Innovative Solutions and Support Q2 2024 Earnings Call Transcript

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Provided by Quartr
May 13, 2024

Key Takeaways

  • Strong revenue growth: total net revenues increased 46.3% year-over-year to $10.7 M in Q2, with net income excluding non-recurring items up over prior year.
  • Integration of Honeywell acquisitions is underway, with some inventory and test equipment delivery delays currently pressuring margins but expected to enhance performance once complete.
  • Heavy R&D focus includes second-generation UMS testing with Pilatus, new cockpit automation upgrades for single-pilot operations, and growing interest in military markets.
  • Overall gross margin declined to 52% in Q2 from 64.6% a year ago, driven by product mix shifts, increased material costs, and temporary inefficiencies from the Honeywell integration.
  • Operating cash flow doubled to $4.4 M in H1 and debt was reduced by about $10 M, strengthening the balance sheet and enabling further strategic acquisitions.
AI Generated. May Contain Errors.
Earnings Conference Call
Innovative Solutions and Support Q2 2024
00:00 / 00:00

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Operator

Hello, and welcome to the Innovative Solutions and Support second quarter fiscal 2024 financial results conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your telephone keypad. To withdraw from the question queue, please press star, then two. As a reminder, this conference is being recorded. I would now like to hand the call to Shahram Askarpour, CEO. Please go ahead.

Shahram Askarpour
Shahram Askarpour
CEO at Innovative Solutions and Support

Good morning. This is Shahram Askarpour, Chief Executive Officer of Innovative Solutions & Support. Welcome to our conference call to discuss our performance for the second quarter of fiscal 2024, current business conditions, and outlook for the coming year. Joining me is Jeff DiGiovanni, our new CFO. Before we begin, I'd like Jeff to read the safe harbor statement.

Jeffrey DiGiovanni
Jeffrey DiGiovanni
CFO at Innovative Solutions and Support

Thank you, Shahram, and good morning, everyone. You should all have a copy of the press release we issued earlier today. If anyone does not have a copy, you can find the full press release on our website. Before we begin, as usual, I would like to remind everyone that this conference call contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements that address operating performance events or developments that we expect or anticipate to occur in the future are forward-looking. These forward-looking statements are based on management's beliefs and assumptions and not on information currently available to our management. Our management believes that these forward-looking statements are reasonable. However, you should not place undue reliance on any of these forward-looking statements because such statements speak only as of today's date.

Jeffrey DiGiovanni
Jeffrey DiGiovanni
CFO at Innovative Solutions and Support

We do not undertake any obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise required by law. In addition, forward-looking statements are subject to certain risks and uncertainties that could cause actual results, events, and developments to differ materially, either better or worse, from our historical experience, our present expectations or projections. These risks and uncertainties include, but are not limited to, those described in the reports which we file with the SEC. In addition, I specifically call our listeners' attention to our disclaimer regarding forward-looking statements contained in the press release issued today. With that, I'll turn it now the call over to Shahram.

Shahram Askarpour
Shahram Askarpour
CEO at Innovative Solutions and Support

Thank you, Jeff. I will begin today with remarks on our performance in the second quarter, 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 Jeff, who will take us through the financials. But before I do, I want to welcome Jeff DiGiovanni to IS&S and introduce him to the investment community. Jeff is a seasoned public company CFO, who joined us at the beginning of April, with extensive experience in SEC filings, financial reporting and acquisitions, as well as capital market interactions. All skills that are highly appropriate for the CFO role at IS&S. We're all looking forward to his contributions in helping us build shareholder value. At the same time, I want to thank Relland Winand for helping us through this transition.

Shahram Askarpour
Shahram Askarpour
CEO at Innovative Solutions and Support

It's been another busy and exciting quarter at IS&S. Revenues were up 46%, with net income, excluding the non-recurring expenses, also up from a year ago. We remain on pace to meet our goal of significantly growing both the top and bottom line this year. We continue to progress with Honeywell integration. Most of the radio business has been transitioned, and we are now handling the new maintenance and repair requests out of Exton. We expect to complete the integration of the Inertial Reference Unit business before the end of the summer. There have been some delays in completion of delivery of inventory and test equipment we purchased. However, we believe that once the integration is fully completed, there will likely be opportunities to improve even more upon financial performance of the acquired products and to leverage inherited relationships to expand our penetration with new customers.

Shahram Askarpour
Shahram Askarpour
CEO at Innovative Solutions and Support

We continue to generate stable revenues and margins from our large OEM contracts with Pilatus for the Utility Management Systems or UMS, Textron for our standby instrument and autothrottle, and Boeing for the KC-46 and the T-7 products. Since its inception, IS&S has built a reputation in the industry for its portfolio of IP-rich avionics technology. This spirit of innovation to develop superior technologies is in the company's DNA, and it is the cornerstone of our long, long-term growth strategy. Consequently, it is no surprise we remain extremely active on the development side. Research and development activities this quarter include both customer-funded and internal programs. On the funded side, we expect to be testing the second generation UMS with Pilatus in the near term. This is a new generation platform, and we believe has the potential to be extended into adjacent markets.

Shahram Askarpour
Shahram Askarpour
CEO at Innovative Solutions and Support

This contract is another testament to our ability to provide state-of-the-art, safe and reliable products and services to the industry. Recently, we've been adding new incremental cockpit automation upgrades to our product portfolio that enhance safety and reduce pilot workload, and these have also added to our revenues. As we replace obsolete cockpit technology with our product lines, we focus on cockpit automation features that enable future single pilot operations. We believe that once the certification authorities approve single pilot operations in Part 25 aircraft, our proven technologies will allow us to retrofit those aircraft at an attractive price for the market. We expect that air cargo operators will become the early adopters. We're also ramping up our business development efforts. With the addition of the Honeywell global business development team, we are developing plans to extend our network into new international markets.

Shahram Askarpour
Shahram Askarpour
CEO at Innovative Solutions and Support

We anticipate the Honeywell development team will help us develop new relationships around the world in relevant market segments. Lately, we have experienced increased interest for our product lines in the military sector, both domestic and internationally, and believe that in the near term, some of our organic growth will be military market-oriented. In order to execute our long-term plan and realize the attractive returns on an aftermarket strategy for autonomous flight, we have developed an accelerated growth strategy consisting of growth by acquisition and modest organic growth. The Honeywell acquisition has demonstrated that we can generate the cash flow to support this strategy, having reduced our borrowing by approximately $10 million in just the first six months after closing. Together, with a growing base of recurring revenue, we also have a model that we believe will support this strategy. We think the time is right in the market.

Shahram Askarpour
Shahram Askarpour
CEO at Innovative Solutions and Support

Consequently, we will continue to opportunistically evaluate and execute additional complementary acquisitions should appropriate opportunities arise. Thank you for your time and interest, and we look forward to updating you in the upcoming quarters. I will now turn the call over to Jeff for a closer look at the numbers.

Jeffrey DiGiovanni
Jeffrey DiGiovanni
CFO at Innovative Solutions and Support

Thank you, Shahram, and thank you all for joining today. Before reviewing our financial highlights for the second quarter, I would first like to say that I'm glad to be part of the IS&S team at this very exciting time in the company's growth. I am confident that I can contribute to our efforts to build shareholder value based on my over 25 years as both a consultant to, as well as the CFO of a publicly traded company. I'll begin with an overview of our second quarter results. As Shahram indicated, our top line finished with double-digit growth versus the prior year, which was consistent with our expectations. Total net revenues for the second fiscal quarter of 2024 were $10.7 million, representing a 46.3% increase when compared with the $7.3 million for the second fiscal quarter of 2023.

Jeffrey DiGiovanni
Jeffrey DiGiovanni
CFO at Innovative Solutions and Support

Total revenues for the six months ended March 31, 2024, were $20 million, representing a 44.7% increase when compared with the $13.9 million for the six months ended March 31, 2023. Product sales decreased $1 million or 17.7%, and customer service increased $3.7 million or 265.4% as compared to the year ago quarter. The decrease in product sales for the three months ended March 31, 2024, was primarily a result of reduced shipments of displays for retrofit programs to commercial air transport customers, partially offset by an increase in shipments of displays to the general aviation and military customers. The increase in customer service primarily reflects customer service sales of the product lines acquired from Honeywell.

Jeffrey DiGiovanni
Jeffrey DiGiovanni
CFO at Innovative Solutions and Support

EDC sales increased $700,000 compared to the year-ago quarter, reflecting increased EDC business. For the first six months ended March 31, 2024, product sales decreased $1.7 million or 15.5%, and customer service sales increased $6.9 million or 279.9% as compared to the prior-period quarter. The decrease in product sales for the six months ended March 31, 2024 was primarily the result of reduced shipments of displays for retrofit programs to commercial air transport customers, partially offset by an increase in shipments of displays to the general aviation and military customers. The increase in customer service primarily reflects customer service sales of the product lines from Honeywell. EDC sales increased $1 million or 282% compared to the prior quarter, reflecting increased EDC business.

Jeffrey DiGiovanni
Jeffrey DiGiovanni
CFO at Innovative Solutions and Support

From an expense standpoint, cost of sales increased by $2.6 million, or 98.3% to $5.2 million, or 48% of net sales in the three months ended March 31, 2024, compared to $2.6 million, or 35.4% of net sales in the three months ended March 31, 2023. The increase in cost of sales was primarily the result of an increase in customer service sales volume for the three months ended March 31, 2024, compared to the three months ended March 31, 2023.

Jeffrey DiGiovanni
Jeffrey DiGiovanni
CFO at Innovative Solutions and Support

Cost of sales increased by $3.5 million, or 65.8%-$8.9 million, or 44.6% of net sales in the six months ended March 31, 2024, compared to $5.4 million, or 38.9% of net sales in the six months ended March 31, 2023. The company's overall gross margin was 52% and 64.6% for the three months ended March 31, 2024 and 2023 respectively, and was 55.4% and 61.1% for the six months ended March 31, 2024 and 2023 respectively. This decrease in overall gross margin percentage is primarily attributable to the increased material costs attributable to the product mix, along with the delayed synergies with the Honeywell transaction for the acquired product lines.

Jeffrey DiGiovanni
Jeffrey DiGiovanni
CFO at Innovative Solutions and Support

As Shahram briefly mentioned, the Honeywell integration continued in the second quarter, creating some pre-production inefficiencies. In addition, some of the inventory and test equipment deliveries we expected were somewhat delayed, which negatively impacted not only our margins, but over our revenues as well. So while the Honeywell products are expected to have margins in line with our historical averages, they're currently a bit lower. However, as Shahram mentioned, we believe once the integration is complete, their performance will improve. Research and development expense was $1.0 million, an increase of $100,000, and 19% in the three months ended March 31, 2024, from $900,000 in the three months ended March 31, 2023.

Jeffrey DiGiovanni
Jeffrey DiGiovanni
CFO at Innovative Solutions and Support

R&D expenses were $1.9 million, an increase of $400,000 or 25.7% in the six months ended March 31, 2024, from $1.5 million in the six months ended March 31, 2023. This increase in R&D expenses were driven due to higher salaries and benefits, due to higher headcount. As a percentage of net sales, R&D expense decreased to 9.6% of net sales for the three months ended March 31, 2024. And lastly, on the expense side, selling general and administrative expenses were $2.9 million, an increase of $500,000 or 18.9% in the three months ended March 31, 2024, from $2.4 million in the three months ended March 31, 2023.

Jeffrey DiGiovanni
Jeffrey DiGiovanni
CFO at Innovative Solutions and Support

Selling, general, and administrative expenses were $5.9 million, an increase of $1.2 million, or 25.6% in the six months ended March 31, 2024, from $4.7 million in the six months ended March 31, 2023. The overall increase in selling, general, and administrative expenses in the quarter ended March 31, 2024, was primarily the result of our investment in additional sales personnel to help drive increased sales. In addition, the increase was largely driven by an increase in legal and other professional fees that are one-time in nature related to the acquisition, CFO transition, and other. These costs approximately $200,000 and $600,000 for the three and six months ended March 31, 2024.

Jeffrey DiGiovanni
Jeffrey DiGiovanni
CFO at Innovative Solutions and Support

In addition, SG&A was negatively impacted by approximately $200,000 and $500,000 for the three and six months ended March 31, 2024, respectively, relating to the amortization of the customer relationship related to the Honeywell acquisition. Interest expense was $171,000 in the quarter, down significantly on a sequential basis from the first quarter as we paid down our borrowings. Under our line of credit agreement, we use cash collections to reduce debt at the end of every day, so we don't hold much cash on the balance sheet. For modeling purposes, I will continue to expect to see interest expense decrease in future quarters. For the second quarter, we reported net income of $1.2 million or $0.07 per share, compared to net income of $1.3 million or $0.07 per share in the year ago quarter.

Jeffrey DiGiovanni
Jeffrey DiGiovanni
CFO at Innovative Solutions and Support

The difference is primarily attributable to non-recurring items previously discussed in the quarter, coupled with the added amortization and customer relationship intangible acquired from the Honeywell transaction, which was $268,000. Therefore, excluding these one-time, non-recurring expenses and the amortization expense, our profitability increased from the year ago quarter. Moving on to the backlog. New orders in the second quarter of fiscal 2024 were approximately $6.6 million, and our backlog as of March 31, 2024, was $10.4 million. Backlog includes only purchase orders in hand and excludes orders from our OEM customers under long-term programs, such as Pilatus PC-24, Textron King Air, Boeing T-7 Red Hawk, and Boeing KC-46A. IS&S expects these programs to remain in production for several years and anticipates they will continue to generate future sales.

Jeffrey DiGiovanni
Jeffrey DiGiovanni
CFO at Innovative Solutions and Support

Further, due to their nature, the product lines from Honeywell do not typically enter backlog. I'll turn to our cash flow and liquidity. In the first half of 2024, cash flow from operations increased from $2.2 million in the year ago comparable period to $4.4 million, primarily due to changes in working capital and higher cash earnings. Our year-to-date cash inflows from investing activities were reflective of the cash inflow from the proceeds of $2.2 million from the sale of the company's King Air aircraft. Our year-to-date cash outflows from financing activities were $8.9 million and consisted of payments against the company's line of credit. I'd like to close by thanking all our teams for their hard work and commitment. And with that, let me turn it over to the operator to begin Q&A.

Operator

Thank you very much. We will now begin the question-and-answer session. To ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, you may press star then two. We will pause momentarily to assemble our roster. Today's first question comes from Sergey Glinyanov with Freedom Finance Global. Please go ahead.

Sergey Glinyanov
Senior Analyst at Freedom Finance Global

Hello, everyone. The first question is for Jeff. Could you provide a bit of financial expectation for 2024 fiscal year, please? Especially I'm interested, margins, because I look at gross margin that decreased a little bit from quarter a year ago, due to Honeywell products acquisition. Thank you.

Jeffrey DiGiovanni
Jeffrey DiGiovanni
CFO at Innovative Solutions and Support

Right. Yeah, so I think Shahram laid out expectations of 40% growth from a year ago, and that included both inorganic and organic, as well as 75% EBITDA growth. Right now, Shahram mentioned we've experienced some synergy delays with the Honeywell acquisition, which is negatively impacting those margins. As the inventory and the test equipment comes in, we would expect those margins to improve once these synergies are in full effect.

Sergey Glinyanov
Senior Analyst at Freedom Finance Global

Okay, and the second question for Shahram. What financial effect, degree from UMS expanded to PC-24 do you expect? What are the existing product lines will enhance organic revenue in foreseeable future? Thank you.

Shahram Askarpour
Shahram Askarpour
CEO at Innovative Solutions and Support

Yeah. So, yeah, on the UMS, right now, I mean, we continue with the production contract that we have with Pilatus for the PC-24. So we're delivering those and that platform is growing since the aircraft has been a very successful platform. On top of that, they gave us a development contract to make the second generation of the UMS. Part of what we're doing on the second generation UMS is adding a lot more powerful microprocessors and improving on the performance of the equipment, as well as opening it up for what we call space to add another channel of processing that would make it a lot more expandable into adjacent platforms.

Shahram Askarpour
Shahram Askarpour
CEO at Innovative Solutions and Support

We plan on utilizing that platform for our future development, including autonomous flight. And this contract from Pilatus is allowing us to expand the capabilities of the product line. We're hoping that also in the business aviation side, that the new platform will, because of its additional capabilities, be more applicable to other aircraft platforms as well.

Sergey Glinyanov
Senior Analyst at Freedom Finance Global

Okay. Thank you, speakers.

Operator

Thank you. As a reminder, if you'd like to ask a question, please press star then one. The next question comes from Doug Ruth with Lenox Financial Services. Please go ahead.

Douglas Ruth
Research Analyst at Lenox Financial Services

Good morning. Could you, can you give us a summary, what were the one-time costs in the quarter? And what do you think the margins would have been? What would they have been if you did not have those one-time costs?

Jeffrey DiGiovanni
Jeffrey DiGiovanni
CFO at Innovative Solutions and Support

... So Doug, this is Jeff. So one regarding the one-time costs, they're in SG&A. So those one-time costs are some acquisition-related costs, legal fees, associated with the acquisition, as well as the CFO transition, fees. You'll see that more disclosure in our 10-Q, that's gonna come out later this week. In terms of the margin impact with the synergies of Honeywell, we can't quantify it at this time because we're still working through some of the, transition issues.

Douglas Ruth
Research Analyst at Lenox Financial Services

But what about the growth mar- Go ahead.

Shahram Askarpour
Shahram Askarpour
CEO at Innovative Solutions and Support

On the gross margins, there are two things contributing to the lower growth margin. Number one is that currently, as you know, we acquired a large amount of inventory from Honeywell on both product lines. There was something like $3.5 million of goodwill that was calculated by our brilliant accountants, that it's being amortized over the inventory. So the cost of goods sold today, as we bleed off that inventory, appears to be higher than normal. So that's one contributor. The second contributor is that when we acquire these product lines from Honeywell, Honeywell does not build any subassemblies. They outsource all of those subassemblies to third-party vendors. Our plan is, during this initial period, to continue down that path.

Shahram Askarpour
Shahram Askarpour
CEO at Innovative Solutions and Support

As we move along and the integration completes, we will be building majority of those subassemblies in-house. That would allow us to reach the 60% gross margins that we get today as we get with our own product lines. Because, as you can imagine, your cost of goods sold is much higher when you outsource those subassemblies. We have capabilities here in our factory to build our own subassemblies.

Douglas Ruth
Research Analyst at Lenox Financial Services

Okay, how long will it take to burn off the Honeywell inventory that you acquired?

Shahram Askarpour
Shahram Askarpour
CEO at Innovative Solutions and Support

So obviously some of the faster-moving inventory will burn out quicker. Some of the slower burn inventory will remain for a few years in the books. But I think it's going to be a gradual improvement as we bleed that off. But I think the big part of it is gonna be as soon as we're in a position that we can start building our own subassemblies here. And to do that, we're still waiting for some information, some drawings, and design information from Honeywell, that's due to arrive sometime soon, that would allow us to then use those to build subassemblies in-house.

Douglas Ruth
Research Analyst at Lenox Financial Services

When you think about the current second quarter, the period ending 3/31, is that the low period for the gross margin, that it might be reasonable to think that in the third quarter, the gross margin might improve?

Shahram Askarpour
Shahram Askarpour
CEO at Innovative Solutions and Support

The gross margin contributed to the Honeywell products, some of it will improve because efficiencies in our production floor as well. So when we look at the second quarter and the first quarter, these were transition quarters. So in some ways, we had a set of technicians here at IS&S performing tasks while they're being trained, as well as Honeywell was also executing partially on our behalf of some of these things. The margins will improve as we move forward due to some of that. The improvement of margin, the significant improvement in margin that we will see a jump coming in, is gonna be when we actually start manufacturing the subassemblies in-house, and that will gradually happen over the next year.

Douglas Ruth
Research Analyst at Lenox Financial Services

Now, when you look at the third quarter, will you be able to make any of the subassemblies, or is that too soon of a time period? Would you be looking more towards the fourth quarter to be able to make some of the subassemblies?

Shahram Askarpour
Shahram Askarpour
CEO at Innovative Solutions and Support

I think that's gonna be looking towards the fourth quarter as well as, you know, main contributions that are gonna come in, fiscal 2025.

Douglas Ruth
Research Analyst at Lenox Financial Services

Okay. Now, my second question, which is my last question, is the management team and the board of directors, after the two-day period, would they be eligible to buy some stock, you know, at that time period?

Shahram Askarpour
Shahram Askarpour
CEO at Innovative Solutions and Support

Absolutely.

Douglas Ruth
Research Analyst at Lenox Financial Services

Or does there continue to be a blackout period?

Shahram Askarpour
Shahram Askarpour
CEO at Innovative Solutions and Support

No, I think, I believe it's like two days after today, that blackout period will be over. So if any of the board of directors like to purchase additional shares or the management within the management team, they can do that. Obviously, I think, a big portion of our management team's income is tied into RSUs. And significant amount of taxes that you would have to pay out of your own pocket because the management team has not been selling RSUs, unlike some other companies, to pay the taxes for it.

Douglas Ruth
Research Analyst at Lenox Financial Services

Yeah.

Shahram Askarpour
Shahram Askarpour
CEO at Innovative Solutions and Support

So that kind of ties up all the, at least on my part, it ties up all my available cash, is to pay 40% taxes on the RSUs. But I think, you know, our stock right now is at a very attractive price.

Douglas Ruth
Research Analyst at Lenox Financial Services

Okay. All right, well, thank you for answering the questions, and I'm optimistic about the company's future.

Shahram Askarpour
Shahram Askarpour
CEO at Innovative Solutions and Support

Thank you so very much.

Operator

Thank you very much. This concludes our question and answer session, as well as the conference. Thank you for attending today's presentation. You may now disconnect your lines.

Executives
    • Jeffrey DiGiovanni
      Jeffrey DiGiovanni
      CFO
    • Shahram Askarpour
      Shahram Askarpour
      CEO
Analysts
    • Douglas Ruth
      Research Analyst at Lenox Financial Services
    • Sergey Glinyanov
      Senior Analyst at Freedom Finance Global
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