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Edited Transcript of ISSC earnings conference call or presentation 6-Feb-20 3:00pm GMT

Q1 2020 Innovative Solutions and Support Inc Earnings Call

EXTON Feb 11, 2020 (Thomson StreetEvents) -- Edited Transcript of Innovative Solutions and Support Inc earnings conference call or presentation Thursday, February 6, 2020 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Geoffrey S. M. Hedrick

Innovative Solutions and Support, Inc. - Founder, Chairman & CEO

* Relland M. Winand

Innovative Solutions and Support, Inc. - Company Secretary & CFO

* Shahram Askarpour

Innovative Solutions and Support, Inc. - President

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Conference Call Participants

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* George Marema;Pareto Ventures;Founding Owner;Managing General Partner

* Mike Heaberg;Axiom Asset Management;Managing Director

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Presentation

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Operator [1]

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Good morning, and welcome to the Innovative Solutions and Support First Quarter 2020 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the call over to Geoffrey Hedrick. Please go ahead.

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Geoffrey S. M. Hedrick, Innovative Solutions and Support, Inc. - Founder, Chairman & CEO [2]

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Good morning. This is Geoff Hedrick. I'd like to welcome you this morning to the conference call to discuss our performance for the first quarter of fiscal 2020, current business conditions and our outlook for the coming year.

Joining me are Shahram Askarpour, our President; and Relland Winand, our CFO.

Before I begin, I would like Rell to read our safe harbor message. Thanks.

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Relland M. Winand, Innovative Solutions and Support, Inc. - Company Secretary & CFO [3]

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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.

Now I'll turn the call back to Geoff.

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Geoffrey S. M. Hedrick, Innovative Solutions and Support, Inc. - Founder, Chairman & CEO [4]

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Thanks, Rell. The new year is off to a good start with our fifth consecutive quarter in which we generated revenue growth quarter-over-quarter. Revenues were comprised primarily of product sales and customer service revenue, both of which carry attractive margins, which led to our 58% gross margin in the quarter, down only slightly from peak margins achieved last quarter.

I'm pleased that we continue growing the business while maintaining healthy margins. Last quarter, as I mentioned, was the best quarter in new orders for more than 2 years, and I am pleased to announce last quarter's orders were also very strong. We once again finished the quarter with a backlog that was greater at the end than it was at the beginning.

In addition, we also have production contracts that extend over a number of years that we believe have promised a different -- additional revenue not reflected in our current backlog.

The largest of these was a very successful Pilatus PC-24. We have previously disclosed that they intend to increase their PC-24 production by 25% this year. This has been a remarkably successful aircraft program, maybe one of the most remarkably successful I've seen in many, many years.

We remain pleased with the financial results we have been recently reporting, but some of our most significant recent project -- progress is not reflected in our current results. Most recently, we were awarded a Supplemental Type Certificate for the revolutionary protection system against catastrophic loss of control with 1 engine inoperative.

The milestone achievement was followed by our first agreement with an aircraft manufacturer to supply our ThrustSense autothrottle as standard equipment on new aircraft production. They reflect, we believe, a market interest to quickly adopt the technology, not only in a targeted retrofit market, but in the OEM market as well.

Authorities suggest that 1 engine-out loss of control accidents are responsible for multiple catastrophic accident annually and our Vmca control system will mitigate or if not, totally eliminate this condition.

Originally developed for the retrofit market, our autothrottle is receiving interest in both best domestic and international OEMs. We are pleased to have announced that an aircraft manufacturer that intends to include our autothrottle as standard equipment in their new aircraft production.

Between the retrofit and aircraft manufacturer systems that have been certified, we believe our potential market opportunity is very large and growing.

Therefore, we are undertaking a number of actions to help accelerate the adoption. First, we're working on means and methods to reduce downtime required for installation, an important consideration in any retrofit application. Second, we are -- we continue to refine and enhance the product, adding new features that add functionality, value that would be -- that will improve operational efficiency and safety.

Finally, we conclude -- continue to pursue new opportunities in all our commercial air transport, military and general aviation markets. We see large potential demand in military and regional aircraft markets for our autothrottle. Our plan is to continue to pursue additional STCs on multiengine aircraft and retrofit market with existing large fleets.

We're also looking to expand our OEM business. Some of the aircraft that we are targeting in these markets are much larger, and we feel our autothrottle can provide a meaningful improvement in aircraft's safety and reduce pilot workload.

With the autothrottle STCs in both single and multiengine aircraft secured and the recent qualification of our Vmca, that is the loss of engine -- loss of control problem, that's what Vmca technology, and the award of the OEM agreement, we believe, autothrottle technology is positioned for a very significant growth.

Let me turn it over to Rell for discussion of our financials.

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Relland M. Winand, Innovative Solutions and Support, Inc. - Company Secretary & CFO [5]

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Thank you, Geoff, and thank you all for joining us this morning. Revenues for the first quarter of fiscal 2020 were $4.5 million, a 13% increase compared to the first quarter of 2019. And majority of revenues in the quarter were generated from product sales, primarily general aviation and military as well as the steady level of customer service revenue. The small amount of engineering revenue we earned this quarter as compared to the first quarter of 2019 reflects the completion of the F5 development contract.

Gross margins for the quarter were 58%, up from 54% a year ago. Gross margins reflect an increase of first quarter revenue from product sales and the growth of our high-margin customer service revenue. Margins also reflect the leverage obtained when we increased volume across our fixed overhead.

Total operating expenses for the first quarter of fiscal 2020 were $2.4 million, up from $2.1 million in the first quarter a year ago.

Research and development expense increased from a year ago. This reflects an increase in the amount of internally funded R&D for which is expense as incurred in contrast to funded R&D, which expense are charged to cost of goods sold. With the wind down of the F5 contract, funded R&D has been significantly reduced.

Selling, general and administrative expenses were up $230,000 primarily reflecting the increased investment in sales and marketing. In the quarter, we earned $96,000 of other income, $79,000 of which was interest income. Due to tax loss carryforwards, we incurred no income tax expense in the quarter.

We reported current quarterly net income of $328,000 or $0.02 per share, more than doubled our $139,000 or $0.01 per share over a year ago. The company remains in a strong financial position, despite a very modest use of cash in the quarter primarily to fund increase in receivables and inventory associated with our steady growth.

At December 31, 2019, we had over $22.2 million of cash on hand and no debt. We believe the company has sufficient cash to fund operations in the foreseeable future.

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

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Shahram Askarpour, Innovative Solutions and Support, Inc. - President [6]

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Thank you, Rell. Good morning, everyone. In the first quarter, we continued to achieve steady progress towards our short-term and long-term goals. In the near term, we had another quarter of top line growth and a doubling of our profit.

Longer term we witnessed 2 important developments that we believe will result in the success of the ThrustSense autothrottle. An STC for our patented Vmca technology and our first contract with an OEM that intends to make our autothrottle as standard equipment on production aircraft.

As Geoff mentioned, as pleased as we are of our string of quarters of revenue growth and profit, we are equally pleased of what these 2 recent developments mean to our future opportunity.

So let me first provide a little bit more color on each of that. We believe, our Vmca Mitigation technology is the first of its kinds and with it, having been evaluated and approved by 3 different departments within the FAA. We also believe that our STC has been validated as a de facto standard for this catastrophic loss of control mitigation feature. We have already discussed how independent evaluation by leading aviation authorities have lauded the product in various aviation trade publications. So relative to competitive product in the market, the ability to incorporate Vmca loss of control prevention in our autothrottle provides a tangible competitive advantage.

The award of an agreement with an aircraft OEM that intends to make our autothrottle as standard equipment on their production aircraft has been announced. Due to the nature of our agreement with the manufacturer, there is little more we can share with you about this agreement at this time other than what was previously announced. Nevertheless, we believe that having been chosen by an OEM as standard equipment for production aircraft is further market validation of our autothrottle value. We are also in discussion with other aircraft OEMs to include ThrustSense as standard fit into their production aircraft as well as retrofitting their existing fleet.

In the propeller market, there are great number of multiengine aircraft, ranging from smaller Part 23 piston to larger air transport Part 25 turboprop aircraft as well as numerous multiengine turbofan aircraft that would benefit from our Vmca technology in both military and commercial markets.

On the aftermarket side, we have been pursuing markets through certified installers and MROs. We are also pursuing large military fleets through approved integrated and military installers. Meanwhile, our strategy is to pursue the larger OEM opportunities directly through our own sales organization. We anticipate autothrottle production orders and installations will start this fiscal year. This will be the beginning of what we believe is a ramp-up that has significantly potential to increase future revenues.

Just quickly reviewing the programs driving current results in the PC-24 program has been running at a steady level that we believe should approximate 50 Pilatus aircraft this year. Again, this is a long-term contract, which we believe will span multiple years and generate demand for thousands of units, only a fraction of ultimate value is in our backlog.

In the commercial air transport market, we are experiencing steady demand for our Boeing 757 and 767 portfolio of cost and technology. We expect that the revenues from the air transport-side of the flat panels will stay at current levels for the near future at least. And since many of these are close to off-the-shelf products, these sales can generate nice margins.

In the military market, our production KC-46 program continues forward. This is an ongoing program, which we believe will provide a continuous revenue stream for a long time.

Development and flight testing on the F5 flight data -- data computer is now complete. The company has now received the expected additional engineering contract to enhance the design assurance level of the unit. Additionally, we anticipate receiving a production order contract for the U.S. Navy in the near future. We also believe this product has the potential to be sold to foreign militaries as well.

Backlog is up again from last quarter and revenues from backlog continue to be supplemented by a steady demand for customer service, intra-quarter book and ship work and the contribution from long-term contract where only a fraction of the total contract is reported in committed backlog. New orders represent a mix of commercial, air transport, military and general aviation programs.

As we glance back at the recent challenging years where we invested significantly in the ThrustSense autothrottle development and initial certification, we are pleased to begin to see the results of that vision.

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

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Geoffrey S. M. Hedrick, Innovative Solutions and Support, Inc. - Founder, Chairman & CEO [7]

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Thanks, Shahram. I attribute these results to our disciplined commitment to better leverage our core technologies and innovation in our designs in both the commercial general aviation and military markets.

After a strong fiscal 2019, we are entering the year with new momentum and new wins. We remain cautiously optimistic. We're obviously excited about our autothrottle program, and we believe this program, over the longer term, can generate expanding acceptance, so that, as it proceeds, the growth will approach an exponential growth rate.

But we are being cautiously optimistic, as I said, about our current projections. We still will have to work to ensure that we can provide our customers with the high quality and reliability on which we have built our reputation.

I'll turn it over to the operator for questions and answers.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from George Marema with Pareto Ventures.

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George Marema;Pareto Ventures;Founding Owner;Managing General Partner, [2]

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I had a couple of questions. The first question on this new OEM. When are you guys expecting to start shipping on that?

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Geoffrey S. M. Hedrick, Innovative Solutions and Support, Inc. - Founder, Chairman & CEO [3]

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In the next 6 to 8 weeks.

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George Marema;Pareto Ventures;Founding Owner;Managing General Partner, [4]

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6 to 8 weeks from now, you'll begin shipping?

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Geoffrey S. M. Hedrick, Innovative Solutions and Support, Inc. - Founder, Chairman & CEO [5]

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Correct.

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George Marema;Pareto Ventures;Founding Owner;Managing General Partner, [6]

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Okay. And are there any -- is there any commentary regarding like the -- how many planes they make a year or a little bit, what's the size of this operation is?

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Geoffrey S. M. Hedrick, Innovative Solutions and Support, Inc. - Founder, Chairman & CEO [7]

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It's going to be formally announced to the industry in the late spring of this year. So we have been asked by the OEM not to comment on it until the announcement comes out. And that's the reason why -- I'm sorry about this. We're not trying to -- there's nothing unique about the situation. It's just simply we want to announce it together at the appropriate time. And that's a few months away.

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George Marema;Pareto Ventures;Founding Owner;Managing General Partner, [8]

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Okay. Okay. And then on the comments you made regarding the military segment, you quite catch all that. What are the -- are we talking about a military opportunity for AutoSense or something else?

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Geoffrey S. M. Hedrick, Innovative Solutions and Support, Inc. - Founder, Chairman & CEO [9]

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Yes, absolutely. Absolutely.

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George Marema;Pareto Ventures;Founding Owner;Managing General Partner, [10]

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Could you elaborate a little bit more on that?

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Geoffrey S. M. Hedrick, Innovative Solutions and Support, Inc. - Founder, Chairman & CEO [11]

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Well, there's a number of aircraft-s that would be helped by autothrottle, and it just hasn't been an autothrottle that was readily installed into existing aircraft. We have 1 that can be. We have a number of opportunities that we've identified. It is simply a question of adapting our actuator into the airplane. We've got 2 or 3 targets that we're working on as we speak. And so we think that the military market is going to be a good and a big one.

In addition, the regional aircraft, like the ATR 42 and 72, these are twin-engine turboprops, have suffered from the same kind of loss of engine accidents and our system has demonstrated that it can protect against that, prevent that from happening. So as a safety feature and to reduce pilot workload, it has a compelling -- it's compellingly attractive. We have multiple patents on the technology. So we're always guardedly confident. But we think there's an opportunity there, and we were just visiting somebody yesterday and talking about the program and they expressed a great deal of interest. So we're optimistic, yes, in all 3 segments: military, commercial and business jet or business...

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George Marema;Pareto Ventures;Founding Owner;Managing General Partner, [12]

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Again, on the AutoSense, on the retrofit market, can you give any commentary on what's happening currently in the first part of 2020 with that? Are you shipping now? Are you...

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Geoffrey S. M. Hedrick, Innovative Solutions and Support, Inc. - Founder, Chairman & CEO [13]

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Historically, we have 2 installations going on right now for airplanes in the commercial line. They're both Pilatus PC-12. We have a King Air. We're looking at -- we're just about to finish the latest version of our King Air and we'll be supplying that for the first commercial installation, I would say, in about 3 months. So it's building momentum. Right now, we're -- we keep refining the product. The twin-engine product has now been certified for the loss of engine recovery, but we've enhanced its operation, so that it will accommodate very high rates of change of the air speed, so that under catastrophic conditions, it still works and provides recovery. It's very good. It's notably unique. It's never been done before by any airplane, commercial or military.

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George Marema;Pareto Ventures;Founding Owner;Managing General Partner, [14]

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Okay. Have you had feedback from the MROs on their outreach to the market on this?

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Geoffrey S. M. Hedrick, Innovative Solutions and Support, Inc. - Founder, Chairman & CEO [15]

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There's 2 things that are going to happen. The OEM, some of the OEMs have certified service centers throughout the world. And that's going to be -- that's already in progress to have them offering for retrofit. So it's a large number of aircraft of all kinds that will be serviced by these service centers. And then we deal with the FBOs, FBOs because this is the area that we're in right now. MROs would deal more generally with the larger aircraft. So we use FBOs, and we expect to have upwards to 20 totally as doing installations on a regular basis.

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Operator [16]

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Our next question comes from Rick Teller, a private investor.

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Unidentified Participant, [17]

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Two things with reference to what you said in your opening remarks. One is that you're still working to reduce the downtime. I recall in the last conference call that you were holding up any possible installations pending you're developing these new methods. How long do you think it would be before you think your installation methods will be kind of, let's call them, standardized enough that you can say, okay, this is good enough to go with?

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Geoffrey S. M. Hedrick, Innovative Solutions and Support, Inc. - Founder, Chairman & CEO [18]

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Now, we're there. But we'll continue to improve it. But right now, the installations that are going on now follow the profile we develop, and it looks very good. But our effort is to try to get this thing down to a couple of days, so that the owners don't have to tie their aircraft up for a week or 2. Anybody that owns an airplane hates to give it up even for a day. So that's why we're doing it this way. Also it increases the number of units that can go through the modification places. If it takes a week, you can do fewer per week. That's simple.

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Unidentified Participant, [19]

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Right. Okay. Good. And one other thing you mentioned, you said that you're also trying to move the product by adding new features. Are these features, things that will have to go through a process with the FAA to get approval? Or are they kind of smaller things that you can just add on without having to do substantial testing?

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Geoffrey S. M. Hedrick, Innovative Solutions and Support, Inc. - Founder, Chairman & CEO [20]

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Well, well, most of them are small enough so that we can get a change to an existing STC and not go through a long recertification process. Other features may or may not be so significant that they'll need recertification. But we're moving in both areas very quickly. And quite bluntly, the FAA has been extremely cooperative. They're still being very prudent, but there's no -- we're not experiencing any delays from getting -- from working on it. They work on it immediately. So we couldn't be happier.

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Operator [21]

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(Operator Instructions) Our next question comes from Michael Fredrick, a private investor.

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Unidentified Participant, [22]

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I had a question about the process of getting the ThrustSense included in a new plane with the OEMs, is that something that also requires an FAA approval, like the retrofit market? Or if it's going in during production, is there a different process to getting that accepted?

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Geoffrey S. M. Hedrick, Innovative Solutions and Support, Inc. - Founder, Chairman & CEO [23]

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Well, I mean it's -- the Supplemental Type Certificate allows an OEM to install the equipment on -- in phase and on the line and ship it, so that it can be used as a -- to support production in early stages. Ultimately, the OEMs are going to want to do a type certificate as opposed to a Supplemental Type Certificate, and he'll take the Supplemental Type Certificate and submit it to the FAA with an application for a type certificate for that exact model and the same installation. So it's not a -- it's 2 different situations. But in either case, it doesn't hold up the OEM's ability to deliver product.

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Unidentified Participant, [24]

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Okay. Okay. And when you're talking about using ThrustSense on these larger military-type planes. Is the -- would the per unit cost of the item go up on a larger plane? Or is it a relatively standard cost across the board?

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Geoffrey S. M. Hedrick, Innovative Solutions and Support, Inc. - Founder, Chairman & CEO [25]

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Well, on a larger airplane, it's going to be more -- obviously more involved. So you can be -- you can figure that the price is going to go up. I mean there are 4-engine airplanes that we do -- that we can do, and it's not an issue, but it would -- the price would go up almost proportional to the number of engines.

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Unidentified Participant, [26]

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Okay. Okay. And then...

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Geoffrey S. M. Hedrick, Innovative Solutions and Support, Inc. - Founder, Chairman & CEO [27]

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I mean it's hard to define. But in general terms, a bigger airplane takes more equipment longer distances, all those things, and therefore, is going to be somewhat more expensive.

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Unidentified Participant, [28]

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Sure, sure. And I know that there's a huge number of planes in the piston market. Is -- eventually, will this product be available for the -- on a price scale low enough for these smaller piston-type planes?

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Geoffrey S. M. Hedrick, Innovative Solutions and Support, Inc. - Founder, Chairman & CEO [29]

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Yes.

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Unidentified Participant, [30]

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Okay. Okay. And...

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Geoffrey S. M. Hedrick, Innovative Solutions and Support, Inc. - Founder, Chairman & CEO [31]

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System -- the system is remarkably adaptable from the very low end, all the way up to the high end. I owned a piston airplane for 35 years. So I'm acutely aware of what it cost. And by the way, none of those are cheap.

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Unidentified Participant, [32]

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Well, I understand. I'm using a relative term. So...

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Geoffrey S. M. Hedrick, Innovative Solutions and Support, Inc. - Founder, Chairman & CEO [33]

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That's brave.

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Operator [34]

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Our next question comes from Mike Heaberg with Axiom.

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Mike Heaberg;Axiom Asset Management;Managing Director, [35]

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A quick question for you. Is it realistic to expect that the -- at some point, the NTSB might make a recommendation to the FAA to mandate the autothrottle for commercial applications because of the safety nature?

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Geoffrey S. M. Hedrick, Innovative Solutions and Support, Inc. - Founder, Chairman & CEO [36]

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I don't know whether the -- honestly, I can't project that. They obviously mandated TCAS which was -- but there was a lot of support from them -- from the Congress on that as well.

I think what's going to mandate is, if you think about it, if your airplane has it, and your competitors don't, why would you want to fly in an airplane that if you got too slow with an engine out, it fits -- rolls on its back unrecoverable and kills you. I mean that's -- if you own an airplane that's $5 million or $10 million or even $1 million, why would you want -- not want the equipment to do it. And I think aircraft manufacturers are very reasonable. I mean they really do -- when they know that something is safe, it helps the safety, I don't think they hesitate finding a way to put it on their airplanes. So whether it's mandated or not, I don't know. It should have...We know it works.

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Mike Heaberg;Axiom Asset Management;Managing Director, [37]

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Has there been any -- has there been any discussion with insurance companies to insure aircraft operators?

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Geoffrey S. M. Hedrick, Innovative Solutions and Support, Inc. - Founder, Chairman & CEO [38]

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I think that's a very strong way to do it and contacting insurance companies is obviously very smart because when they do fail, it is a pretty ugly conclusion. It's -- there's not too many survivors. So at any rate, we -- the only reason it hasn't been done before is that it never existed before. I think based on our experience to date, the manufacturers are very interested and are being very expeditious about their -- about implementing it.

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Operator [39]

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As we have no further questions, this will conclude our question-and-answer session as well as today's call. Thank you for attending our presentation. You may now disconnect.