Good day, everyone, welcome to the Innovative Solutions & Support Third Quarter 2017 Earnings Conference Call. [Operator Instructions] Please do note that this event is being recorded. .

At this time, I would like to turn the conference over to Mr. Geoffrey Hedrick, Chairman and CEO. Please go ahead, sir. .

Good morning, this is Geoff Hedrick. I would like to welcome you to this -- this morning to our conference call to discuss the third quarter of fiscal 2017 results, current business conditions and outlook for the upcoming year. Joining me today are Shahram Askarpour, our President; and Relland Winand, our CFO.

Before I begin, I'd like Relland to read the safe harbor statement.

Rell?.

Thank you, Geoff, 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.

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Now I will turn the call back to Geoff. .

Thank you. Revenue in the third quarter was consistent with the second quarter of this fiscal year. In the third quarter, gross profit margins exceeded 50%, and we generated positive cash flow adding to our strong financial position.

This strong financial position enabled us to maintain a high level of investment in new product research and development relative to revenue in both third quarter and fourth -- third quarter and first 9 months of the fiscal 2017. .

Over the past 3 months, we continue to make progress, expanding our product portfolio, and growing our global distribution network. In June, we have received an STC for our Autothrottle for retrofit on the PC-12.

The Autothrottle can be integrated with our recently introduced PC-12 next-generation Flight Deck, for which we received an STC in the second quarter, where it can be independently installed. Patents are pending on this autothrottle. .

In July, we announced the partnership with Blackhawk Modifications, which will become a distributor and installation center for our NextGen Flight Deck and integrated Turboprop Autothrottle for the King Air platforms. We expect the autothrottle certification for the King Air to be issued within the next few months.

With over 5,000 aircraft eligible, we believe that King Air represents the largest pool of upgrade candidates in the world. .

Our customers have described our NextGen Flight Deck and Turboprop Autothrottle as one of the most innovative products they've ever seen in the market. Our Autothrottle is the only autothrottle that earned an FAA part 91 and 135 certification.

We believe, based on conversations with aviation experts and partners, that this first-of-the-kind technology should open the market for at least 25 different aircraft types with a total opportunity in excess of 10,000 aircraft.

Consequently, with this broad application to the Turboprop market, we believe the Autothrottle can make significant contribution to our future growth. .

Last quarter, we announced efforts to establish an MRO distribution network, anchored by the signing of Lufthansa Technik, the world's largest MRO. In the third quarter, we are -- have been steadily adding to both our new MRO relationships and prospects. We are growing our portfolio of products.

In addition to the Autothrottle's growth potential, our utility management system represents another growth platform as we continue to have ongoing discussions with a variety of OEMs. .

Let me turn it over to Rell for a discussion of our financial results.

Rell?.

Thank you, Geoff, and thank you all for joining us this morning. For the 3 months ended June 30, 2017, net sales were $4.5 million, little change from the second quarter this year, but down from $6.5 million in the year ago quarter. .

Consistent with recent experience, over 95% of our quarterly revenue was from more powerful production-oriented sales, including customer service rather than from engineering revenues. For the third quarter of fiscal 2017, gross margins were once again over 50%.

We've managed to maintain gross margins at this level for the last 2 quarters of fiscal 2017, despite lower overall revenue. However, as always margins can vary from quarter-to-quarter as a result of changes in either product mix or volume. .

Total operating expenses in the third quarter were 2.1 -- $2.9 million, down considerably from $3.7 million in the third quarter of 2016. In the year-ago quarter, operating expenses included higher legal expenses attributable to the double litigation.

Research and development expenses were $1.2 million in the quarter, down slightly from $1.4 million in the year-ago quarter as we continue to self-fund virtually all of our new product development initiatives. .

For the quarter, we invested 27% of revenues in research and development. As Geoff mentioned, new products are the lifeblood of our business so we strive to maintain a strong financial position that enables us to invest in the business in both up and down markets.

For the third quarter of fiscal 2017, we reported net income of $19,000 or $0.00 per diluted share. And net income benefited from a $537,000 tax benefit in the quarter, attributable to the change in the estimated annual profitability in the current year. .

In the year-ago quarter, we reported net income of $227,000 or $0.01 per diluted share. At June 30, 2017, the company remains in strong financial position with nearly $25 million of cash on hand and no debt. Cash flow from operations was $1.3 million in the quarter.

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, Rell. Good morning, everyone. Let me provide a quick update on some of the strategic and operational progress achieved during the quarter. As Geoff mentioned, we had 2 recent major announcements. First, we received an STC for our new Pilatus PC-12 NextGen cockpit, followed by a second STC for our Turboprop Autothrottle.

With this new STC, we have all the certifications required to integrate the Autothrottle with our NextGen Flight Deck to offer what we believe is the best price for performance in the industry to owners and operators of PC-12. .

Our Autothrottle provides engine protection and prevents engine over-torque and over-temperature conditions, while providing speed envelope protection. This eases pilot workload and enhances safety by automatically controlling the power settings of the engine.

Our Autothrottle features an automatic take-off mode that smoothly brings the turbine engine to max power in a few seconds. When engaged by the pilot, the Autothrottle system adjusts the throttles automatically to achieve and hold selective torque or air speed guarded by a torque/temperature limit mode..

The Autothrottle is integral to our growth strategy with units in production. Additional orders are expected now that the STC has been awarded. Definitely, we have started work on an autothrottle for King Air series of turboprops.

As Geoff mentioned, we are partnering with Blackhawk Modifications who is allowing us to use more of their King Airs for their development work. King Air represents the single largest fleet of turboprops that would be candidates for an autothrottle upgrade.

The autothrottle for twin engine turboprops such as King Air series provides for additional safety features that are designed to help prevent loss of control accidents after an engine failure at low air speeds. .

This quarter, we have signed new MROs into our distribution network for both air transport and business aviation markets. We plan to continue with this strategy with several additional MROs in the wings.

As new MROs undergo training and gain experience on installation of IS&S products, we expect them to become valuable partners that help increase sales volume. Our marketing strategy in the Far East is beginning to show results as we are experiencing interest from China through our dealer network for our 757/767 cockpit.

There's also a growing amount of 737 cargo aircraft in China, and we expect to incorporate some of our systems and gain market share in that region. .

As Geoff mentioned, along with the Autothrottle and our NextGen retrofit cockpit, we believe the utility management system developed for the Pilatus PC-24 adds growth potential in other OEM platforms.

Our product strategy has been to develop solutions that increase safety and at the same time, provide operators with the tools to effectively comply to the upcoming NextGen mandates.

Both our growing portfolios of what we believe are the best-in-class price-for-performance products and expanding global distribution network are instruments that will help build value in the Innovative Solutions & Support brand. .

Let me turn the call back to Geoff for some closing remarks. .

Thank you, Shahram. We continue to establish a solid foundation for future growth by investing in new technology that we believe provides improved situational awareness, safety enhancements and operational performance at the best price-for-performance proposition in the industry.

I'm very excited about the potential for our new Autothrottle and believe it can generate significant growth opportunities for IS&S over the coming years. .

I appreciate your time and interest today, and I'll be happy to answer any questions.

Operator, please?.

[Operator Instructions] And today's first question comes from David Campbell of Thompson, Davis & Company. .

I have a question, a couple of questions, first for Rell. You mentioned the tax credit -- tax benefit, $537,000, assumes came from a reassessment of the company's earnings estimates for the year 2017.

Does that imply that there'll be no profits in the fourth quarter?.

It does not -- no. It's just a reassessment that from where we thought we were going to be. It doesn't mean it's going to be a loss in the quarter. It's just -- it's an ongoing -- you do your rate on an annual view basis. So it's just a trueing-up, if you will. .

So if there is a profit in the fourth quarter, there wouldn't be any unusual charges for taxes or anything like that within the... .

It wouldn't be a -- there shouldn't be a benefit for like an over accrual. It's basically an over accrual is really what this is. .

Right, right, right.

And what is the outlook for revenues in the fourth quarter? The backlog is -- has the backlog changed much since June 30?.

No. .

So the outlook for revenues in the September quarter is comparable to what we just saw in the third quarter?.

It's -- it would be in the ballpark. I wouldn't say it's that number, but... .

It'll be in that ballpark? What's your greatest opportunity right now in your opinion? Is that the PC-12 or the opportunity for 737s in China? What's your greatest opportunity?.

The business aviation market is more immediate right now. The air transport stuff, especially over in the Far East, it's a longer term. It will involve obtaining approval of the Chinese certification authorities of our cockpit installations, and that takes typically in order of 6 to 9 months to do that. So that's a longer-term benefit.

We did it on the PC-12 on the STC that we have and it seems to be the more immediate opportunity. .

Right.

And what is the latest you have -- information you have on the FAA mandate for NextGen implementation? Do you have any update on that as to what's going on?.

Like most of these things generate a couple of years out. It's all speculation where it's going, whether it's going to stay on track or extend. I mean we know it's going to be implemented, it's going to be big. Whether it gets stretched or not is your question.

I guess we've have all gotten used to the delays, but I think it, hopefully this time, will be more like RVSM where they held to the dates more or less. .

All right.

And you would assume in that situation that you would get substantial new business once the FAA mandate is firm?.

I think that's true. And we also believe that some of the work we've done with the Autothrottle allows us to do things like required time of arrival and some other operational aspects that give our airplanes that are equipped with our equipment real advantages as a minimum preferred treatment. .

That's right. Well, it certainly is a -- you certainly have a lot of... .

It also provides -- in the twins, it provides some real safety features that are very desirable and we hear a lot of very good things about it. So we have a -- the initial reception has been extremely good. We're hoping to work on that and exploit the market opportunity. [indiscernible] all of the other products moving along. .

You have a lot of opportunities. The question is when they will be realized? And... .

Well, you're right. And -- but we've added additional staff in the form of marketing professionals in program management that's helping our sales. And not -- and even more importantly, the agreements with Lufthansa, we believe will be a major source of revenues as they get established in the marketplace. .

Yes, there certainly is a need for some of your equipment in Europe. And I can't think of any better company to do that than Lufthansa. .

Yes, they're terrific. .

I wish we had one of those over here in the United States, instead of the old dogs. But anyway, I appreciate your help and I look forward to continuing to watch your situation. I hope for a pickup in revenues from these new STCs, which shouldn't be too late in coming. You should get some growth out of these STCs in fiscal '18, we think but... .

We're optimistic about it, very optimistic. So we'll see how it works. .

And ladies and gentlemen, our next question today comes from Jay Kumar of Midsouth Fund. .

I got a quick question about the inventories and the receivables going down.

Is that just correlation to the revenues going down as well?.

And receivables going down. .

Oh, receivables, yes, that's just -- well, they're -- that's what generated a lot of cash obviously in Q3. We had like about $4 million in receivable outstanding in Q2. And the collection receivables is what really generated the cash in the -- and that was kind of flattened out with the level of business at this point. .

So the reason of drop in revenue is that because a lot of biggest customers you have moved on to something else? Or is there any particular reason?.

No, it's because we did a better job collecting primarily. But now -- and that's why, which is hopefully a good thing, we're trying to keep our receivables under control. So we improved the collection of our receivables and kept the aging to a manageable rate. They had some big long-termers out there. The -- It's not going to continue to fall.

We believe it'll be relatively stable from now on. .

Okay. And the last question is, do you guys see -- foresee buying back stock? Or -- because you got a ton of cash sitting down there.

So what's your aim to do with that?.

Well, we always look at buying back. That's a standard analysis. And we discuss it at the -- we will be discussing it again at the board meeting. We think it's good value. We've just proven that in the past. So we have no -- nothing to announce at this point, though. .

Okay.

Do you see any management looking to buy back -- buy stock as well in the open market if it's cheap? Because that gives a pretty good confidence to the investors?.

Well, at least one person at management owns virtually double what any other investor does. So that ought to be some sort of endorsement. .

And our next question today comes from Charlie Pine of Van Clemens & Co. .

I've got just a few questions for you. Last quarter, in answer to a question regarding a potential buyback, you alluded to wanting to sort of keep your powder dry in cash because you -- there was potentially a very large order pending for the company that you were working on.

Can you give us any information -- additional information on what, if anything, might be going on with that?.

Not a lot. Right now, that's not in the forecast. So that would -- that's no longer applicable. That program will be stretched and we may -- and we are no longer a contender in that program. .

Okay. And regarding the STC with intent to acquire for the autothrottle on the King Air.

After that's acquired in a few months, how quickly thereafter would you expect to begin to get some revenue recognition from -- and see some installs from Blackhawk?.

Within a couple of months. I understand where we are right now. We have -- we sold our first system to a critical customer, a customer that has great experience in the product line. And we're doing a field installation analysis.

We're monitoring his operation -- his use of the equipment for the next couple of months prior to releasing volume production so that we make sure that it's completely bug-free or as bug-free as we can make it. And everything is moving on very well right now.

With the King Air, we should have a much, much shorter field evaluation because we will already have history on the Pilatus. So I would expect it to be pretty short from the STC to actual production deliveries. .

I understand it's a pretty significant fleet of aircraft, that the target of opportunity there is awfully large.

If -- an opportunistic basis, how quickly could -- I mean, I assume it's going to start out onesie-twosies, but how quickly could it ramp up into significant numbers?.

I mean, I -- that's -- that would be speculation. But what I would expect to happen is that there'll be fleet operators so we'll have 10, 20, 30 at a time. So you would expect those to be the large step function increases in volume.

We're offering a -- we would be offering a variety of -- I say a variety, a gap of autothrottle installations and it's our intention to do both the full cockpit and just in Autothrottle, we have -- we will be offering a stand-alone autothrottle so that we can capture markets where they already have an advanced cockpit and don't want to rip it out and put a new cockpit in.

So we're addressing both sections of the market. .

I understand the dollars for -- if you do a full cockpit and your full instrumentation panel along with the autothrottle.

But the full ticket on that for a plane is -- it's a pretty substantial amount of dollars for aircraft, isn't it?.

Yes, it is. But we're -- we've come up with 2 other versions. We have another version, which allows the operator to keep his existing radios. The initial offering required the replacement of radios, virtually everything in the cockpit.

We now have an offering, which will allow him to keep the radios and reduce his installed cost by probably $75,000, which is very significant. In addition, we'll be offering for operators with -- like the Pilatus NG where there's -- a brand new aircraft comes out of the factory. They're not going to want to rip out the cockpit.

We will be offering a stand-alone autothrottle system that can be readily installed. So we're addressing the market. And as we get some actual experience, remember we really didn't have it in the field and being exposed. Now we're getting feedback from our customer base, and we're adapting to it. .

Okay, final question.

When do you anticipate you might start seeing some benefits in your revenues from some of these new MRO relationships?.

We're hoping in the next 6 months, but you know actual revenues over the next 6 months. But they're just getting trained in the product and just starting to get out in the field. So it's a little uncertain. But for the next 6 months sounds reasonable. .

Okay.

And I guess as a follow on, in addition to Lufthansa Technik and a couple -- how many do you currently have right now?.

Maybe about a dozen various agreements in place, and we're trying to grow that to about double of that over the next year. .

And this concludes our question-and-answer session. I'd like to turn the conference back over to Mr. Hedrick and the management team for any final remarks. .

Thank you. I appreciate your interest today. We're trying to build a broader base for our product line so that we get a longer-term demand for our product. As we develop new products, we're trying to increase their life span.

And the Autothrottle is one of those products, which we believe will have a very long life span and happily, with its patent protection, will be around for a long time. We appreciate your interest today. Thanks for joining us. Goodbye. .

And thank you, sir. Today's conference has now concluded, and we thank you all for attending today's presentation. You may now disconnect your lines. And have a wonderful day..