Innovative Solutions & Support Inc (IA) Q3 2022 Earnings Call Transcript

Good morning and welcome to the Innovative Solutions & Support Third Quarter 2022 Earnings Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the call over to Shahram Askarpour. Please, go ahead.

Good morning. This is Shahram Askarpour, Chief Executive Officer of Innovative Solutions & Support. Welcome to our conference call to discuss our performance for the third quarter of fiscal 2022 and business conditions and outlook for the coming years. Joining me is Mike Linacre, our new CFO who joined us in July upon Rell's retirement. We are excited to welcome Mike to IS&S. Mike not only has extensive financial experience in the manufacturing environment, but he also has a strong track record of driving results. Before we begin, I'd like Mike to read the safe harbor statement.

Thank you, Shahram, 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 and 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 other risks and uncertainties reflected in our company's 10-K, which is on file with the SEC and other public filings. Now, I'll turn the call back to Shahram.

Thank you, Mike. In the third quarter, we continued our steady growth with revenues up 12% and operating income up 41%, ending the quarter with over $14 million of cash and no debt. Together with our strong first half, this is one of the best first nine months in many years. The business continues to deliver attractive returns and generate significant free cash flow, as we grow revenues and generate operating leverage. As I have stated before, our winning formula starts with excellent products in attractive growing markets, including our award-winning autothrottle and our flat panel displays for cargo conversions. We have delivered over 500 cockpit upgrades in 757, 767, and 737 platforms, and we are now rapidly growing our presence in general aviation. And IS&S has always been a valuable partner to our military, as well as other militaries around the world, continue to receive orders on our military products. As this installed base grows, it creates opportunities in adjacent markets while also delivering a steady demand for customer service, which is now running at approximately $1 million per quarter. On a price-for-performance basis, we remain an industry leader. The business continues to be well balanced not only between the commercial transport, general aviation, and military markets, but also within the OEM and retrofit markets, as our partner OEMs in general aviation markets are currently in a growth mode. In the case of one of our OEMs, they have placed firm orders for deliveries further into the future than normal, to secure their supply chain and meet their own delivery commitments. On the retrofit side, we continue receiving orders on the air cargo platforms from various airlines internationally, as well as domestically. This diverse mix of business provides a solid foundation for growth. And from this space, we add other features and capabilities to our existing base. Growth will not just come from new products, but also from a more aggressive sales and marketing effort. For instance, this quarter we saw an increase in our business development expenses, which we anticipate will lead to increased future sales. As we continue executing our organic growth strategy, we are beginning to consider additional growth by acquiring similar product lines which would utilize our existing infrastructure. Last quarter, I spoke about an anticipated certification from the FAA to introduce a product installation service for our King Air and PC-12 customers. I'm pleased to report that we have received our installation approval certificate and have performed two installation approvals. We're also broadening our product market potential by developing new autothrottle technology, not just for other variations of the King Air, but also for other aircraft platforms in both commercial and military markets. As we're ramping up our several marketing activities post-pandemic, we are attending more trade shows, meeting face-to-face with customers, and performing more customer flight tests, resulting in an increased backlog compared to March 31. Let me just quickly touch on the impact of some macroeconomic factors, as we are battling inflation, supply chain challenges, and labor availability. On the contract side, we are protected by cost escalators that enable us to pass along some price increases during periods of inflation. On the supply chain side, we have added safety stock to our inventory and in some cases at a premium. We are also battling the widely reported shortage of skilled technical professionals. Despite the challenges, our turnover has been very manageable, and we have been able to bring on new, highly qualified engineers and other skilled labor to support our growth. Now, I'd like to turn it over to Mike to review our financials in more detail.

Thank you, Shahram and thank you all for joining us this morning. I'd like to say, I'm very pleased to have joined Innovative Solutions & Support. I'm looking forward to working with Shahram to provide the investment community with the continued outstanding disclosure and transparency for which the company is already known. Turning to the results. For the third quarter, revenues were $6.9 million, up 12% from $6.2 million a year ago. Growth was primarily attributable to continued strength in the sales of flat panel displays for retrofit programs to commercial air transport customers, as well as autothrottle sales to the general aviation market, especially with Pilatus under the company's PC-24 contract. Textron and Pilatus both reported strong demand in their general aviation business, both of which we support with our autothrottle. In addition, we have a third OEM production contract with Boeing for the KC-46A, which also continues to generate steady revenue. Finally, we generated over $1.3 million in customer service revenues this quarter, as a result of a growing portfolio of installed IS&S products. Total new sales in the quarter were approximately $12 million, so that we ended the quarter with a backlog of $12.6 million, up from $7.6 million at the end of the last quarter. Third quarter orders include a large contract with one of our general aviation OEMs, that is locking in their supply chain beyond their normal advance order. Note that all of our long-term OEM production contracts include escalator clauses that provide for the passing along of any cost increases incurred as a result of inflationary pressures. Gross margin for the last quarter was 58.5%, up from 54.3% in the quarter a year ago. The increase in margins is attributable to favorable leveraging of fixed costs resulting from the increased sales and production volume, lower employee headcount, and a favorable product mix. Our model produces attractive margins as we scale the business. Total operating expenses for the third quarter of fiscal 2022 were $2.4 million, up from $2.2 million in the same quarter a year ago. The increase reflects an increase in professional fees and business development. The increase in business development expenses is a result of ramping up sales and marketing efforts post-pandemic, as mentioned by Shahram. We're more frequently traveling to customer locations and prospect sites, as well as making additional in-person marketing appearances at aviation trade shows. Research and development was essentially in line with a year ago, as we continue to target 10% to 12% of revenue for R&D. Net income for the quarter was $1.4 million or $0.08 per share compared to $2.7 million or $0.16 per share a year ago, which included a $1.5 million tax benefit. For the third quarter of 2022, we recorded $359,000 in taxes where a year ago, we had a $1.5 million tax benefit due to the reversal of a deferred tax asset valuation allowance. Operating income of $1.7 million was up 41% from our $1.2 million a year ago. Due to this tax anomaly, we believe the comparison of operating income better represents our improved performance this quarter. We anticipate a 21% tax rate for the year. The company remains in a strong financial position. We generated $3 million of operating cash in the third quarter and $6.4 million over the first nine months of fiscal year 2022. At quarter end June 30, we had $14.5 million of cash on hand. As previously discussed, the company anticipates that due to the ongoing supply chain issues and challenges as a result of the COVID-19 pandemic, we will continue to maintain a slightly higher-than-normal level of inventory as an added measure of precaution. The company is debt-free. We believe that the company has sufficient cash to fund operations in the foreseeable future. Now, I'd like to turn it back to Shahram for some closing remarks.

Thank you, Mike. The first nine months of 2022 are amongst the best in the company's history. End markets are firming as the global economy is opening up. Our foundation of long-term OEM contracts is with large global aircraft manufacturers that are experiencing rising demand, and our flat panel displays continue to offer a compelling value proposition in the aftermarket. The company continues to generate strong cash flow and has a solid balance sheet that provides us the resources to invest in growth opportunities in the markets that are once again expanding. These are exciting times and we appreciate your continued support and encouragement. We will now open the floor for questions.

Thank you. At this time, we will open the floor for questions. Our first question comes from John Moran with Robotti & Co. Please go ahead.

Hi, thanks for taking my question. Can you elaborate at all on the large order that you received that you cited being responsible for that large increase in the backlog and new orders? For example, what the delivery period would be for that and or even how large it was?

That came from one of our OEM programs where we typically receive orders about six months in advance, but they provided closer to one year, though not exactly that long. They extended their timeline a bit more than usual, which resulted in a significant increase.

Can you say whether the core business was up, flat, down, or outside of that order?

It was in line with typically our quarterly orders that we received. Again, from quarter-to-quarter, it varies. If you followed our backlog, the orders, the timing of them vary. And this was nothing unusual other than the extra orders that were received from one customer with an OEM contract.

For the quarter from a sales perspective, as mentioned our commercial retrofits and our air cargo was up quite a bit that kind of drove the increase on a comparative quarterly basis.

Our next question comes from Michael Weiser with Weiser Partners. Please go ahead.

Good morning. With over $14 million in cash on the balance sheet, could you provide some insight into the amount of cash you believe is necessary to maintain operations? Many shareholders are keen on the dividends the company has provided in the past and are eager to see them continue. Could you please clarify how much cash you feel is required on an ongoing basis? Thank you.

Historically, the company has been sitting on $40 million cash. So we're nowhere near those numbers. But currently, I'm not aware of any plans for imminent dividends. Obviously, it's a Board decision as to how they would do that. But I'm not aware of any at the moment.

Could you comment please on what you feel your ongoing cash need is?

Yes. I mean for operations, we like to have less than $5 million available.

We're at a run rate now we're generating about $2 million in cash every quarter. And from an operational standpoint that around $2 million to $5 million is plenty to support our operations.

Okay. And the balance of the cash is being used for what purpose?

The balance of the cash is there for us to do investments in the growth of the company.

Well I appreciate the sentiment that you expressed, but the difference between the cash on the balance sheet and what you say you need to run the enterprise on an ongoing basis is a considerable margin for an entity that's generating something in the order of $30 million a year in sales.

I'm sure the Board will take those things into consideration. And really that decision as to whether they would be giving dividends not all of our shareholders are looking to get dividends, and some of them would like to see investment in technology.

Thank you.

Our next question comes from David Campbell with Thompson Davis & Company. Please go ahead.

Thank you very much for taking my questions. And Mike, congratulations on your new appointment as Chief Financial Officer.

Thank you.

Looking forward to talking with you in the future.

Yeah. Thank you. Thank you.

I want to ask about the balance sheet as I commented the asset on the balance sheet at the end of June for $1.558 million assets held for sale. Are these the components of the order you're talking about where the customer is trying to fix his expenses?

No, this is an airplane that we have that we are selling.

That's the King Air?

The King Air PC-12 aircraft that is for sale, yes.

Yes, I understand. Jeff liked that plane, but he's not here anymore. So that will presumably be a capital gain whenever you sell it.

That will be a fourth quarter event when the sale is finalized.

Okay. So it could be in the fourth quarter?

Yes, it could be.

More cash coming into the company?

Yes.

You mentioned that a significant amount of new business came from cargo conversions. So, were cargo conversions a significant part of the increase in revenues?

Yes, I would say that along with steady and increased demand from our existing OEM customers buying our autothrottle as well.

So why does the backlog only show orders received and not include any backlogs for cargo conversions? I assume that isn't part of the backlog?

Yes. The backlog includes all the purchase orders that we have in hand at the moment. And as mentioned, our backlog typically is for a few months to six months. But right now it includes orders from one of our OEM customers for a longer period of time, almost up to a year.

But does the increase in backlog indicate a potential rise in revenues, or is it simply a timing issue that doesn’t suggest more revenues?

I would say not necessarily. It's just based on when we received the purchase orders at a given point in time.

All right. All right. And I’d tell you there's no engineering and development revenues this year like there was last year in the last quarter. Is that something unpredictable that you may get in a given quarter or not the next quarter?

Yes. I mean again the timing of that is there's two parts to it: when we book it and then when the completion is done so we can recognize the revenue.

Right.

But we do – I mean we do continue getting orders for engineering services in a steady form.

Can you provide more details about what you're seeking? You mentioned the possibility of acquiring new products, including those in your sales catalog. What does that entail? Are you considering purchasing new aerospace products?

We've done this in the past. We've acquired, for example, GPS technology, we've acquired flight management system technology. And we continue looking for opportunities. The way the industry is going on right now, there's a lot of consolidation happening at larger organizations. As they do acquisitions of companies, sometimes there are product lines within that acquisition that don't fall in line with the strategic plan and those will become targets for divestiture. So we're reviewing some of those opportunities to see if their products fit within our strength of our organization for manufacturing and we could leverage it to grow our base. So we're spending some more time than we did in the past reviewing those kinds of opportunities.

These products will be products that are operable to what you already produce?

Exactly. Yes. And may open new contracts for us with OEMs. Again it's – we're not trigger happy here to go buy something, but we are looking.

Yes, it had to be satisfied that you can sustain gross profit margins on these products that are comparable to what you already produce.

Absolutely.

Okay. Well, you did have an excellent quarter and I'm hoping that the September quarter will also be a good one helped by the backlog to some extent but also by your sales. Do you have any comments on what to expect in the fourth quarter?

You know we don't do that.

Excuse me?

We don't give forward-looking comments.

Okay. Well, thank you very much for your help and I'll be in touch.

Thank you very much.

The next question comes from Craig Rose with Axiom. Please go ahead.

Hey, guys. One clarification. The PC-12 is what's being held for sale, is that correct?

Yes. Right.

Okay. The other thing is you mentioned you were looking to expand the autothrottle into commercial and military. Could you explain how the development of that would work? And who would pay for it?

We are actively supporting our internal research and development efforts. Currently, there is an engineering project underway to enhance the autothrottle system. We're receiving interest from military trainers and other military platforms interested in the additional capabilities the autothrottle offers. We are in the process of developing several product lines, including expansions for the King Air platform and exploring other platforms as well.

Okay. Also, sometime last year I believe the Eclipse Aviation was purchased from bankruptcy. Does that offer opportunity for us at any point in the future?

We have conversations with Eclipse. I'm not 100% sure where that's going to go with that platform. But we work closely with them. We support them, where they need help, but they have challenges with starting up production and other challenges. But once they get their foothold of where they're going to go, we're there to support them. I mean, we've got a good working relationship with them, but nothing in the cards short-term.

Okay. Thank you. That’s all for me. Guys thank you very much.

Thank you, Craig.

Our next question is a follow-up from John Moran with Robotti & Co. Please go ahead.

Yeah. Hi. Could you just remind us, based on the company's existing facilities and personnel, how large of a business can this be? Like from organic growth, it seems to me that at one point, when you had other products, it was quite a different business that you were for example generating $60 million in revenue or whatever. I know that that wouldn't be comparable to the business that you guys have today. But could you speak to that?

Within this facility, a few years ago, we generated over $60 million in annual revenue. We have all the necessary capabilities and machinery in-house to replicate that. This is one area where we could consider product acquisitions that align with our operations to increase revenues. We can do this without significant infrastructure investment. If we find the right product mix, it could be beneficial. However, it's not simply a matter of purchasing; we need to identify, assess, and ensure the products are suitable. Regarding our personnel, our direct labor costs account for less than 5% of our sales price, meaning it doesn’t require much of an increase in direct labor to boost revenue. The company is structured to facilitate this growth without causing significant strain.

Are the discussions on the autothrottle with military customers on aircraft that are not yet certified?

Some of them are. And as I mentioned, some of them are on the PC-12 and the King Air platforms.

But some, they are not.

Some of them are not because there is considerable spending on new military platforms. Some of these new platforms still utilize the PC-6 turboprop engine, which has certain protection limitations, and our autothrottle fits well with those. Additionally, some of the new features we are developing align with how the military operates these aircraft.

Have you had a large fleet order yet for autothrottle?

Large fleet order on the aftermarket?

Yes.

Yes. We've had. We've had. Not the largest, but I'd like it to be. What we've had like a half a dozen orders that kind of size orders. There are not that many large fleets of business aviation aircraft. It's not like air transport that somebody is going so a lot of them are smaller fleets.

Our next question comes from Michael Friedrich, a private investor. Please go ahead.

Good morning. I wanted to follow up on the recent calls regarding your marketing strategies for the autothrottle in the aftermarket. Can you provide an update on this? It seems from today's discussion that the retrofit market for the autothrottle might not be as prioritized compared to other initiatives. What is the current status? I understand you were considering assembling a team to travel and implement these changes, so what is the latest on that front?

We are continuing to focus on the sales and marketing of the autothrottle, as we see significant potential for the product in the market. In our sector, gaining market acceptance can take time and is not something that happens instantly. Currently, we face minimal competition in the platforms where we offer the autothrottle and we have received approval from OEMs. There is also a growing interest from the military. Therefore, we will persist with our sales and marketing efforts. I view this as a consistent source of revenue for our company. For instance, with the 757 and 767 platforms, it took several years to reach a point where we were simply receiving orders, as we became well recognized in that market. I am confident that the autothrottle will reach a similar status.

Okay. Thank you.

This concludes our question-and-answer session. The conference has also now concluded. Thank you for attending today's presentation. You may now disconnect. Have a good day.