Good morning, and welcome to the Innovative Solutions & Support Second Quarter Fiscal 2018 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. .

I would now like to turn the conference over to Mr. Hedrick, Chairman and Chief Executive Officer. Please go ahead. .

Good morning. This is Geoff Hedrick. I'd like to welcome you this morning to our conference call to discuss the second quarter fiscal 2018 results, current business conditions and our outlook for the upcoming year. Joining me today are Shahram Askarpour, our President; and Relland Winand, our CFO.

Before I begin, I'd like to let Rell to read our safe harbor message.

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 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.

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

Thank you, Rell. In the second quarter, both revenues and backlog were up sequentially from a weak first quarter. However, revenues are down 20% as compared to a year ago, reflecting a lower beginning backlog in the quarter. In the quarter, we maintained our high level of investment in new product development, representing 28% of the quarter's revenue.

This investment in new product development was in line with the year-ago quarter and has not significantly changed during the past year, regardless of the changes in the level of our revenue..

Today, you will hear discussion about our Autothrottle program. Our Autothrottle is not simply a cruise control but an important addition that enhances safety and protects vital engine components from damage. Our ThrustSense Autothrottle is the only certified Turboprop Autothrottle available for Part 23 aircraft..

Business & Commercial Aviation news referred to us to refer to it in a recent feature article as -- and I quote "as such a system marks a major step in reducing pilot workload, especially in these aircraft that are typically flown by a single pilot.".

We continue to invest in innovative solutions. Recently, we were awarded an STC for a standalone Autothrottle, which is controlled by our integrated standby unit for the Pilatus PC-12. It builds on our existing STCs for Turboprop Autothrottles integrated with our display for the PC-12.

It incorporates plug-and-play technology that reduces installation time and offers owners an economical solution to put this technology into their PC-12s. As such, we expect to provide a template to reduce time required to add certifications for other aircraft platforms. .

We are now working on a standalone Autothrottle for the King Air. To accelerate the development, certification and demonstrations, we purchased a 2008 [ sic ] [ 2018 ] King Air aircraft which will enable us to control all aspects of the program.

Consequently, we believe we can reduce the time to obtain a King Air STC, so we can enter the market of more than 5,000 King Air Turboprops. .

We continue to focus on our sales and marketing. In particular, we are continuing to build a global MRO network by signing distribution agreements with domestic and international MRO organizations. This provides a brand-new channel to market for the company.

At the same time, we are also building up our internal sales and marketing resources and activity. We will strengthen our Autothrottle focus with the addition of a product line director with proven product and market experience. .

We are investing -- we are also investing in building a portfolio of new products implementing our new sales and marketing strategy and getting key distribution partners and sales resources in place. .

We believe this strategy will allow us to better control our operations while reducing the inherent risk of large engineering contracts over the long term, it is a right decision. We remain in a strong financial position to implement our strategy. .

Historically, we have been an operating cash flow positive. We are focused on returning us to these traditional levels of performance. Ultimately, it is about developing what we believe is the industry's most compelling price for performance products responsive to impending NextGen mandates. .

We believe that it is what we enable -- it is what will enable us to grow the business and create value for our shareholders. .

Now I'd like to turn it over to Rell for some more detailed financial discussion. .

Thank you, Geoff, and thank you all for joining us this morning. For the 3 months ended March 31, 2018, net sales were $3.7 million compared to $4.7 million in the second quarter of the fiscal 2017..

The system with recent quarters, the majority of revenue was either from production contracts or customer service, including revenues recognized on intra-quarter book and ship orders. .

For the second quarter of fiscal 2018, gross margins were 44%, down from 51% in the year-ago quarter. Product mix in the quarter included a high proportion of units with higher material cost and reflect the effort of lower sales volumes, reducing the coverage of fixed cost.

This is consistent with our observation that margins can vary from quarter-to-quarter, as result of changes in either product mix or volume. .

Total operating expenses in the second quarter were $2.8 million. In the year-ago quarter, we reported a total operating expense credit when we booked the reversal of a $3.6 million unbilled receivable reserve coincident with the settlement of the Delta lawsuit. .

On a sequential basis, total operating expenses were up modestly from the first quarter, reflecting some increased general and administrative spending. .

Research and develop investment was relatively unchanged from a year ago and has been running at a relatively consistent $1 million to $1.1 million to $1.2 million per quarter for some time now. We continue to remaining committed to funding internal new product development..

Note that in the year-ago quarter, we recorded $4.1 million of the Delta settlement as other income. .

For the second quarter of fiscal 2018, we reported a net loss of $1.3 million or $0.08 per share. As a result of the Delta settlement, net income and earnings per share were significantly higher in the second quarter a year ago. .

Income tax expense for the second quarter of fiscal 2018 was $0.2 million with an effective tax rate of negative 18% and reflects a change in the valuation allowance in the current period. .

Income tax expense was $1.2 million for the 3 months ended March 31, 2017. .

The company remains in a strong financial position. At the quarter end, we had $23.4 million of cash on hand and no debt despite being somewhat operating cash flow negative for the first time in several quarters.

Although capital expenditures have been relatively light in any particular quarter recently, I would note that we are likely -- that we will have a $2.4 million purchase of a King Air airplane, which we expect to complete in the fiscal third quarter. .

We believe the company has sufficient cash to fund operations in the foreseeable future. .

Now I'd like to turn the call over to Shahram. .

Thank you, Rell. Good morning, everyone. As Geoff mentioned, both revenues and new orders in the second quarter were up from the first quarter. This is consistent with our expectation for steady improvement over the course of this year. .

Orders in the quarter were $4.2 million and backlog as of March 31, 2018, was $3.8 million. We're undertaking a concerted effort to strengthen our Autothrottle franchise. Once the STCs are obtained for the King Air series, we will have a range of Autothrottles in the market that address a fleet, the estimate totals 5,000 aircraft..

As we increase the potential installed base of our Autothrottle by developing additional STCs, product recognition from industry publications, complemented with our increased emphasis on sales and marketing, is resulting in growing interest in the Autothrottle product line. .

We expect to broaden up from this space with products for other Turboprop aircraft that leverage the technology behind the design of our standalone Autothrottle. .

To that extent, we are in discussion with a number of potential candidates as part of the process of hiring an experienced Autothrottle product manager to be the focal point for program management, marketing and sales of this high-potential product line. .

We also have been approached by a major engine manufacturer, with an interest to team and jointly monitor the Autothrottle with their engines. .

Our discussions with various aircraft OEMs, with regards to offering our utility management system, continues to gain momentum. Pilatus PC-24 is now in commercial production and is providing a steady pace of ongoing orders as we are the sole source supplier of the utility management system on that platform..

International opportunities continue to be a focus of our 7 marketing efforts. In fact, in the second quarter, 40% of our revenue was from international business. .

In China, air cargo growth continues, and many operators are looking to convert older Boeing 737, 757 and 767 aircraft into cargo planes. .

This is an area where we have great product and retrofit expertise. To capitalize on the local knowledge, we are partnering with MROs in that region to develop opportunities. .

[ And ] MROs remain an important facet in our overall sales and marketing strategy. In addition to the local knowledge they can impart, they offer a cost-effective means to globally expand our distribution network. We plan to continue with growth of our MRO network within the U.S. and international. .

The number of aircraft in which we have installed equipment continues to increase. As a result, we are experiencing a steady growth in customer service revenues. .

In summary, we are focused on creating value for shareholders through our strategy to develop the industry's best price -- performance products and to grow the sales by expanding on marketing. .

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

Thanks, Shahram. We are pleased that we're on our way to a steady improvement in revenues and backlog. I believe that the direction that we are taking in building a strong franchise with the development of a portfolio of Autothrottles through our sales and marketing team.

And with the aid of our growing MRO network, we are expanding our ability to get these products in front of ready buyers around the world. In Asia, the surge in cargo air traffic is expected to be a spark for renewed growth in some of our legacy products as well as the new ones.

These are opportunities we are aggressively pursuing, and though -- it all -- and through it all, we are -- we maintain a strong financial position that will enable us to make strategic decisions that will create value for our shareholders over the longer term. .

I appreciate your interest today. And now I open the call for questions. Thank you. .

[Operator Instructions] The first question comes from David Campbell of Thompson, Davis & Company. .

I just wanted an update on the status of the NextGen aircraft modifications that are supposed to be going into the FAA plans at some point.

I see increasing talk about companies developing products for that system, including one company that's been on the news wires, has been commercially advertising the connectivity systems between aircraft and citing that this will be very much a big savings to aircraft operators in taking off and landing aircraft.

I don't know if you've seen the commercial, but could you give us an update on the status of all that, and what you're doing to participate?.

Sure. I guess connectivity has been -- it's been kind of [ bragged ] by a number of larger companies such as Honeywell, for example, where they project that all the aircraft will talk to each other and tell each other about the weather upfront and all of that great stuff.

One of the main things that -- of NextGen is it's getting tighter and tighter air spaces, aircraft that they can closely do faster landings. To that extent, the -- a lot of the air transport aircraft, they're all equipped with flight management systems that have very good vertical navigation capabilities as well as Autothrottle.

What we have done by developing and introducing Autothrottle into the business and general aviation market, coupled with our VNAV flight management system that we have developed, is bring that technology into that -- those platforms. That's unprecedented by any other major avionics manufacturer -- or minor avionics manufacturer for that reason.

So this is what we're doing for NextGen. .

So that combination of Autothrottle and fleets and Flight Management Systems is unique in the industry. .

The aviation industry, it is -- what it allows aircraft to do is to follow each other tightly into landing. When we talk about, in a 3D space, when we talk about doing RNP approaches and require time of arrival, these are all the things that it's great to be.

Right now everybody's got the heads wrapped around this ADS-B apps, which is only the beginning phase, the stepping stone, the first stepping stone for NextGen. Once all of that is going to be done by December 2019.

The Airbuses is going to be on, now "how do we take advantage of that technology?" And we have developed the tools to be able to take advantage of that technology by allowing the business aviation aircraft to be equipped with required time of arrival and precise 3-dimensional, if you add the time to it, what they call a 4-dimensional navigation, that is going to be the future of aviation.

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But in order to be effective, you need to have an Autothrottle STC for all of the business aircraft that are used?.

Well, some of the business aircraft, when you look at high-end business aircraft, like Gulfstreams and some of those, they already have Autothrottle in them.

In the midmarket of King Airs and the other Turboprop aircraft, the PC-12s, a lot of the regionals don't have Autothrottle and without Autothrottle, you cannot have a very good vertical navigation capabilities. You will not be able to accurately monitor speed and time of arrival. It will be too much pilot workload to try to manage all of that.

So we bring that product into those markets, which clearly lack. Even new airplanes they make today don't have that capabilities in those types of aircraft. .

Right.

And so you see this developing during calendar '19 and calendar 2020?.

I think that's when people are going to want to take advantage of all of this money they've been spending on telling other airplanes precisely where they are and where they're going. So that when they start taking benefit from that, we have developed a product in order to do that. .

And this commercial has been on television citing that they can do that. It seems like they're saying they can do that. .

They can do it if they have -- an Autothrottle for a commercial air transport is about $200,000. And it weighs upwards to 40 pounds, 50 pounds. And it's big and it doesn't fit readily in any Turboprop -- reasonable Turboprop aircraft, and that's why they're not used.

And also because there was no critical requirement for speed control until NextGen came along. NextGen is coming along, and already we have -- we already have airports now with slot times, where you're allowed to arrive and land in a 2-minute window. That's going to be increased with required time of arrival.

It means that have to constantly monitor your speed and adjust it. And that, when it goes to high levels of adjustment, it puts it an incredible addition on the pilots' workload and also puts the engine at risk by over-speeding it or under-speeding it. So that's why Autothrottles are attractive.

But to date, they've been heavy, expensive and difficult to install, and our unit can be installed as an example in a PC-12 in a few hours, that's remarkable, instead of a week. So it's those features that we believe is making it attractive.

And oh, by the way, the leading bizjet periodical, part of aviation week did a cover story on it, our Autothrottle, in the February issue. And reigned about is performance and the fact that it acted like a copilot. So we think it's a good product. We see a lot of opportunity.

And for engine manufacturers, it provides a real protection of the engine preventing over speed and over-temperature conditions which seriously impact the life of the engine. .

OEMs already have that built into their engines, right?.

No. The new engines, some of the new turbo-fan engines, the fan engines are FADEC engines, full authority digital engine control. And they protect the engine from over speed and over-temperature and hot starts and a bunch of things.

However, they don't automatically protect the airplane from over speeding which puts an aircraft at risk or under speeding which makes you fall out of the sky or other serious problems. That requires an Autothrottle.

And if you couple the new engine with the Autothrottle, you can get what we produce in a single Autothrottle for about a quarter of the amount of money. .

How long will you take to get the King Air STC done?.

A few months. .

A few months. Just to give you an idea. We purchased a used airplane because the modifications that were necessary, the test flying with the FAA, et cetera, we simply could not find an airplane, a reasonable airplane that the owner was prepared to essentially shut down for a year and have major modifications done to it.

So we ended up doing it this way, and we believe we can resell it and either make money or, at least breakeven, we hope. So it's a practical way to do it. We labored, looking at the alternative, for about 5 -- 4 months or 5 months, and it was delaying the program and the board overwhelmingly said, go ahead and do it. That's why we have cash on board.

And it's not going to affect the balance sheet, and we can resell it when were finished demonstrating it. So that's why we got it. .

And it sounds like a great idea to accelerate the King Air market which -- these and STC, that's all it needs and then you can start using it. .

You're absolutely right. We kept -- we did a couple of opportunities with partners. They tried to be very helpful, but it was compelling that it just wasn't going to work. We could not have the airplane available when we need it to actually do the installation. This is -- we got one that's excellent.

We will get delivery of the airplane sometime in the end of next week, or the week after and start -- immediately start installation of our equipment and start flight testing, and demonstrating to the FAA. With the paperwork delays and the rest of it, it's going to take a couple of months. But we're well on our way moving quickly. .

Did you put the Flight Management System in that plane too?.

Yes, we will do that. Right now, we have it in the PC-12. We are looking at doing exactly same thing in the King Air. It depends on the configurations. The newer ones have a Flight Management System albeit not one that uses an Autothrottle because the airplanes don't have an Autothrottle. So that's like the FMSs are in there don't use that feature.

Ours does. And the older units where we completely we would replace the cockpit, avionics with our system, which has an integrated vertical navigation -- 3D navigation system, it incorporates the Autothrottle.

And you can do things like follow the airplane in front of you by precisely 2 miles or 3 miles or 4 miles in complex holding patterns, and it will do it all automatically. You can never do that manually. That's all tied in to the NextGen and all that stuff.

ADS-B, coupled with ADS-B, you can sit there and follow the airplane in front of you at a precisely same speed. .

[Operator Instructions] ..

At this time I'd like to turn the conference back to Mr. Hedrick for any closing remarks. .

Do we have anybody else in line? Looks like we have a couple of people in line. .

Yes, 2 have just answered. If it's okay, I'll take their questions if you wish. .

Go ahead. .

We have a question from [ Jason George ], private Investor. .

I've been a shareholder for the last couple of years, and I just had 2 questions if you would.

I noticed at the end of the last quarter, the conference call you spoke about other companies perhaps expressing interest in acquiring ISSC, there any update on that, given the compelling nature of the Autothrottle?.

Actually, last quarter, I talked about the fact that we were considering engaging a company that we do regularly to evaluate the best use of our funds. And that's all. We've had people -- a number of people contact us, but that's ongoing, that's been going on since we went public. Nothing new and no progress.

Nothing to comment on, I guess is the answer. .

Okay. All right and my other question is, and this is pretty far out, but just given the announcement by Uber yesterday about having flying cars in the next 5 years [ indiscernible ].

I was kind of curious of whether Autothrottle was the type the technology that could be applied to that -- to that type of vehicle?.

Yes, I understand. I think we'll see's if it's around 5 years. The lady in Texas that's dead, probably doesn't think it's a great idea. .

Now they're flying cars. As a matter of fact, they're done with driving and now they're flying. .

But I'll tell you what we do, do, which is very interesting.

And there's an article coming out in Flying Magazine in the next month or so, in which we -- let one of the editors -- senior editors fly the airplane, and we showed him that from rotation -- from the lift-off of the airplane to flying to a destination out 100 or 200 miles away and going all the way down to 100 feet or 200 feet over the runway, he did it without touching any control in the airplane.

The Autothrottle did it all automatically. The flight management system navigated automatically at a level of precision that I don't think you can do manually and brought the airplane precisely to the edge of the runway, 200 feet above the runway. And we already did that. So beyond that, I'm a pilot, trust me.

If I'm sitting in the back, I want a pilot to land the airplane. Although the senior airplanes land themselves all the time. I'll tell you what the hardest part is, putting on the brakes and steering it in the ground. It's not flying it in the air, that's easy. Once you get it on the ground.

Putting on the brakes and making sure that you go on to the taxiways. Essentially, like driving a car I guess. Go ahead. .

And we have a question from Charlie Pine of Van Clemens & Company. .

I have a couple question for you folks.

First off, can you just give a little more clarification on the process of how it -- what transpired over the last, say, 6 to 9 months about the STC for the Autothrottle for the King Air? I was under the impression that, last fall you had an announcement or a deal, you were partnering with a company called Blackhawk Holdings to do an install and the testing for it, and then we didn't really hear much about that.

And then late last year, we were informed that you were supposed to have an FTC or the testing was supposed to be completed by January or February of this year. Now we're hearing that you have to go out and buy your own aircraft. So I'd like to get more clarity and -- around the process that's been occurring with this.

And how much comfort do you actually have now in -- as to where you are at and that you actually really do feel you're going to have an STC in a couple of months. .

Well, the quick answer is yes, we do. And I'll explain what happened. And that was what precipitated, actually, purchasing the aircraft.

Everybody that we found as a partner, had an airplane but did not want to commit the airplane to an uncertain time and take it -- in certain cases they were modifying airplane and selling it, and they didn't want to tie up the capital, the cash, on their credit line for an indeterminate amount of time.

We keep, kept running into this, and we kept hoping that we could solve it. And in fact, we couldn't. And it was at that point we finally determined, and I went to the board and said, look this is a problem we can't get a commitment. They have a problem tying up or committing their aircraft. So that's when we went ahead and purchased an aircraft.

And, the other ... .

Let me interject for a second.

How many flight hours are required for the testing of this?.

Not as many flight hours. But you have modification hours and installation into the aircraft. And it's not so much the number of hours, which probably could be done in 20 or 30 hours. That's if it was a straight, contiguous time, would be easy. But that's not the problem.

We say, okay, "We want the aircraft." And they say, "Well you can have it for 10 days." Well, you can't start a program with the FAA and say, "Oh, well you only have 10 days to approve this, so get going." It's always an open-ended process.

So there was no way that we could -- first of all, you have to dramatically modify the airplane, and then we would have to de-modify the airplane and give it back to them. So that's what double the amount of time.

And for many of these people they say, "Well, I'm not sure I want you to modify it and then demodify it." So it became a constant, recurring problem, and that's why we went ahead and did it. And it's -- we feel that now we can do this and move along. The airplane will be delivered.

Actually, the people -- it's -- right now, with Textron, services in Florida, that's actually the manufacturer. And they have a service center, and they're going to be doing the modification as well. And they are also very interested in our products. .

Okay, a couple of quick follow-ons.

So the STC that you're going to be applying for with -- for the Autothrottle on this particular King Air, is this for the standalone drop-in Autothrottle, or is this the one like the predecessor that you first got for the Pilatus PC-12 where it's the Autothrottle and your Flight Management System, which one is it?.

It's a standalone drop-in Autothrottle. And that's the first one we're doing. And you can get the details from Shahram. Shahram, pick this up. .

Sure. So for the first STC on the King Air, we were doing the standalone Autothrottle as Geoff [ indiscernible ], which [ closed ] in with our standby instrument. So essentially, we replaced the standby instrument in the aircraft with our standby instrument, and that provides all the controls for the Autothrottle.

And we've done that because a lot of the, the more valuable, [ haul ] aircraft have modern cockpits in them. So this is going to give us the quickest path to revenue, is to provide this standalone Autothrottle system.

Once we're done with that, we will look into getting an older aircraft where we would do the full cockpit replacement for it with our display and flight management. .

Okay, great now I have 1 other follow-up. This has to do with your channel -- with you MRO channel partners. You folks talked a lot about over the last year all of these MROs that you've signed agreements with. There was a big press release that you had regarding your relationship with Lufthansa Technik.

I'm curious, as to this point of time now, you've been involved with these MROs, and you've been more aggressive with them as far as having relationships now for about a year.

Are you beginning to see some revenue lift from these relationships? Or is that still yet to come? Are we starting to see that in this quarter? Or -- and if not, when can we anticipate that we're going to?.

Typical. And just to give you some background, when we talk about air transport, our typical sales process takes about 2 years. From when we start talking to an airline, until we actually start seeing revenue, it takes about 2 years.

So the MRO relationships that we've had, including Lufthansa Technik, we're seeing a good progress, although has not turned into revenue. We're hoping over the next few quarters, we'll be able to see, because we've done a lot of quotes with them, we've done a lot of joint offerings, which hopefully will turn into orders. .

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect..