Innovative Solutions and Support Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
May 8, 2023

There are 4 speakers on the call.

Operator

And welcome to the Innovative Solution and Support, Inc. 2nd Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded.

Operator

It is now my pleasure to introduce your host, Michael Linacre, Chief Financial Officer. Please go ahead.

Speaker 1

Thank you, operator, and good afternoon, everyone. I would remind our listeners that certain matters discussed The conference call today, including information about new products and operational and financial results for future periods, are forward looking statements including other risks and uncertainties reflected in our company's 10 ks, which is on file with the SEC and other public filings. Now I'll turn it over to our CEO, Shahram Askarpur.

Speaker 2

Thank you, Mike, and good afternoon, everyone. I will begin today with remarks on our performance in the fiscal Q2 of 2023, followed by comments on our long term growth plan and strategy. I will then turn the call over to Mike, who will take us through the financials. Our 2nd quarter results demonstrated continued momentum of our business and elevated demand to $7,300,000 This improvement was driven by the higher volume of our aftermarket Including our oral call for the King Airs. I would like to remind our investors and stakeholders Not to over analyze our quarterly performance as it can be subject to variations in purchase order timings For our aftermarket products, which currently represent approximately 40% of our revenue.

Speaker 2

While we are pleased with our strong performance this quarter, it is crucial to take a more comprehensive and long term view of our financial performance and growth. As we have reported on in the past, our business is well positioned Benefit from significant operating leverage on higher sales, which was demonstrated again in the Q2. As such, Our gross margin expanded to 64% from 61% in the prior year, primarily due to leverage on higher volume and a favorable product mix. Operating profits in the current quarter was $1,400,000 which was $380,000 lower than the previous year. The decrease in operating profit was primarily due to higher SG and A expenses, which were mostly One time in nature and related to non cash stock based compensation and relocation expenses.

Speaker 2

Turning to net income, we achieved $1,300,000 which is a slight decrease from the prior year of 1,400,000 for the same reasons. As we continue to invest in our sales and business development initiatives, We are experiencing strong returns as indicated by our end of the quarter backlog of $14,800,000 A significant increase from a year ago and driven by new orders of $13,600,000 in the quarter, which is a record in recent years. Moving forward, our goals are clear. We want to increase facility utilization to maximize our margin potential. We have a 2 pronged approach to achieve this goal, through organic growth by driving new product introductions And through inorganic growth via M and A.

Speaker 2

To support our organic growth, we continue to invest Our IR and D programs. Although, our R and D as a percentage of sales is still below our full year target of 13%, we anticipate meeting our target on an annualized basis As we continue to expand our engineering department, selectively with highly qualified and self motivated engineers. We believe that investing in IR and D is critical for long term success and we remain committed To this approach, specifically, we remain focused and see our primary competitive advantage In the area of cockpit automation, which you have seen with the introduction and broad market success of our orothrottle programs, That would ultimately lead to reduction in number of pilots in the aircraft. To that end, I'm pleased to announce that we have shipped our initial orders On our recently awarded SDC for the ThrustSense Orafoil for the Beechcraft King Air 203 100 aircraft with the Garnt cockpit. This certification has allowed ThrustSense to be installed On an additional 700 potential platforms.

Speaker 2

On the inorganic side, we are actively seeking opportunities for M and A I've been working diligently to develop a robust pipeline. During the quarter, we made improvement important progress by obtaining shareholder approval to amend our articles of incorporation. This strategic action will enable us To secure the financing needed to implement a more aggressive M and A program and execute to our long term goals. To this end, we are currently working closely with our banking team to evaluate the best structures for our needs, And we plan to keep our investors informed of our progress in upcoming quarters. In our M and A programs, We are focused on identifying and acquiring complementary products and technologies to our existing portfolio.

Speaker 2

We are targeting smaller bolt on acquisitions that are under $25,000,000 Our goal is to expand our portfolio and fill capacity in our facility and we believe that these targeted acquisitions will allow us to do so efficiently and effectively. We are constantly evaluating potential acquisitions, Target and look forward to providing incremental updates in the coming quarters. In summary, we believe that our performance in the 2nd quarter demonstrates continuous momentum and strong demand for our innovative products. Moving forward, we have clear goals to increase our facility utilization and maximize our margin potential through both organic and inorganic growth. Thank you for your time and interest, And we look forward to updating you with the future details in the upcoming quarters.

Speaker 2

Now I will turn the call over to Mike for a closer look at the numbers.

Speaker 1

Thank you, Shahram, and thank you all for joining us today. I will review our financial results for the Q2 of fiscal 2023. Our revenues were 7.2% higher at $7,300,000 in the 2nd quarter compared to 6.8 in the Q2 of fiscal 2022. The growth was largely driven by new orders from commercial air transport customers in the Boeing 75767 aftermarket retrofit business. An increase was also seen due to new autothrottle installations.

Speaker 1

As we noted during our last earnings call, orders in the aftermarket retrofit business fluctuate from quarter to quarter. Since it is approximately 40% of our business, our overall revenues may fluctuate from quarter to quarter. This quarter's results, for example, reflect certain orders that were carried forward into the Q2, but were originally expected during the Q1. While we do not anticipate any significant changes in the long term organic growth trajectory of our business, we believe that our progress to be evaluated on an annualized basis. 2nd quarter gross margin was 64 point 6% compared to 61.1% in the 2nd quarter period from a year ago.

Speaker 1

The improvement in gross margin reflects an expansion in Operating leverage as a result of higher product sales, a favorable product mix, an increase in inventory and a slight decline in direct The gross margin improvement is very much in line with what we have previously mentioned. Our optimized operating model is Based on a fixed cost platform with relatively low employee headcount with operating leverage and margin profile well positioned The benefit from revenue growth. We plan on continuing to see additional operating leverage as sales continue to grow. Operating profit in the current quarter was $1,400,000 or 19.4 percent of sales, which was lower than the previous year's $1,800,000 or 25.4 percent of sales. Total operating expenses were $3,300,000 in the 2nd quarter versus $2,400,000 in the prior year Q2.

Speaker 1

The rise in operating expenses were primarily related to higher SG and A. These expenses included non cash stock based long term incentive compensation. Expenses were also higher as a result of additions made to the sales and business development teams as well as marketing and investor relations and investor facing related expenses. Higher SG and A expenses were partially offset by higher interest income Due to larger cash balance and higher interest rates compared to the same period in the prior year. R and D expenses of 11.8% of revenue And in line with the year ago second quarter levels, we still expect to spend 13% of our revenue on R and D by the end of the year and continue to hire engineers to support product development efforts.

Speaker 1

Tax expense in the 2nd quarter was $300,000 compared to $400,000 in the prior year quarter. 2nd quarter net income was $1,300,000 or 0 point 0 $8 per share versus 1,400,000 2022. Net income was $1,300,000 or $0.07 per diluted share, down slightly from the prior year of $1,400,000 or $0.08 per diluted share. Backlog was $14,800,000 as of March 31, 2023 versus only 7.5 as of March 31, 2022. New orders for the Q2 were 13,600,000 The increase is largely due to customers locking in orders for a longer period of time, such as Pilatus, who has ordered through late 2024.

Speaker 1

Additionally, Boeing has given us larger long term orders as well. And these factors have largely contributed to the growth and our backlog. Our customers' confidence in us is reflected in these longer term orders, From the Pilatus PC-twenty four, Textron, King Air and the KC-forty 6A long term programs in our total backlog. We anticipate that these programs will remain in production for about a decade and should continue to add to production sales already included in the backlog. We had $19,800,000 of cash on hand as of March 31, 2023, up from $19,400,000 of cash Cash on hand was $11,600,000 as of March 31, 2022.

Speaker 1

The company generated cash flow from operations of $400,000 during the quarter. Our cash generation was impacted by the new IRS Section 174, R and D tax regulations that increased our estimated tax payment by approximately $400,000 An inventory build of $600,000 $300,000 due to timing of accounts receivable payments received. We continue to generate cash flow and grow our cash balance without any debt on our balance sheet. This provided us With significant financial strength and flexibility as we seek to execute on our organic and inorganic opportunities going and deliver returns to our internal and external stakeholders. For the remainder of fiscal 2023, we anticipate generating strong cash flows with similar With that operator, we are ready for questions.

Operator

Our First question comes from Tim Moore with E. F. Hilton. Please go ahead.

Speaker 3

Thanks and congratulations on the strong orders catch up in the quarter and it was nice to see the backlog up 74% sequentially from December And double from a year ago, very impressive strong book to bill. I do appreciate you guiding to Thinking of everything maybe on a 12 month rolling basis, but it was still impressive. So my first question is, I know you elaborated a bit on the gross margin, Which was amazing in the quarter. Was most of that caused by the mix? Was there more aftermarket sales there?

Speaker 3

Or was it more caused by the operating leverage benefit? Just trying to wrap my head around maybe the main drivers of that margin expansion.

Speaker 1

Yes, it's a combination, but we did in Q2 have a higher proportion of aftermarket business, which is typically A bit higher margin than our OEM business. So it was a combination between that and the increased sales overall to create that operating leverage.

Speaker 3

Great. That's helpful. And something I just want to follow-up You were giving good clarity on this maybe. Your SG and A expense, from what I recall, There was a bit more pressure on it in the first half of the fiscal year, which you just reported Because there were some one off, professional expenses, banking fees, maybe legal fees and some catch up. When you kind of think about the year as a whole for this year, we should probably expect SG and A as a percentage of revenues to drop in the second half of the year, right, compared to the first half of the year?

Speaker 3

Did you roll off a couple of

Speaker 1

things? That's correct, Tim. In Q1, you'll see a Q1 and Q2 and through the 1st 6 months, you'll see SG and A roughly around the 30 low 30% of sales Compared to our traditional run rate of about 26% in Q3 and Q4 that will be closer to our historical run rate With the elimination of some of those one time impacts of we'll be roughly running 27 ish percent and Finishing the year probably a few basis points, a few points above our typical run rate of around the 30% range. But definitely, we see a relief coming in Q3 and Q4.

Speaker 3

Thanks, Mike. That's really helpful. As I Do my modeling, I just want to check that, because you yes, that will show up nicely in the operating margin expansion. What about I know that you're spending more on R and D and you're focusing still on your continued product development, which has always been The core of Innovative Solutions support. Can you speak to any kind of the timing of any developments?

Speaker 3

I remember reading last month about the Helix Light Decks announcements And I think there probably could be some cargo instruments or engine innovation coming. Can you kind of give us a sneak peek of Maybe some new things or adjacencies that are maybe in the pipeline over the next year?

Speaker 2

Yes. And actually to your first question also, we have been Investing in our business development and sales organization to essentially it Starts there where we would grow the top line. So some of the increases in the SG and A From tradition, there will be slightly higher because we've hired some good capable sales and marketing to help us grow the business. With regards to product development, again, Our ultimate goal for pilot development is to get to the point where you start reducing number of pilots In the cockpit, that has a significantly lucrative business case. And but in order to get there, we've taken an incremental approach Where we would have where we would develop products that would get us there in a series of steps.

Speaker 2

That way we can continue to innovate and generate revenue By increasing the automation in the cockpit, reducing the pilot workload to a point where you will get That you're not maybe on some of these Part 25 aircrafts that it will be clear that there is no need for a second pilot in So that's our goal. And meanwhile, we will generate new products and reduce pilot workload, increase safety And those are marketable products. That's our main strategy for product development. We also Looking at developing products that will replace some of the existing obsolete Components in the aircraft, we've done that traditionally. So the closest thing we have coming, which we believe we should get the Certification completed.

Speaker 2

In this fiscal year is the engine and crew alerting system for the 75,767. We also continue getting certifications In terms of our installation team, we're expanding that part of our business, what we call our mobile installation And adding accreditations that we can do more and more of our products and maybe other people products Installed in this way that we're doing where we're actually going to customers and doing it at their site, Saving them a lot of trips back and forth and saving them a good amount of cost. So our focus is on those areas. We continue developing new features for the We've recently also certified 2 of those, which are aimed for the military Sign of the oral trial and that they have resulted in some good interest From our military and government customers.

Speaker 3

That's very helpful, Shahram. I appreciate that color. Another catalyst for your stock in your company, and I know you mentioned this in your earlier remarks, is increasing the capacity utilization. Have you or Mike come up with maybe a rough estimate of how high maybe your Gross margins could be when you reach a larger sales inflection point, whether it's through organic or inorganic, when you get to something like a 40,000,000 Annual sales rate. Could the incremental gross margins be above 70%, 75%?

Speaker 2

Yes, Tim.

Speaker 1

And that's it is as sales increase the margin and will increase right along with it. And We were just modeling this just last week and $50,000,000 in sales is going to get us over 30% EBITDA. So That will continue to grow and that EBITDA number is only around 20% projected for this year on roughly $20,000,000 less in sales. So we do see that increasing quite a bit as sales grow.

Speaker 3

Great. That's helpful. So $50,000,000 in sales, 30% EBITDA margin, is that what I heard correctly?

Speaker 2

Yes. We will approach 30% once we get above $50,000,000

Speaker 3

Great. That makes sense. You have so much incremental Leveraging that facility, if I remember it's something like the 3rd utilized right now, the levels. Just my last question, and I know, Shahram, you mentioned this in some of your remarks about acquisitions and it was really nice to see That shareholder approval go through last week for the majority vote for flexibility. You mentioned under $25,000,000 bolt on targets.

Speaker 3

Given your cash balance, it seems like almost any acquisition you make could probably be accretive or nicely accretive. I realize you're probably just in the early stages maybe of the pipeline, but are you starting to see or encounter Reasonable asking valuations out there or you may be not at that stage? I'm just wondering, is the economy cooled off a little bit in the last Maybe some of the sellers are getting more reasonable what they want for multiples on valuations.

Speaker 2

I think what we've Seeing is that kind of the high multiples is driven by a lot of the venture capital that's out Going by, I guess, people who don't have to worry about what's going to happen in 2 years to that product line. They just kind of accumulate in these things and then they're going to sell it up to somebody else. It will be somebody else's problem. We look at the long term Approaching obviously, we're not going to do we're not going to try to compete with that. Unfortunately, it seems like in our products sector, the aerospace industry, Even though the kind of the capital market is tightening up, there is still a Strong venture presence, venture money presence in the aerospace industry and that's because Of the stability of the industry and the fact that today we have Both the defense and the kind of the aerospace market, Both of them are strong.

Speaker 2

The OEMs have long rating lists for new aircraft And obviously, we're pumping a lot of money into defense. And that gives the I guess the The investors have some level of confidence that they're not going to be too far off the market. And But the multiples are there. I mean, the average multiple now they talk about in our industry is about 7.5x EBITDA. And that's kind of that's where we are.

Speaker 2

But a lot of the times finding the right product line Would help us justify as long as we see that within our P and L that that acquisition Would yield similar gross margins as our products do and that kind of makes it beneficial to us.

Speaker 3

That's very helpful color and it's good to hear that you have the cash on hand to help out with acquisition accretion. So Just again congratulations on the impressive gross margin and orders in the quarter and I look forward to seeing you at our conference on Thursday. That's it for my questions.

Speaker 1

Thank you, Tim. Thanks,

Operator

Drew. There are no further questions at this time. This concludes today's teleconference. You may disconnect your line at this time. Thank you for your participation and have a great day.

Powered by Quartr
Earnings Conference Call
Innovative Solutions and Support Q2 2023
00:00 / 00:00