Innovative Solutions and Support Q3 2023 Earnings Call Transcript

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August 10, 2023

There are 4 speakers on the call.

Operator

Good day, and welcome to Innovative Solutions and Support Third Quarter Fiscal 2023 Financial Results Call. All participants will be in listen only mode. After today's presentation, there will be opportunity to ask questions. Please note that this event is being recorded. I'd now like to turn the turn over to Mr.

Operator

Shyam Askarpur, CEO. Please go ahead, sir.

Speaker 1

Good morning. This is Shahram Askarpur, Chief Executive Officer of Innovative Solutions and Support. Welcome to our conference call To discuss our performance for the Q3 of fiscal 2023, current business conditions and outlook for the coming year. Joining me is Mike Linacre, our CFO. Before we begin, I'd like Mark to read the Safe Harbor statement.

Speaker 2

Thank you, Shyam, and good morning, everyone. I would remind our listeners that certain matters discussed in the conference call today, including new products and operational and financial results for future periods, are forward looking statements that are subject to risks and uncertainties that could cause actual results to differ materially either better or worse from those discussed, including the impact of the Honeywell product line license and asset acquisition and other acquisitions as well as other risks

Speaker 1

Thank you, Mike. I will begin today with remarks on our performance in the fiscal Q3 of 2023, followed by comments on our long term growth plan and strategy, including the recent acquisitions from Honeywell. I will then turn the call over to Mike, who will take us through the financials. Revenues In the 3rd quarter, increased 15% to $8,000,000 and were also up sequentially from the 2nd quarter. This improvement was driven by the steady contribution of our production contracts and the growth in revenue from our aftermarket products, including our King Air autostrottle and flat panel displays for the air cargo market.

Speaker 1

We're also generating revenues from new programs or services, including our new oral througherl installation services And FrostSense Oral Travel for the Beechcraft King Air 203 100 aircraft. With this new SDC has opened a new market of potentially 700 additional aircraft. Margins were also up from a year ago, which led to another strong quarter of bottom line results. All in all, financial performance that continues to illustrate steady profitable growth. In addition, at the end of the Q3, we licensed and acquired several product lines from Honeywell Aerospace.

Speaker 1

The products both enhance our current offering and leverage our existing infrastructure, Making this an ideal fit with the acquisition strategy we have articulated. These products Can be found on literally thousands of aircraft in our target air transport and business aviation markets, And we believe we have the potential to expand them into the military market as well. This acquisition together with continued strong organic revenue represents an important inflection point in our revenue growth rate. Once fully integrated in 2024, We expect these new products to drive consolidated revenue growth to approximately 40% With an even more significant impact on earnings, where we expect EBITDA to increase by 75% Clearly illustrates that we are committed to our strategy to better leverage our existing infrastructure By layering on new revenues that have a similar margin profile as our existing operations and that can utilize our current excess capacity in manufacturing. The integration of these operations is proceeding as planned and is on track To begin adding to our financial performance starting in the Q4.

Speaker 1

Although we have just completed this acquisition, we are still focused on identifying and acquiring additional products and technologies that complement that complement our existing portfolio. As a reminder, we are targeting smaller bolt on acquisitions that are around $45,000,000 and continue to be actively engaged in evaluating potential acquisition. There is still another 50% excess capacity to be leveraged As we anticipate generating more cash from the increased revenues combined with additional borrowing capacity, We will have more than sufficient resources to continue to implement our strategy. Mike will walk you through more on license and asset acquisition. In addition to the progress achieved on our short term objectives, We also continue to invest in our long term vision.

Speaker 1

Our primary competitive advantage is in cockpit automation where we have already introduced many new technologies that reduce pilot workload and improve safety, Most recently, our oral side programs. This is a stepping stone to a reduction in the number of pilots in the aircraft. It is an area where we have significant intellectual property and intimate knowledge. Consequently, we have been increasing our research and development budget to leverage this competitive advantage and as shown By increasing our R and D spending, have recently been adding new engineers for this explicit purpose. Our research and development expenses may further increase in future quarters.

Speaker 1

However, This is a long term program and we believe we are responsibly managing the balance between investing for the long term while delivering attractive returns for our shareholders in the near term. We are excited by the success we've achieved So far this year, growing organically, completing an accretive acquisition, Investing for the future, while continuing to consistently deliver quarter after quarter of strong earnings. For over 30 years, we've built a reputation through the industry for developing some of the industry's most Competing price for performance products. This remains our formula for success. Thank you for your time and interest, and we look forward to updating you in the upcoming quarters.

Speaker 1

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

Speaker 2

Thank you, Sherm, and thank you all for joining us today. I'll review our financial results for the Q3 of fiscal 2023. Revenue growth in the 3rd quarter 15%, an acceleration relative to the 2nd quarter revenue growth. This quarter, we once again generated revenues stable OEM production contracts, which offer a solid base of predictable recurring revenue as well as an increase in aftermarket sales. Revenue was also well diversified among our target commercial air transport business and military markets.

Speaker 2

In particular, we saw new orders from the air cargo market for commercial air transport Boeing 757 and 760 7 flat panel display conversions, an increase at our production military contract and strong autothrottle installations revenue, which is new business this year. The company completed an acquisition of several Honeywell product lines on June 30, 2023. The company did not recognize any revenues and net income related to those product lines in the Q3 of 2023. Keep in mind that both quarterly financial performance and new bookings are subject to variation in the timing of purchase orders, especially with our aftermarket On average, 40% of our revenues are from aftermarket sales. Consequently, as a management team, we evaluate our performance on an annualized basis, and we encourage our investors to do the same.

Speaker 2

3rd quarter gross margin was 59.5% compared to 58.5% in the 3rd quarter a year ago. This improvement in gross margin reflects better absorption of our fixed overhead as a result of revenue growth, a favorable product mix, somewhat offset by a slight increase in direct material costs. Overall for the year, Martin's continued to trend in line with historical averages with any fluctuation from quarter to quarter primarily attributable to product mix as well as Our fixed manufacturing costs achieved through revenue growth. We don't anticipate the addition of the Honeywell product lines to have a material effect on future margins. Operating profit in the current quarter was $1,400,000 or 17.9 percent of sales, down on a relative basis This quarter SG and A again includes non cash stock based long term incentive compensation as well as a few one time items associated with the closing of the Honeywell acquisition, including expenses for commissions and legal costs related to our new bank term loan.

Speaker 2

In the 4th quarter, overhead will include the legal, Accounting, audit, professional and other one time expenses associated with the Honeywell product line acquisition. At the same time, Any of the one time items that impacted the last few quarters, such as the immediate vesting of non cash long term incentive compensation awards, have been recognized and will not impact Our goal is to decrease our overhead run rate to approximately 20% over time, which will be aided by the increase in revenues from the Honeywell acquisition that entails little incremental overhead as well as the absence of the many one time items over the past few quarters. We continue to fund research and development We still expect to spend 13% of our revenue on R and D by the end of the year. Interest income was up in the quarter due Honeywell acquisition. Tax expense in the Q3 of fiscal 2023 was $400,000 compared to the same amount in the Q3 of fiscal 2022.

Speaker 2

3rd quarter net income was 1,400,000 dollars per diluted share in line with the $1.48 per diluted share we achieved in the Q3 of fiscal 2022. Backlog as of June 30, 2023 was $13,800,000 and new orders in the Q3 of fiscal 2023 were $6,900,000 This is a bit of a step down from the previous quarter when orders benefited from some pull forward as customers lock in orders for a longer term. As always, quarterly orders can vary due to a number of factors and are not meant to provide an indicator of future revenues. Virtually all of the Honeywell revenues are from primarily intra quarter book and ship orders. Cash on hand June 30, 2023, it was $2,600,000 after utilizing approximately $16,000,000 in the quarter for the acquisition of the Honeywell product loans.

Speaker 2

In the fiscal Q3, to further strengthen our financial position and provide additional liquidity, we secured a $20,000,000 term loan. IS and S was able Maintain a strong financial condition with sufficient cash on hand to run the operations of the business with ample liquidity with access to increased borrowing capacity. Let me quickly review the Honeywell acquisition. The purchase price was $36,000,000 which included inventory valued at approximately $10,000,000 equipment valued at approximately $4,000,000 with the balance categorized as intangibles. These have been added to our balance sheet as of June 30, 2023.

Speaker 2

The purchase was paid in part with $16,000,000 of our cash The remainder borrowed under the new term loan I just mentioned. In addition to financing the acquisition, the term loan provides additional liquidity for ongoing operations and While we expect cash flow from both our existing and acquired operations to enable us to quickly produce our borrowings, Nevertheless, do expect annual interest expense to be in the range of approximately $1,600,000 for the fiscal 2024. These product lines have attractive margin profile characteristics that are similar to our current product portfolio, which is an essential element of our strategy. Consequently, once they've been integrated into our operations in 2024, we expect the transaction to materially contribute to our revenues and Revenues are expected to grow over 40%, while EBITDA is expected to grow roughly 75%. We also expect the resulting EPS be accretive in fiscal 2024 with potential for additional net income increases in future years from various synergies.

Speaker 2

For the remainder of fiscal 2023, we anticipate generating strong cash flows with similar or Higher gross margin levels as capacity utilization and operating leverage expand against the backdrop of revenue growth from organic and inorganic opportunities. With that, operator, we'd like to open it up for any questions

Operator

First question will be from Tim Moore, EF Hutton. Please go ahead.

Speaker 3

Thanks and congratulations on the strong impressive organic sales growth in the quarter in your core business. And Mike, thanks for the color On the September quarter commentary, that's appreciated. And maybe Shahram, I got a question for you. Is there any update on the UMS? I know you gave comments on the King Air autothrottle progress and the great progress of flat Display panels for air cargo, but just wondering if there's any update on the UMS or even more ThrustSense autothrottle incoming inquiries or interest by new possible Customers or them trying it out?

Speaker 1

Sure. Yes. I mean, the UMS It's a long term program. We're actually in the process of Developing the next generation of that product line in partnership with Teladas. With regards to the Urusal, we're looking at additional platforms, actually some of them In the regional airline market that we are in current conversations, but Pretty preliminary.

Speaker 1

With regards to the kind of the market that we're On the King Air side, we're expanding our sales activities internationally And we're seeing good interest coming from Organizations across the world on the King Air platforms, obviously, As more and more aircraft is produced by Textron, with our Autosol in it, Some of these customers who already have existing fleets, They look into upgrading their existing aircraft to bring them in line with the new aircraft That they've taken delivery itself. So the prospects look promising.

Speaker 3

Great. That's very helpful insights and details. And just related to that, you started to touch on it maybe with King here going nationally, but can you maybe talk a little bit about the change or the enhancement in business development opportunities, Innovative Solutions? I recall maybe you added a VP of Sales about a year ago and it sounds like there's some really good development opportunities to cross sell with Honeywell and penetrate Both of your sides better. Is there any kind of progress or tactics you're thinking about for that?

Speaker 1

Yes. I mean, we just added another VP of Technical Sales as well to our business development activities To increase, obviously, with the acquisition of the product lines from Honeywell, We need to strengthen our sales force. A lot of International sales are going to result from the Honeywell acquisition. So We hired the sales guy full time in the Australia, New Zealand area that would also support some of our Southeast Asia region. We're also looking at strengthening our partnership in Europe And we're in conversations actually.

Speaker 1

Our new Vifio sales is actually in Europe this week To talk about partnerships as well as finding a place where we would maybe inventory Some equipment in Europe to support these new product lines that we acquired. So We're busy growing our sales and marketing group as well as customer service and customer It's exciting times for us.

Speaker 3

Well, that's a great update really that added color on the sales and technical team development build out. I mean, you have such a good opportunity, Seth, I'm glad you're investing The proper hiring. Just a quick question, your core business from when I recall, and Mike mentioned this, pre acquisition Honeywell and pre license Was about 40% aftermarket. What will the pro form a mix be? Is Honeywell a bit more book and ship?

Speaker 3

Is it higher aftermarket? And do you think company's overall mix will be about 50% aftermarket?

Speaker 1

Yes. But we've also been we're also busy With OEMs to get new OEM content, we've recently got Another OEM program, which we haven't been able to announce yet because the aircraft hasn't been announced. So but that's about a year out in terms of production revenues. But I like the mixture of forty-forty-twenty is good because obviously on the aftermarket margins So we will rebuild the OEM Side of it to get us to back to forty-forty-twenty. 'twenty.

Speaker 1

The and Screw, maybe the next acquisition that we do We'll have some more OEM contents on it and that would help as well.

Speaker 3

That's interesting. Thanks for sharing that color and looking forward to that next OEM award announcement when the aircraft gets announced. My last question is, I know this is probably not a fair question. And I realize it's only 6 weeks into the acquisition of the some Honeywell products and the license deal. But given that the team got there very quickly, I think they were there 1st week of July and their experience From the heritage that they have with the Honeywell lines, how is integration going and the progress with the new team?

Speaker 3

Just kind of curious about that.

Speaker 1

Actually, it's progressing well according to our plan. So We've been fortunate that the team at Honeywell have been very cooperative. We have a very good relationship with them. They've been very supportive of this. Obviously, they want this to be successful.

Speaker 1

Again, this acquisition wasn't about the highest bidder, was about Who is actually going to be able to work well with Honeywell and their customer to have a Successful transition and we were chosen based on that and everything is progressing well and we continue executing it.

Speaker 3

Thanks, Shahram. And that's it for my questions. I'll follow-up with Mike offline later on. Thanks, Tim. Thank you.

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Earnings Conference Call
Innovative Solutions and Support Q3 2023
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