Innovative Solutions and Support Q1 2024 Earnings Call Transcript

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February 15, 2024

Key Takeaways

  • Revenues rose 43% year-over-year in Q1 and net income increased 51%, driving margins up to 59.3% and positioning the company to hit its 40% growth target with Honeywell product additions.
  • Robust cash flow of $4.2 million allowed the company to reduce debt by $8.9 million to $10.6 million, with plans to use future cash to pay down more borrowing as interest rates decline.
  • The Honeywell product line integration is nearly complete, expanding recurring OEM contracts with Boeing, Textron and Pilatus and adding hundreds of new global customers through an enhanced sales footprint.
  • R&D expenses rose to support development of new products—most notably a funded Pilatus contract for a 2nd-generation UMS—and to advance long-term single-pilot air transport capabilities.
  • SG&A costs increased due to expanded sales staffing, amortization from the Honeywell acquisition and professional fees, partly offset by a $162,000 gain on the sale of a King Air aircraft.
AI Generated. May Contain Errors.
Earnings Conference Call
Innovative Solutions and Support Q1 2024
00:00 / 00:00

There are 6 speakers on the call.

Operator

Good day, and welcome to the Innovative Solutions and Support First Quarter Fiscal 2024 Financial Results Conference Call. Over to Doctor. Shahram Askarpur, Chief Executive Officer and member of the Board of Directors. Please go ahead.

Speaker 1

Good morning. This is Shyam Askarpur, Chief Executive Officer of Innovative Solutions and Support. Welcome to our conference call to discuss our performance for the Q1 of fiscal 2024, current business conditions and outlook for the coming year. Joining me is Ruel Binan, our CFO. Before we begin, I'd like Rell to provide a cautionary statement about forward looking information.

Speaker 2

Thank you, Sharon, and good morning, everyone. I would remind our listeners that certain statements made in matters discussed in the conference call today, including those about new products and operational and financial results for future periods, contain forward looking information. These forward looking statements are subject to assumptions, risks and uncertainties that could cause actual results to differ materially, either better or worse, from those discussed. I specifically call our listeners' attention to our disclaimer regarding forward looking statements in our Form 10 Q yesterday, which disclaimer along with our public filings represented describe these assumptions, risks and uncertainties. I also remind our listeners that plans and expectations we express speak only as of today's date and listeners should not place undue reliance on any forward looking statements.

Speaker 2

Now, I'll turn the call back to Shahram.

Speaker 1

Thank you, Raul. Will begin today with remarks on our performance in the Q1 of fiscal 2024, followed by comments on our long term growth plan and strategy, including the ongoing integration of the products acquired and licensed from Honeywell. I will then turn the call back to Rell, who will take us through the financials. For the quarter, revenues were up 43% with net income increasing 51% from a year ago. This increase has us on pace to meet our goal of increasing revenues by 40% of the organic fiscal 2023 revenues due to the addition of the Honeywell product lines.

Speaker 1

At this time, we expect full integration of the Honeywell product lines to be nearly completed this fiscal year. 1st quarter results were in line with expectations expressed previously. That aside, results once again demonstrate the strength of our strategy addressing the diversified military, Commercial Air Transport and Business Aviation Markets. Although we have experienced An anticipated slowdown in commercial air transport and cargo markets, We have counted this slowdown by renewed strength in the military markets. With the addition of the Honeywell product lines, An increasing proportion of our revenues are now recurring in nature, including our OEM production contracts with Boeing, Textron and Pilatus.

Speaker 1

These production contracts provide a growing base of reliable revenue that generates strong margin and strong cash flow. Margins this quarter were 59.3%, an improvement from the Q1 of fiscal year 2023. Cash flow was strong in the quarter enabling us to reduce our debt position by nearly $9,000,000 in the quarter. We expect the credit line balance will continue to be reduced throughout the fiscal year, barring another acquisition. We also maintained our commitment to research and development as evidenced by the increase in R and D expense.

Speaker 1

This increase includes our effort to develop new products and to add new capabilities to existing technologies and to integrate the acquired Honeywell product lines. This work is directed at our long term vision where we believe there is increasing demand for technologies that reduce pilot workload and would ultimately lead to single pilot flights in air transport aircraft. Our funded R and D represents a contract with Pilatus to develop a 2nd generation UMS, a product we expect to be extended into additional airframes. This is further evidence of our strong value proposition and the confidence we gained with our customers. Part of the increase in selling, general and administration expense in the quarter was the increase in staffing, our sales organization.

Speaker 1

While we have always enjoyed a good reputation internationally, the Honeywell acquisition provided us an experienced established global sales footprint, which we believe opens large new markets, not only for the Honeywell products, but also for our legacy products. Many of the hundreds of customers that came along with the new products are new to ISNS, representing another new market we believe offers great promise. Quickly updating the status of the Honeywell product line, all the test equipment and inventory is arriving and the Honeywell training associated with the products have been completed. We are now processing maintenance and repair of radios in house. Meanwhile, the transfer of the IRU inventory is progressing with the handoff of these products expected to occur by the end of the current quarter.

Speaker 1

We expect the top and bottom line benefit of these new products to begin to gradually ramp up. As I mentioned, we have increased our sales and marketing to support the sales of these products. As we begin to develop strategies to fully recognize the inherent synergies and potential of these products, we believe that we will realize growth from Sykes Synergies and strategies. For these reasons, we will continue to opportunistically evaluate and make plans to execute additional complementary acquisitions should appropriate opportunities arise. Our goal now is to leverage this momentum to sustain this growth over both near and longer term organically and through additional acquisitions.

Speaker 1

Finally, I want to update you on our ongoing search for a permanent CFO. We have retained an executive search firm and we have already completed a round of interviews that yielded several highly qualified candidates. Thank you for your time and interest and we look forward to updating you in the upcoming quarters. I will turn the call over to Raul for a closer look at numbers.

Speaker 2

Thank you, Sharon, and thank you all for joining today. Let me quickly review the highlights our financial results for the Q1 of fiscal 2024. Revenue in the Q1 was up 43% due to the contribution of customer service sales of the product lines acquired and licensed from Honeywell. 1st quarter gross margin was 59.3 percent, up from a year ago, but down slightly on a sequential basis in the 4th quarter, primarily due to the impact of increased material costs and overhead absorption in customer service. In the Q1 of fiscal 20 24, research and development expense was $900,000 or 9.7 percent of net sales.

Speaker 2

Note that research and development expense have increased in absolute terms, but has decreased as a percentage of net sales. When the current engineering development contract The engineers working on that development contract will return to research and development efforts. This will result in increased research and development expense in subsequent quarters. 1st quarter fiscal 2024 Sowing, general and administrative expenses increased from a year ago, primarily due to an increase in sales and marketing expense, The quarterly amortization of the intangible asset associated with the Honeywell product line license and acquisition and professional and consulting fees. I will note that we sold the King Air airplane in the quarter for $2,300,000 And the resulting gain on the sale was used to reduce total selling, general and administrative expenses.

Speaker 2

The gain was $162,000 Interest income was down in the quarter consistent with our new P and C Bank line of credit account that daily cash balance to reduce debt at the end of every day. Interest expense in the quarter was up from 0 a year ago, although we do not expect interest expense, although we do expect interest expense to trend down, not only as interest rates are anticipated to fall, but also because we're planning to use the majority of our cash flow to pay down debt. Taxes are being accrued at a rate of 12.8% versus the statutory rate of 21%, reflecting increased state tax expense due to the gain on the sale of the King Air airplane. Net income for the quarter was $1,100,000 or $0.06 per up from $700,000 or $0.04 per share in the year ago quarter. New orders in the quarter were approximately $10,400,000 so that we ended the quarter with a backlog of approximately $14,600,000 As always, quarterly orders can vary due to a number of factors and are not meant to provide an indicator of future revenues.

Speaker 2

Virtually all the Honeywell revenues are from intra quarter book and ship orders that are not included in the backlog. For the Q1 of fiscal 2024, The company generated $4,200,000 of cash flow from operations. The company's debt on December 31, 2023 was $10,600,000 down $8,900,000 from $19,500,000 as of September 30, 2023. As a result of the daily cash balance sweep component of the company's line of credit is required to be classified as a current liability on the balance sheet. During the 3 months ended December 31, 2023, cash also benefited from the sale of our King Air Aircraft for $2,300,000 With that operator, we're ready for questions.

Operator

We will now begin the question and answer session. The first question comes from Theodore O'Neil with Litchfield Hills Research. Please go ahead.

Speaker 3

Thank you very much. I just have two questions. The first one is about on the sales side. The reduced shipments of displays for the retrofit in the commercial market, Do you have a view on if and when that would might change and what would be the driver for it?

Speaker 4

So it's

Speaker 1

some of it It's seasonal. Some of it is we're introducing a new product line in that market, We should begin or finish the certification this quarter and we should begin to see some revenues from it from next quarter. But we've anticipated that on the cargo market, As these airplanes get older and older, that eventually we will see a slowdown in these upgrades, which and because of that, we developed some additional products and put a larger emphasis On our military efforts, which were kind of not In some ways, there were not a priority before we were focusing on the oral flower product lines. So we've put an emphasis over the last couple of years. On the military side of things, we got an OEM new OEM contract Boeing on the T7 Trainer, we continue to work on a lot of new opportunities that are coming both OEM as well as the aftermarket and the military side.

Speaker 1

So we're looking at that over the next few years to essentially be a larger driver than the air transport side. On the air transport side, what we're doing is that we're offering a lot of upgrades, and eventually to the single pilot operation for these Part 25 airplanes. The single pilot operation is the longer term strategy. Meanwhile, we will be seeing some revenues from some of these additional features that we are offering on these cockpits. But the big ticket items of completely retrofitting a cockpit of a 57, 67 aircraft, That has slowed down and like I said, we had anticipated.

Speaker 3

Okay. Yes, makes sense. And on the SG and A expense, The amortization of the customer relationships that was in the SGA in the quarter, is it a significant Part of the increase and does it continue on for many more quarters?

Speaker 2

Yes, it goes so this it's a 10 year amortization. It's about $268,000 quarterly. It will continue obviously. So that's a Big driver of the increase. And of course, as Sharon mentioned, we've hired sales additional salespeople, so that's a big piece

Speaker 3

Okay. Thanks very much.

Speaker 1

Generally, our auditing fees and

Speaker 2

legal fees have been high. Quarter to quarter, They were fine.

Speaker 1

As the acquisition is Yeah.

Speaker 3

Okay. Thanks, guys.

Speaker 4

Thanks. The

Operator

next question comes from Andrew Rem with Odinson Partners. Please go ahead.

Speaker 4

Good morning, gentlemen. I just had a question to start with. How should we think about gross margins within the customer service segment?

Speaker 2

In what way? Typically, it's been higher?

Speaker 4

Right. So if

Speaker 2

we look

Speaker 4

at the 4th quarter rate, 68.5 percent

Speaker 2

and in

Speaker 4

fiscal 2023 year to date It had been running 71%. And so I don't know if I mean you mentioned some under absorption, But you had much higher revenue this quarter than 1st, 2nd or Q3 of last year.

Speaker 2

And so Right. So it's go ahead. Sorry.

Speaker 4

No, I'm just trying to understand some nuances.

Speaker 2

Yes, well, you got

Speaker 1

Andrew, can you repeat that please? You said we had gross margins of 71%.

Speaker 4

Well, the year to date through the 1st three quarters of fiscal 3 was running 70%, 71%. Then 4th quarter was 68.5% and then now you have 59%. So I'm just trying to understand the nuance What moves the gross margin around and this quarter's revenue in customer service was higher than the revenue run rate In the 1st 3 quarters of last year.

Speaker 2

Right. But the customer service revenue is a bigger piece of the whole. It's going to end up with more overhead absorption into it, as well as we've seen material, as you can understand has cost of material, the price has increased. So we have to keep increasing our standards. So it's And it's mix, depends on what you're repairing.

Speaker 2

But yes, it is down from previous. But like I say, half of your sales almost is customer service. So that's going to get a bigger piece of everything, if that makes any sense

Speaker 4

Okay. And then on the cost material side, how long does it take you to kind of get some price recovery there?

Speaker 2

To get some what, can you repeat that? I missed that.

Speaker 4

On the cost of materials, How long does it take you to get this recovery?

Speaker 2

It doesn't take on the customer service side, not too much because a lot of what we do other than warranty is cost up. So as we've been increasing those, it's going to flow through to the what we charge the customer.

Speaker 4

Okay. And then on inventories, obviously, you had a pickup in the 4th quarter due to Honeywell, But you also had another pickup this quarter about $1,700,000 Can you just help us understand what's going on? And Is this related to are you excess inventory as you make these product transitions? Is that what's driving it?

Speaker 2

Yes, you have a couple of things. So you have the Honeywell inventory coming in, right? So that's going from the prepaid. You can see the movement there into inventory. And we have some last time buys.

Speaker 2

We have items in flow that We're going to need the inventory inflow meaning production ahead of us and to produce ahead a little bit. So all that's going to Increasing obviously as we get more Honeywell, you're going to see that grow and grow and grow because the prepaid Honeywell inventory was $12,000,000 As you receive that, comes out of there and comes into your normal inventory, if that makes sense.

Speaker 4

Did we expect in the second half of the year kind of inventory kind of normalizes, you get the product transition, you get that behind you, you brought in All the Honeywell inventory, is that reasonable?

Speaker 2

Yes, but it will be a big number. I mean, because you got It's

Speaker 1

going to be a big number, but it's going to It

Speaker 2

should level up.

Speaker 1

It should level up.

Speaker 4

Okay. And then on CapEx, go ahead.

Speaker 2

Then you're going to order that kind of thing, right?

Speaker 4

All right. On CapEx, can you just comment on it was pretty high this quarter. How should we think about that for the full year?

Speaker 2

Let me look. CapEx, we've increased ability and done some work in the building, things like that. So that's going to be a part of it.

Speaker 4

Well, I'm just looking at $182,000 versus $300,000 for the full year fiscal 'twenty three.

Speaker 2

Yes. Well, we've probably bought some machinery. Now we're working on having

Speaker 1

It usually Bought a lot of benches.

Speaker 2

Yes, bought a lot of stuff for the Honeywell. So, fitting that out as well as making upgrading a part of the building, the plant for that. So all that's adding into a little higher than normal in a period of time.

Speaker 1

Yes, that should all That

Speaker 2

should stabilize. Yes. Typically, we don't have 200,000, 300,000 generally a year. It's always not a big number.

Speaker 4

Right. Yes. No.

Speaker 1

An investment in our IT structure as well. Yes, sure. Because as you know, this cybersecurity now is becoming a And so, we are doing some

Speaker 2

Upgrading servers.

Speaker 1

A lot of upgrades as well as increasing our cybersecurity practices. And I think long term, it saves us money because that reduces your insurance costs as well.

Speaker 4

Can you guys comment then Like if we just think about CapEx and what the incremental components, so you mentioned IT infrastructure would be for this year and then some incremental CapEx related to everything that you're doing around Honeywell. Can you kind of So if we if you've got a base CapEx spend a couple of 100,000 and then how much incremental from these IT and Honeywell related?

Speaker 2

Not a lot, $100,000 $100,000 $100,000 $100,000 $150,000 maybe. We're pretty much done that, if you will.

Speaker 4

Okay.

Speaker 2

I can say, Tim, it's different. Some more another is 250 maybe on average, I

Speaker 1

Yes. Going forward, you also got a lot of gas. Air conditioning system, which is 20 years old.

Speaker 4

All right. Well, I guess that's it for me, but I did want to say that you guys have done a pretty amazing job, generated good cash flow here. You've taken a turn and a half out of your debt. I had speculated That maybe you guys could exit this fiscal year below one times. I think it looks like you maintain the current trajectory, you guys are going flow right through that.

Speaker 4

So kudos to you guys and the team for doing a great job improving the balance sheet so quickly. So anyway, thanks a lot. Appreciate it.

Speaker 1

Thank you, Andrew.

Operator

The next question comes from Doug Ruth with Lennox Financial Services. Please go ahead.

Speaker 5

I want to start off by congratulating you on a really strong quarter. You've done a wonderful job. I had a question. Is the management team and the Board of Directors, do you folks now have the ability to buy stock?

Speaker 2

Well, when the window is open, yes. When the window, yes. The window opens actually on For us, it's the 3rd business day after earnings Monday. So there's and it closes a couple of weeks before the end quarter or so, it's so as of Monday, there is an open window, yes.

Speaker 5

Okay. I think the investment community would really appreciate if the Board and Some of the managers could buy some stock. I think it would really make a significant difference. And again, I want to congratulate you on a really strong quarter. Thank you

Operator

And this concludes the question and answer session and the Innovative Solutions and Support Conference. Thank you for attending today's presentation. You may now disconnect.

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