FLYHT Aerospace Solutions Ltd

XTSX:FLY

Earnings Call Transcript

[Operator]

Welcome to the FLYHT Aerospace Solutions Second Quarter 2018 Results Conference Call. As a reminder, all participants are in listen-only mode and the conference is being recorded.[Operator Instructions]I would now like to turn the conference over to Tom Schmutz, Chief Executive Officer for FLYHT. Please go ahead, Mr. Schmutz.

[Thomas R. Schmutz, Chief Executive Officer]

Thank you, Lisa. The format for this call will be the same. I will provide a review of our second quarter results operationally and financially from a high level. Alana Forbes, our Chief Financial Officer will then provide a more detailed review of the financial results for the second quarter. I'll then discuss some current activities of FLYHT and answer some questions that we received via emails prior to the call. Finally we'll answer any questions that may be called in.I'd like to start by thanking our shareholders and those that have dialed in or accessed the online recording of this call to learn more about FLYHT at flyht.com under Investor Relations and Presentations and Webcasts.FLYHT's Q2 total revenue was $3.1 million, which was down from Q2 2017 by 3%. There were puts and takes in the revenue relative to 1 year ago. AFIRS Hardware revenue was up 15% while the licensing revenue was down 15%. Software as a Service revenue was down 7% while Technical Services revenue, though relatively very small, was up 300% relative to the second quarter in 2017.Overall, the expenses in the quarter were down 15% relative to the second quarter of 2017, demonstrating the continued effectiveness of management on controlling these expenses. Things look similarly mixed from a year-to-date perspective, overall revenues are down 8% relative to this time last year. The AFIRS Hardware revenue was up 34% over the same period from last year. Software as a Service revenue was down 8% and licensing revenue was down 38% while Technical Services revenue again while small, is up 209% relative to this time last year. The total expenses for the first half of this year are down 8% relative to the same period in 2017.Although this quarter sounds a lot like the previous few, there is good news and that the continued strength of the hardware sales, the AFIRS Hardware sales, which continues to grow relative to historical performance. We shipped 48 AFIRS units and kits in the first half of this year, which is more than double the 23 units that FLYHT shipped in the first half of last year.We have received strong orders from our backlog for shipments in the third quarter. We have stated previously that we believe this increase in direct hardware sales will ultimately improve the revenues in the Software as a Service category. Although FLYHT's Software as a Service revenues were slightly down this quarter relative to last year Q2, we do project that this will not be the case next quarter. We have been steadily growing the Software as a Service quarterly revenues, but the relative performance has been [indiscernible] due to the expiration of a substantial Software as a Service contract last June. We've recovered a portion of that contract and remain hopeful that we will converge on the remainder in time. Even so, we expect to begin to show growth here next quarter.We are ahead of our projections for licensing revenues for the year, though the projection for the year is unchanged. And as we have covered in the past, this revenue category is quite lumpy. We do not expect revenues in this category in the third quarter based on the forecast that we have received and projected. We do expect revenues in this area in Q4 and while it's possible they could start to show up in Q3, we currently do not expect them to.FLYHT has also announced a $4.45 million sales contracts for the second quarter which preserved an end of the quarter $26 million in sales order backlog for AFIRS hardware and Software as a Service.FLYHT gained a new European operator customer who purchased AFIRS units to integrate into a subset of their aircraft for future air navigation compliance, taking advantage of the Canadian TSO-159b approval which FLYHT owns on our AFIRS 228s product. We also had leased aircraft which were installed AFIRS make their way to a new customer in Australia who turned on FLYHTVoice, FLYHTLog and FLYHTHealth on those aircraft.FLYHT renewed and expanded Software as a Service contract with seven other airlines and a leasing company during the second quarter. FLYHT also sold hardware kits and technical services to three existing customers in the second quarter. Finally, FLYHT sold an existing OEM partner modems with related license fees for delivery in the quarter. FLYHT was issued two supplemental type certificate for AFIRS 228 in the second quarter. We received the Mexican civil authority STC for Boeing 737 series and the Brazilian Civil Aviation Authority validation for the Transport Canada STC for the Embraer E190/100 series.Finally, during the quarter, FLYHT announced the issuance of the FLYHT stream patent in Canada, which had previously been issued in the United States and in China, it's patent pending elsewhere. We believe that this patent is seminal for future compliance to the timely access to FLYHT recorder data requirement, which has been issued by the International Civil Aviation Association or ICAO for new airframes in 2021.On the negative side of things, a significant microcap fund shareholder liquidated their position in FLYHT, during the first half of this year. Their selling began in the February time frame and accelerated into the summer. This places a great deal of downward pressure on the stock price, it is our understanding that the shareholder has completed the [indiscernible].Now I'd like to turn the call over to Alana, who will provide details on the financial results. Alana?

[Alana Forbes, Chief Financial Officer]

Good morning, shareholders. Before we discuss the detailed financial results, I just wanted to mention again, you will notice a difference in our comparative 2017 revenue and cost of sales. If you're comparing this report to our Q2 2017 report, you will notice that 2017 numbers have been restated, resulting from our January 1, 2018 adoption of IFRS 15.So having said that, our second quarter revenues of $3.1 million were in line with revenues for each of the past 4 quarters and were lower than Q2 2017 by $96,000. SaaS revenues has been increasing over the past 4 quarters, as we've been converting contracted backlog into SaaS revenues, while recovering from last year's Q2 expiration of one of our larger contract. A portion of that recovery was due to the re-signing of a portion of that contract.AFIRS Hardware revenues showed a decrease over the last few quarters successive, but came in $111,000 higher than Q2 2017. Year-to-date, this category remains a strong and consistent source of revenue for us. Licensing revenues decreased from Q2 2017 as fewer modems with related licensing fees were ordered and shipped in 2018.Gross margin came in at 66% in the quarter, up from last quarter's 60%, but down from Q2 2017's 69%, which is due to the relative portion of AFIRS hardware sales versus licensing revenues in each of those quarters.G&A expenses showed an overall decrease, particularly in the distribution and admin categories with an increase in R&D expenses. There were two main factors affecting our G&A categories this past quarter. The first area of decrease was in people costs, particularly in distribution and admin, partly due to an increased focus of our staff on R&D activities, partly due to a difference in the contractor versus full-time staffing mix, but also as a result of changing our employee option plan in 2018 to extend the vesting period over 3 years. While this extends the recognition of these costs into the future by extending the vesting time horizon, it also increases the options relevancy for retaining and rewarding our employees as they support the company in executing our long-term goal.Secondly, you will notice the lack of SRED funding recovery to offset our Q2 2018 R&D expenses. While the funding we have received through WIN has allowed us to fund our development efforts, amounts eligible for funding under WIN are by default not eligible for the CRA's SRED credit program. SRED credits will vary for us from year-to-year based on the stage of each of our development programs. 2017's SRED recovery was about half of the level we saw in 2016 and the development expenses that may have been eligible for a 2018 recovery have all fallen into the WIN bucket.We continue to assess and evaluate the benefits of both programs, given the stage of each of our development projects and continue to strive to maximize the funding available to us under a combination of both programs.Our Q2 net loss and EBITDA, both were an improvement over Q2 2017, reflecting our commitment to running as lean as possible and so we are able to attain a position of consistent profitability.And now turning to the balance sheet; cash decreased from year-end by $1.1 million to $897,000 on June 30, which was the recovery of $267,000 from the end of Q1 2018. We increased our cash balances following quarter-end by closing on a private placement of $2 million in July and continue to receive funding each quarter through the WIN program. A small number of warrants were exercised in Q2 and the remainder that were being carried on the balance sheet expired on May 12, as per the agreements with those warrant holders.While decreasing from year-end, our customer deposits have remained fairly steady since the end of Q1. The larger than normal balance we carried through year-end in this category was largely recognized in Q1, which for Q2 means we held steady at a similar level of new customer deposit -- as new customer deposits were received and applied to Q2 shipments.I will now pass the mic back to Tom for a review of current activities at FLYHT. Tom?

[Thomas R. Schmutz, Chief Executive Officer]

Thanks, Alana. Strategically, FLYHT has been working on several programs this last quarter. We will jointly publish and present a paper with Boeing and Embraer to the Airlines Electronic Engineering Committee or AEEC, Global Aircraft Tracking Working Group meeting in Kelowna, Canada in 2 weeks, covering the applicability of the work that we did with Boeing on the FedEx Boeing 777 Eco demonstrator program using satellite streaming of data for timely access to flight data in autonomous distressed tracking. This is the next step in our process of receiving industry acceptance for FLYHT's technology and intellectual property to meet the industry criteria to satisfy these forthcoming mandates.I mentioned last conference call that we would demonstrate the virtual cockpit capability to senior representatives at the NTSB and the FAA. We did that and there is significant interest in what FLYHT has accomplished. Characterizing the results for Industry Committee is the proper next step.FLYHT also continues to work with Inmarsat strategically on their black box in the cloud initiative. FLYHT was recognized during the quarter by Inmarsat as the first worldwide recipient of the Certified Application Provider or CAP program for their SwiftBroadband-Safety network. This certification makes FLYHT's AFIRS products the first certified application for use on their newly rolled out SwiftBroadband-Safety network and FLYHT is very proud of this accomplishment.FLYHT also announced debt financing prior to the end of Q2 and closed on July 24. The debentures were oversubscribed, there was significant interest. We targeted a sum that was necessary to reinforce a strategic initiative, which we have been working on for most of the past 6 months along with providing some working capital to manage some of the orders from backlog we've been receiving.FLYHT management has been working to develop new revenue verticals to more quickly grow the revenue top line. As I stated earlier, I feel like we've done a good job as a management team in controlling costs. There is a certain structural size dictated by operational functions that FLYHT must maintain to be a viable entity and a candidate for growth. So I remain convinced that profitability is a top line rather than a bottom line challenge. For this reason, and because growth in our core business areas have been slower than desired, we've been developing new opportunities for revenues, including new product opportunities and methods to introduce new revenue verticals. I cannot share the details of these efforts yet, but there is significant effort underway to bring diversity to our revenues.So with that, I would like to answer some of the questions that have come in from email. Some of the questions in email that I feel were answered in the body of my presentation, I won't directly answer, and in some cases, questions that I don't feel like I can answer, I will provide a more private response.The first question is for the third party software-as-a-service contract that expired last June, what percentage of that has been recovered since? So we had a large Software as a Service contract expire in June of last year. Again, we indicated that's been masking some of the growth that we've had in this area since. We have recovered 17% of that contract since that time and we're working on the remainder.How many units are actively earning Software as a Service revenue at this time? The number of units that are earning Software as a Service revenue is slightly short of 300 units.It says in the letter to shareholders, it stated that we ran out of customers ready to take shipments, this seems highly problematic, are any contracts in danger of going unfulfilled for this reason, are there punitive clauses in the contracts for customers not taking the units that they have ordered in a timely manner?I probably should have used different words. What I meant by ran out of customers ready to take shipments, I simply meant that we've got a fairly large number of outstanding units that we've sold under contract that have yet to be delivered and the schedule with which we can deliver those units is determined by our customers. So our customers have to make the aircraft available for installation, these are typically [indiscernible] which can take several days to format. So the operator has to take the aircraft out of service or in some cases, they may have signed a contract for aircraft that they are yet to take delivery of. So I probably should have used better words. There's -- I wasn't trying to imply that there was any problems with the contracts we've signed, it's just the, I guess the -- there is a limit in our business with regards to installing the equipment, it does take a bit of time to get the equipment installed on the aircraft, that is a bit of a limitation to how rapidly we can grow. This is another reason why we're looking for other revenue verticals to help fill in the gaps when the aircraft are not available for installation. Hopefully that clarifies that.[indiscernible] Software as a Service revenue was to singularly be the road to profitability, it seems that doubling the number of active units would be required. Without a dramatic uptick in units coming online, this could take a while.Can you restate the motivating factors, i.e., the mandates for companies with orders already taken -- already placed to take the product sooner than later and for new companies to place orders?The mandates and the motivating factors are those which we have been communicating. The first of which has been the requirement within China for aircraft operators there to -- the aircraft operation centers need to contact the aircraft within 4 minutes when it's operating inside of China airspace and since there is a limited amount of VHF coverage in the country, this essentially dictates that they implement sat comm. So we've been working in selling units in China for some time on the back of this mandate. We introduced data services to China only 2 years ago. We've got approximately 60 units that are providing Software as a Service activities in China. So that's a pretty decent growth relative to the rest of the world.We look to continue to grow China, again getting the equipment installed to satisfy the voice mandate and then upselling services. In the rest of the world, we typically have a higher percentage of sales that include voice and data services as part of the initial sale. This wasn't true of the European sale that we made last quarter, which was a sale where the operator wanted to implement FANS, the Future Air Navigation System and they purchased our product and performed the integration activities with a third party on their aircraft in order to install and get the operational benefits of FANS, the details of which exceed our ability to cover on this call. But that was sort of an exception, but generally we are selling product in the rest of the world inclusive of data services.The most recent example of that was [indiscernible] which took a very nice order, it took it very rapidly and they took it for the purposes of meeting the [indiscernible] oncoming requirements, which we discussed earlier, which is the autonomous distressed tracking and timely access to FLYHT data requirement. So there are companies that are proactively taking product in order to satisfy those mandates and depending upon the countries and locations that those companies exist, there's different motivations driven by their regulatory bodies as to what time they should take those orders. So hopefully that clarifies that question.The next question says for licensing revenue to bring FLYHT closer to profitability would take more OEM installs and steadier stream, is FLYHT in talks with Boeing about such installs? Would FLYHT need L3 as a partner in a deal with Boeing, are any discussions taking place with ATR or Embraer about licensing? Any life in the agreement with Comac on the ARJ21 8 years ago? Whether talks ongoing with any other OEM manufacturers?I will summarize the answer to this question to say that we are and have been very aggressively working with new OEMs for sales. In some cases, we're discussing selling directly to those OEMs and airframers, in some opportunities, we're discussing selling through third parties to those OEM and airframers. In some situations, we're exploring both options. It is a very, very high priority and one of our company goals, both last year and this year, to increase our OEM installation base. I can say that we are seeing progress in this area, but I don't have the opportunity to provide anymore update than that at this time.Can you elaborate on the comment made in the letter to shareholders, we've been focused on building our technical services revenue component and developing new revenue verticals at FLYHT?I believe I expanded on this a little bit in the discussion earlier on this call. We believe strongly in the core business that we're building. The challenge that we have is that I think as any shareholder at FLYHT has come to appreciate is that the sales cycle is somewhat slow. And the growth is not happening at the rate that we would like. So we've been strategically looking at ways that we can actually round out the portfolios that we can get growth in other areas. That's about as much as I can say at this point. I can't say that I'm excited about some of the initiatives that are underway and I hope to be able to bring you more news on those soon.I believe that I've either answered the questions that I received or provided details in the management discussion [indiscernible] there's any caller questions, we can take those now.

[Operator]

[Operator Instructions] And our first question comes from Marc Berger with MKB Associates.

[Marc Berger]

First question, could you elaborate a little more on the R&D expenses, they are substantially higher than they've been in the past, what is the R&D basically for, is it to update 228 or other things or maybe it's into the verticals. And what do you think going forward, the R&D will still continue to be at what kind of rate?

[Thomas R. Schmutz, Chief Executive Officer]

That's a great question, Marc. The primary activities that are underway currently are the continued migration of our UpTime service from the fixed server to the cloud, so that continues to be an ongoing effort. We're funding a good portion of that development with the WIN grant that we've covered -- we've been talking about before, which represents a coupon along from the Canadian government. Bundled in that and included in that activity is development activities that we perform for customers to access customer specific functionality and capabilities. When I say customer capability, specific capabilities we look at on a case-by-case basis, opportunities to expand the types of services that AFIRS and UpTime can provide to a customer and provided we believe either the business case for our individual customer is a standalone logical development case or if we feel like that we can develop it for a specific customer and then leverage it into others, so that we can make a good return on that development and include that development inside of this ongoing project that migrates our fixed server to the cloud. We do also have development activities underway that we have not discussed that deal with future products and unfortunately I can't talk about those at this time, but there are activities underway in that regard as well. With regards to R&D, I think I've covered this either maybe two calls ago, I don't expect R&D to essentially change. I think that the -- this business that we're in is going to continue to require investment. What we're focused on is trying to accelerate the top line to fund that development, which we understand is absolutely essential to do in a move forward basis.

[Marc Berger]

Based on the SaaS revenues on a run rate, it looks like you had about $4.3 million a year and if we have approximately 300 units sold, that's bringing that money in my estimation is we're getting close to 1,200 a month in terms of revenue. If we take a look at the shipments where you say you have 2,200 units out there, there is a substantial amount that is not contributing. So if we just take 1,500, say that goes to the OEM partner, and if we can get that 1,500 to contribute at the same 1,200 rate, we're looking at $21 million, which is a huge amount of money. Now those L3 orders that we received, I have to assume that since these guys have the box and the ability to create this recurring revenue for us, thereby 2021, we should be getting some money off that because they're being required to being forced into doing some of this. Am I wrong in that thinking and is there anything you're doing to try to improve and get most of these people to sign on and actually start streaming that revenue because they already got the box, they already have the ability, why not do it since they're going to have to anyway?

[Thomas R. Schmutz, Chief Executive Officer]

Yes, that's a great question, Marc. It's a very high priority for us to begin conversions of aircraft so that we get maximum participation in our Software as a Service product offering. We have the authority to do so and we are working very, very hard on trying to get that work accomplished, a very high priority.

[Marc Berger]

Do you have any timetable on that as to based on discussions, when you think you might close some of these?

[Thomas R. Schmutz, Chief Executive Officer]

I'm reluctant to provide a timetable because I don't want to disappoint. I can only say that it's extremely high priority for us.

[Marc Berger]

Last question, can you give us a little more color on the Inmarsat deal that we're working with, has that trial already started or what's the timing on that?

[Thomas R. Schmutz, Chief Executive Officer]

I have provided the details that I feel like I can. I will say that we're excited about the opportunity and I will provide you more information when I can.

[Operator]

[Operator Instructions] This concludes the question-and-answer session. I would like to turn the conference back over to Tom Schmutz for closing remarks.

[Thomas R. Schmutz, Chief Executive Officer]

Well, thank you for your interest in FLYHT. FLYHT is celebrating our 20th anniversary as a company dedicated to improving aviation safety, efficiency and profitability. To acknowledge the progress that the company has made over this time frame, we included a picture on Page 2 of the quarterly report that compares the first AFIRS prototype developed in 2002 with the AFIRS 228 that we are currently marketing today. The visual impact is amazing and I recommend you take a look, if you have an interest in that area. We're looking forward to the second half of this year with a great deal of enthusiasm. There is a significant potential for more than one of these strategic opportunities that I've been working -- that we've been working to bear fruit. I understand that there's some anxiety over the first half and with the languishing stock price and it's been a quiet first half in terms of news. So I want to assure you that I feel very excited about the items in the pipeline and that myself, I feel as a significant shareholder in the company myself that I will be rewarded for the additional patience required for the business at this time. So thank you for your support have a great weekend.

[Operator]

This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.