the current fiscal year. As previously stated our backlog does not include future production orders and OEM program.

We recently renegotiated an engineering development program with a customer and changed it into a production agreement by which we will receive payment for each chipset of product delivered. We expect development to be completed this summer and production revenues to commence this fiscal year.

Our goal is to grow our product portfolio to create a greater opportunity to participate in the adaption of the new cockpit technology in the commercial business jet and military market. While we have certainly made progress relative to a year ago, we remain dedicated to grow the business and profit and generate cash.

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

Thanks, Shahram. The first quarter was certainly a good start and the new orders increased backlog. So we can provide a nice tailwind to the year in which we expect to build momentum. We’ve worked hard and feel that we can effectively transition our resources to restore positive growth trajectory.

We believe the business is back on solid foundation on which it was built, price performance and technical leadership financial discipline and expense control. These disciplines have served us well in both weak and strong markets.

The challenge remains to continue to develop new products and solutions that provide owners and operators for the cost effective answers to their need for increased safety reliability and performance. Our goal for 2016 is to grow profitably in the business and generate cash. We believe this is a solid strategy to create value for our shareholders.

We thank you for your continued interest and support. Operator, we are now ready to take questions..

[Operator Instructions]. And our first question comes from David Campbell of Thompson Davis & Company. Please go ahead..

I just wondered if you could please email me the quarterly report, I used to get them emailed to me but I did not get this one..

We will get it out this morning..

Thank you. Rell, I just had some question about you mentioned this receivable that was cancelled, that was in January I guess after the quarter ended..

No we had at September 30, we had reserve against the unbilled, that was at September 30. It's little confusing because the other side of it comes in Q2 and this was Q4 and the 1.2 benefit will come in Q2..

Okay. And why is that benefit? I'm a little bit confused..

Because it's a relieving of liabilities that we have on the balance sheet so when you relieve liabilities it's going to come flow through your P&L as a benefit..

Okay.

And in the quarter it'll be below the line non-operating item?.

The one will be reduction to NRE cost of sales so that’s the contract loss accrual and the other one may, we’re still looking into that. It may come in below the line, we're still dealing researching that. But it may come in that way but it will be of benefit on the P&L..

So it's a total of 1.2 million in the second quarter, March quarter?.

Yes..

It clears up the contract and makes it more consistent with our aims to focus on production contracts which as opposed to engineering development. One was an engineering development that was fixed which had no upside and this gives us some upside as well as and we get paid when we perform.

So it's a clear way to address it in a process we had to make these two rules which were relatively self-compensating..

Right.

You mentioned that the -- there was an engineering contract that was converted to production, I assume that was after the end of the quarter?.

Well the contract was renegotiated in January of '16..

In January right, so it's not included in the December 30 backlog?.

Right. That's correct..

Right, it will be in the March quarter backlog and it will be production revenues in the fiscal years..

We receive the order for it, it will be included in the backlog..

And we expect again orders as not in one big lump but in progressive orders over the years.

So we’ve effectively converted an engineering development contract which we transferred the intellectual efforts, the intellectual property and we've converted it to a production contract and now we sell these functions independently, it's better for the customer and it's better for us..

And you mentioned, Rell you mentioned the legal costs extraordinary legal costs in the quarter.

And that I didn't get it quite, you said they would continue in future quarters at a higher level is that what you said?.

I didn't say what level, it's just going to continue. So there will be an impact but I don't -- can't say what the impact is going to be but there will be an impact in the P&L for the next few quarters..

Right, it may not be -- it may be the same amount or could be more or less you still don’t know yet..

Right..

So is there any update on the Eclipse, status of the Eclipse business?.

We've had meetings with the new leadership in the organization and results have been very positive, we have had very good -- Alan Klapmeier the Founder of Cirrus is now heading up Eclipse.

This is the guy who understands the industry and understands how to build airplanes, they were building 800 a year but there's some work to be done but they have expanded their efforts into Asia and the Middle-East and Russia and see some progress in all of those three market areas.

So we feel good and confident, the airplane continues to evolve and offer a lot better performance than it has in the past..

Well it seems to be an increasing array of very light jets coming out from other manufacturers now and I just wonder what Eclipse can do?.

Not like this. The only other -- I'm not aware of any increase you want -- in fact some of the competitors have had dramatically reduced sales. The Phenoms [ph] is selling but not selling strongly the Eclipse, it's a smaller airplane and maybe better equipped to serve markets than the larger and expensive Phenoms.

We think it has no direct competition in it's market, in it's price range of performance. There is no competitor for Eclipse and developing that market is what they got to do now.

So we're relatively encouraged, what's even more encouraging is we have now taken the Eclipse cockpit with the enormous functionality as part of that cockpit and applied it to a PC-12 and announced new PC-12 cockpit with our patented auto throttle at the NBAA show and it got tremendous reviews, we've got write ups and we believe -- and we've been asked to speak at a convention.

So we think we have been able to leverage an existing development, an expensive development for Eclipse into a totally new market segment that promises opportunities of significant number of production application.

So we’re kind of excited about it and we think that’s a good opportunity and we will be applying that same cockpit, we hope to several other medium sized [indiscernible] points..

I was thinking about the Honda, isn't Honda coming out with a very light jet?.

They have been working on that for 10 years. They started that program 10 years ago and I don’t know what the certification effort is but it's [indiscernible] the last I heard. And it's not a cheap airplane..

So as far as fiscal '16 is concerned you’re still hoping for a profit is that correct?.

That’s correct. A lot depends on legal expenses which are non-trivial [ph] which represent -- I mean breaking even would suggest that the business operating profits of the business are very good. It's a significant legal expense, but we’re confident that good sense will prevail.

So we’re optimistic about the future on that and we're probably regarded to proceed with the legal actions to their conclusion..

And our next question comes from David Starkey from Morgan Stanley. Please go ahead..

Can you quantify those annual legal expenses at this point and any kind of timeframe that all that you can expect to resolve this situation which has been going on for a while and secondly can you give us kind of an estimate of what it cost you to stay a public company right now with all the reporting you have to do..

I can't give you that estimate, it would be a speculation. We know obviously in general terms, what is difficult to quantify is the offsetting value of being a public company..

There hasn't been much of that though..

I don't think that's true..

Well for your investors it's certainly true. You haven't made any money for your investors in a long time..

My 3.5 million shares that I leave in the company, I'm very aware of it. Taking us public enabled us to hire people with whom we would otherwise not be able to hire because very few, very important people, capable people want to go to a company with unlisted stock because it doesn't have a lot of value.

So that was the reason we did those things specifically and also to gain credibility as a company. We have had some difficulty times in the past and we're trying to recover. We believe that going public had a real value from the operation of the business and credibility in the marketplace, so that's why we did it.

And since I haven't so much stock it wasn’t for me to bail out and so I don't believe that we have a viable public company.

The additional costs and inconveniences of maintaining a public company are always troublesome, I think it pays well when we meet with as we did recently a customer when understood that we were a public company listed on NASDAQ, it gave them sufficient confidence that in the meeting from -- this was a foreign airline operation he immediately shook hands and made a deal.

So I think those are very difficult to quantify.

So I don't know the exact number but you can speculate that you’ve stocks accounting issues and the obvious cost of operating a public company, but I think if we turn the business around and get it going they're going to be relatively small compared to the profitability of the business and historically the business has earned as much as 18 million net after tax.

So, the cost of being a public company was a $1 million I would say that was not perfect and anyway that’s at least our thinking for whatever it's worth.

As far as legal expenses you know it's speculative to look at the legal expenses but based on what we see now and I would prefer not to discuss it in detail for a number of reasons which I'm sure you can speculate on.

We're as you can see even with a significant legal expense this quarter and you asked us do we expected to continue? It would appear that based on the expenses today that that is probably a good conservative estimate of our legal expenses on a quarterly basis and we hope the conclusion of this will be before the end of the calendar year..

Okay, before the end of this year. Okay..

And it's inappropriate to discuss the cost of it and anything about the suit [ph] if you will forgive us..

But you would be in a profitable position without those expenses?.

Very profitable..

Okay, I will use the word very..

I can't just say profitable. I don't know when enough is enough, but we would be solidly profitabile that’s correct..

It would be nice if you could -- I don't know what why legal expenses should be such a private thing but it would be nice if you could break those out separate so that we could see the actual profitability..

I've been -- there are things that you can't discuss. We’re in the middle of doing a lot of things you can't discuss them. So I can identify specifically. But you can figure out very clearly is take a look at the gross margins, gross margins are 50%.

The gross margin is 50%, you can kind of figure out what profit you're making without the legal expenses..

We will go back from there--.

It's the only I can get it to you, the gross margins at our historical levels and when we run it at the historical levels we make reasonable profit..

Do you expect your backlog to continue to improve or are you going to be able to work through that the next couple of quarters?.

We have worked hard using our backlog. We’re very focused on sending teams out, Shahram just got back from the Middle East on a business call with a number of our customers. So we're very focused now, the products are doing well. We have some product development but the existing products are selling well and we're looking at pushing sales in that area.

So we would hope to build the backlog actually is more rapidly than we already have..

Right.

Is there anything on the horizon that you can see from a regulatory standpoint from the FAA or anybody that requires certain products like you had a few years ago that everybody had to put in their planes?.

Yes actually yes, exactly. There is the next generation traffic control system. Aspects of that are going to go into -- are going to become mandatory in Europe in 2017 and in the United States in 2020. Full implementation is several years after, but numbers like $100 billion for the industry are around.

So it's a significant regulatory demand and we’re -- and if you might recall our discussion about next gen, we’re very focused on providing next gen solutions for those mandates that are coming. And they are -- and next gen is almost in order of magnitude larger than RVSM.

We’re absolutely focused on that and by the way some of our new products are actually tuned for that..

And that concludes our question and answer session. The conference is now concluded. Thank you for attending and you may now disconnect the line..