IA 10-Q
Innovative Solutions & Support Inc (IA)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
For the quarterly period ended
OR
[For the transition period from to ]
Commission File No.
(Exact name of registrant as specified in its charter)
| ||
(State or Other Jurisdiction | (I.R.S. Employer | |
(Address of Principal Executive Offices) | (Zip Code) |
(
(Registrant’s Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class |
| Trading Symbol(s) |
| Name of each exchange on which registered |
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files).
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
☐ Large accelerated filer | ☐ Accelerated filer |
☐ | |
If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No
As of July 31, 2023, there were
INNOVATIVE SOLUTIONS AND SUPPORT, INC.
FORM 10-Q June 30, 2023
INDEX
|
| Page No. |
|
| |
|
| |
Condensed Consolidated Balance Sheets – June 30, 2023 (unaudited) and September 30, 2022 | 1 | |
|
| |
2 | ||
| ||
3 - 4 | ||
|
| |
5 | ||
| ||
Notes to Condensed Consolidated Financial Statements (unaudited) | 6 - 23 | |
|
| |
Management’s Discussion and Analysis of Financial Condition and Results of Operations | 24 - 32 | |
|
| |
32 | ||
|
| |
32 | ||
| ||
|
| |
33 | ||
|
| |
33 | ||
|
| |
34 | ||
|
| |
34 | ||
|
| |
34 | ||
|
| |
34 | ||
|
| |
35 | ||
|
| |
36 |
PART I—FINANCIAL INFORMATION
Item 1- Financial Statements
INNOVATIVE SOLUTIONS AND SUPPORT, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, | September 30, | |||||
| 2023 |
| 2022 | |||
(Unaudited) | ||||||
ASSETS | ||||||
Current assets | ||||||
Cash and cash equivalents | $ | | $ | | ||
Accounts receivables | |
| | |||
Contract assets |
| |
| | ||
Inventories |
| |
| | ||
Prepaid inventory | | — | ||||
Prepaid expenses and other current assets |
| |
| | ||
Total current assets |
| |
| | ||
Goodwill | | — | ||||
Intangible assets, net | | | ||||
Property and equipment, net |
| |
| | ||
Deferred income taxes | | | ||||
Other assets |
| | | |||
Total assets | $ | | $ | | ||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||
Current liabilities | ||||||
Current portion of long-terrm debt | $ | | $ | — | ||
Accounts payable | | | ||||
Accrued expenses |
| |
| | ||
Contract liability |
| |
| | ||
Total current liabilities |
| |
| | ||
|
| |||||
Long-term debt | | — | ||||
Other liabilities | | | ||||
Total liabilities |
| |
| | ||
Commitments and contingencies (See Note 6) | ||||||
Shareholders’ equity | ||||||
Preferred stock, | ||||||
Common stock, $ |
| |
| | ||
Additional paid-in capital |
| |
| | ||
Retained Earnings (accumulated deficit) |
| |
| ( | ||
Treasury stock, at cost, |
| ( |
| ( | ||
Total shareholders’ equity |
| |
| | ||
Total liabilities and shareholders’ equity | $ | | $ | | ||
The accompanying notes are an integral part of these statements.
1
INNOVATIVE SOLUTIONS AND SUPPORT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Three Months Ended June 30, | Nine Months Ended June 30, | |||||||||||
| 2023 |
| 2022 |
| 2023 |
| 2022 | |||||
Net Sales: | ||||||||||||
Product | $ | | $ | | $ | | $ | | ||||
Engineering development contracts |
| |
| — |
| |
| | ||||
Total net sales |
| |
| |
| |
| | ||||
Cost of sales: | ||||||||||||
Product |
| |
| |
| |
| | ||||
Engineering development contracts |
| |
| — |
| |
| | ||||
Total cost of sales |
| |
| |
| |
| | ||||
Gross profit |
| |
| |
| |
| | ||||
Operating expenses: | ||||||||||||
Research and development |
| |
| |
| |
| | ||||
Selling, general and administrative |
| |
| |
| |
| | ||||
Total operating expenses |
| |
| |
| |
| | ||||
Operating income |
| |
| |
| |
| | ||||
Interest income |
| |
| |
| |
| | ||||
Other income |
| |
| |
| |
| | ||||
Income before income taxes |
| |
| |
| |
| | ||||
Income tax expense |
| |
| |
| |
| | ||||
Net income | $ | | $ | | $ | | $ | | ||||
Net income per common share: | ||||||||||||
Basic | $ | | $ | | $ | | $ | | ||||
Diluted | $ | | $ | | $ | | $ | | ||||
Weighted average shares outstanding: | ||||||||||||
Basic |
| | | |
| | ||||||
Diluted |
| | | |
| | ||||||
The accompanying notes are an integral part of these statements.
2
INNOVATIVE SOLUTIONS AND SUPPORT, INC.
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
(unaudited)
Three Months Ended June 30, 2023 and 2022 | |||||||||||||||
(Accumulated | |||||||||||||||
Additional | Deficit) | Total | |||||||||||||
Common | Paid-In | Retained | Treasury | shareholders’ | |||||||||||
| Stock |
| Capital |
| Earnings |
| Stock |
| equity | ||||||
Balance, March 31, 2023 | $ | | $ | | $ | | $ | ( | $ | | |||||
Share-based compensation | | | — | — | | ||||||||||
Net income | — | — | | — | | ||||||||||
Balance, June 30, 2023 | $ | | $ | | $ | | $ | ( | $ | | |||||
Balance, March 31, 2022 | $ | | $ | | $ | ( | $ | ( | $ | | |||||
Share-based compensation | | | — | — | | ||||||||||
Exercise of stock options | | | — | — | | ||||||||||
Net income | — | — | | — | | ||||||||||
Balance, June 30, 2022 | $ | | $ | | $ | ( | $ | ( | $ | | |||||
The accompanying notes are an integral part of these statements.
3
INNOVATIVE SOLUTIONS AND SUPPORT, INC.
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
(unaudited)
Nine Months Ended June 30, 2023 and 2022 | |||||||||||||||
(Accumulated | |||||||||||||||
Additional | Deficit) | Total | |||||||||||||
Common | Paid-In | Retained | Treasury | shareholders’ | |||||||||||
| Stock |
| Capital |
| Earnings |
| Stock |
| equity | ||||||
Balance, September 30, 2022 | $ | | $ | | $ | ( | $ | ( | $ | | |||||
Share-based compensation | | | — | — | | ||||||||||
Exercise of stock options | | | — | — | | ||||||||||
Net income | — | — | | — | | ||||||||||
Balance, June 30, 2023 | $ | | $ | | $ | | $ | ( | $ | | |||||
Balance, September 30, 2021 | $ | | $ | | $ | ( | $ | ( | $ | | |||||
Share-based compensation | | | — | — | | ||||||||||
Exercise of stock options | | | — | — | | ||||||||||
Net income | — | — | | — | | ||||||||||
Balance, June 30, 2022 | $ | | $ | | $ | ( | $ | ( | $ | | |||||
The accompanying notes are an integral part of these statements.
4
INNOVATIVE SOLUTIONS AND SUPPORT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
For the Nine Months Ended June 30, | ||||||
| 2023 |
| 2022 | |||
CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||
Net income | $ | | $ | | ||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||
Depreciation and amortization |
| | | |||
Share-based compensation expense |
| |||||
Stock options | | | ||||
Stock awards | | | ||||
Impairment of long-lived assets | | — | ||||
Loss on disposal of property and equipment | — | | ||||
Deferred income taxes | ( | | ||||
(Increase) decrease in: | ||||||
Accounts receivables |
| ( |
| | ||
Contract asset |
| ( |
| — | ||
Inventories |
| ( |
| ( | ||
Prepaid expenses and other assets |
| ( |
| | ||
Other non-current assets | ( | — | ||||
Increase (decrease) in: | ||||||
Accounts payables |
| |
| | ||
Accrued expenses |
| ( |
| | ||
Income taxes payable/receivable | ( | ( | ||||
Contract liability |
| ( |
| ( | ||
Net cash provided by operating activities |
| |
| | ||
CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||
Purchases of property and equipment |
| ( |
| ( | ||
Acquisition of a business |
| ( |
| — | ||
Net cash used in investing activities |
| ( |
| ( | ||
CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||
Debt proceeds | | — | ||||
Proceeds from exercise of stock options | | | ||||
Net cash provided by financing activities |
| |
| | ||
Net (decrease) increase in cash and cash equivalents | ( | | ||||
Cash and cash equivalents, beginning of period | | | ||||
Cash and cash equivalents, end of period | $ | | $ | | ||
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION | ||||||
Cash paid for income taxes | $ | | $ | | ||
The accompanying notes are an integral part of these statements.
5
INNOVATIVE SOLUTIONS AND SUPPORT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Summary of Significant Accounting Policies
Description of the Company
Innovative Solutions and Support, Inc. (the “Company,” “IS&S,” “we” or “us”) was incorporated in Pennsylvania on February 12, 1988. The Company operates in
The Company has continued to position itself as a system integrator, which capability provides the Company with the potential to generate more substantive orders over a broader product base. This strategy, as both a manufacturer and integrator, is designed to leverage the latest technologies developed for the computer and telecommunications industries into advanced and cost-effective solutions for the general aviation, commercial air transport, United States Department of Defense (“DoD”)/governmental and foreign military markets. This approach, combined with the Company’s industry experience, is designed to enable IS&S to develop high-quality products and systems, to reduce product time to market, and to achieve cost advantages over products offered by its competitors.
On June 30, 2023 (the “Acquisition Date”), the Company entered into an Asset Purchase and License Agreement with Honeywell International, Inc. (“Honeywell”) whereby Honeywell sold, certain assets and granted perpetual license rights to manufacture and sell licensed products related to its inertial, communication and navigation product lines (the “Product Lines”) to the Company (the “Transaction”). The Transaction involves a sale of certain inventory, equipment and customer-related documents; an assignment of certain customer contracts; and a grant of exclusive and non-exclusive licenses to use certain Honeywell intellectual property related to its inertial, communication and navigation product lines to repair, overhaul, manufacture sell, import, export and distribute certain products to the Company. See Note, “Acquisition” in the Supplemental Balance Sheet Disclosures section below for more details.
Basis of Presentation
The accompanying unaudited consolidated financial statements are presented pursuant to the rules and regulations of the United States Securities and Exchange Commission (the “SEC”) in accordance with the disclosure requirements for the quarterly report on Form 10-Q and, therefore, do not include all of the information and footnotes required by generally accepted accounting principles in the United States (“GAAP”) for complete annual financial statements. In the opinion of Company management, the unaudited consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) necessary to state fairly the results for the interim periods presented. The consolidated balance sheet as of September 30, 2022 is derived from the audited financial statements of the Company. Operating results for the three-and nine-month periods ended June 30, 2023 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2023 which cannot be determined at this time. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes of the Company included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2022.
Reclassification
The Company presented intangible assets, net separately in the consolidated balance sheet as of June 30, 2023. In order to conform to the presentation of the consolidated balance sheet as of June 30, 2023, the Company reclassified $
Principles of Consolidation
The Company’s consolidated financial statements include the accounts of its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
6
Use of Estimates
The financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America, which require management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from those estimates. Estimates are used in accounting for, among other items, valuation of tangible and intangible assets acquired, long term contracts, evaluation of allowances for doubtful accounts, product warranty cost liabilities, income taxes, engineering and material costs on Engineering Development Contract (“EDC”) programs, percentage of completion on EDC contracts, the useful lives of long-lived assets for depreciation and amortization, the recoverability of long-lived assets, evaluation of goodwill impairment, and contingencies. Estimates and assumptions are reviewed periodically and the effects of changes, if any, are reflected in the consolidated statements of operations in the period they are determined.
Acquisitions
The Company evaluates each of its acquisitions in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, Business Combinations (“ASC 805”), to determine whether the transaction is a business combination or an asset acquisition. In determining whether an acquisition should be accounted for as a business combination or an asset acquisition, the Company first performs a screen test to determine whether substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets. If this is the case, the acquired set is not deemed to be a business and is instead accounted for as an asset acquisition. If this is not the case, the Company then further evaluates whether the acquired set includes, at a minimum, an input and a substantive process that together significantly contribute to the ability to create outputs. If so, the Company concludes that the acquired set is a business.
The Company accounts for business acquisitions using the acquisition method of accounting. Under this method of accounting, assets acquired and liabilities assumed are recorded at their respective fair values at the date of the acquisition. When determining the fair values of assets acquired and liabilities assumed, management makes significant estimates and assumptions. The Company’s estimates of fair value are based upon assumptions believed to be reasonable, but are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Any excess of the purchase price over the fair value of the net assets acquired is recognized as goodwill.
During the measurement period, which may be up to one year from the acquisition date, the Company adjusts the provisional amounts of assets acquired and liabilities assumed with the corresponding offset to goodwill to reflect new information obtained about facts and circumstances that existed as of the acquisition date that, if known, would have affected the measurement of the amounts recognized as of that date. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded within the Company’s consolidated statements of operations.
Intangible Assets
The Company’s identifiable intangible assets primarily consist of license agreement and customer relationships. Intangible assets acquired in a business combination are recognized at fair value using generally accepted valuation methods deemed appropriate for the type of intangible asset acquired and are reported separately from any goodwill recognized.
Intangible assets with a finite life are amortized over their estimated useful life and are reported net of accumulated amortization. They are assessed for impairment in accordance with the Company’s policy on assessing long-lived assets for impairment described below.
Indefinite-lived intangible assets are not amortized, but are subject to an annual impairment test, or when events or circumstances dictate, more frequently. The impairment review for indefinite-lived intangible assets can be performed using a qualitative or quantitative impairment assessment. The quantitative assessment consists of a comparison of the fair value of the indefinite-lived intangible asset with its carrying amount. If the carrying amount exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. If the fair value exceeds its carrying amount, the indefinite-lived intangible asset is not considered impaired.
Goodwill
Goodwill represents the future economic benefit arising from other assets acquired that could not be individually identified and separately recognized. The recorded amounts of goodwill from business combinations are based on management’s best estimates of the fair values of assets acquired and liabilities assumed at the date of acquisition. Goodwill is assigned to the reporting units that are expected to benefit from the synergies of the business combination that generated the goodwill. The Company’s goodwill impairment
7
test is performed at the reporting unit level. Reporting units are determined based on an evaluation of the Company’s operating segments and the components making up those operating segments.
Goodwill is tested for impairment annually or in an interim period if certain changes in circumstances indicate a possibility that an impairment may exist. Factors to consider that may indicate an impairment may exist are: the macroeconomic conditions, industry and market considerations such as a significant adverse change in the business climate, cost factors, overall financial performance such as current-period operating results or cash flow declines combined with a history of operating results or cash flow declines or a projection/forecast that demonstrates continuing declines in the cash flow or the inability to improve the operations to forecasted levels, and any entity-specific events.
If the Company determines that it is more likely than not that the fair value of the reporting unit is below the carrying amount as part of its qualitative assessment, a quantitative assessment of goodwill is required. In the quantitative evaluation, the fair value of the reporting unit is determined and compared to the carrying value. If the fair value is greater than the carrying value, then the goodwill is deemed not to be impaired and no further action is required. If the fair value is less than the carrying value, goodwill is considered impaired and a charge is reported as impairment of goodwill in the consolidated statements of operations.
Cash and Cash Equivalents
Highly liquid investments, purchased with an original maturity of three months or less, are classified as cash equivalents. Cash equivalents at June 30, 2023 and September 30, 2022 consist of cash on deposit and cash invested in money market funds with financial institutions.
Inventory Valuation
Inventories are stated at the lower of cost (first-in, first-out) or net realizable value, net of write-downs for excess and obsolete inventory.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are provided using an accelerated method over the estimated useful lives of the assets (the lesser of to
Long-Lived Assets
The Company assesses the impairment of long-lived assets in accordance with FASB ASC Topic 360-10, “Property, Plant and Equipment.” This statement requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. In addition, long-lived assets to be disposed of should be reported at the lower of the carrying amount or fair value less cost to sell. The Company considers historical performance and future estimated results in its evaluation of potential impairment and then compares the carrying amount of the asset to estimated future cash flows expected to result from use of the asset. If the carrying amount of the asset exceeds the estimated expected undiscounted future cash flows, the Company measures the amount of the impairment by comparing the carrying amount of the asset to its fair value. The estimation of fair value is generally measured by discounting expected future cash flows.
Fair Value of Financial Instruments
The net carrying amounts of cash and cash equivalents, accounts receivable, accounts payable, and short-term debt approximate their fair value because of the short-term nature of these instruments. For financial assets and liabilities measured at fair value on a recurring basis, fair value is the price the Company would receive to sell an asset or pay to transfer a liability in an orderly transaction with a market participant at the measurement date. A three-level fair value hierarchy prioritizes the inputs used to measure fair value as follows:
Level 1 — Unadjusted quoted prices that are available in active markets for the identical assets or liabilities at the measurement date.
8
Level 2 — Other observable inputs available at the measurement date, other than quoted prices included in Level 1, either directly or indirectly, including:
| ● | Quoted prices for similar assets or liabilities in active markets; |
| ● | Quoted prices for identical or similar assets in non-active markets; |
| ● | Inputs other than quoted prices that are observable for the asset or liability; and |
| ● | Inputs that are derived principally from or corroborated by other observable market data. |
Level 3 — Unobservable inputs that cannot be corroborated by observable market data and reflect the use of significant management judgment. These values are generally determined using pricing models for which the assumptions utilize management’s estimates of market participant assumptions.
The following table sets forth by level within the fair value hierarchy the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis as of June 30, 2023 and September 30, 2022, according to the valuation techniques the Company used to determine their fair values.
Fair Value Measurement on June 30, 2023 | |||||||||
Quoted Price in | Significant Other | Significant | |||||||
Active Markets for | Observable | Unobservable | |||||||
Identical Assets | Inputs | Inputs | |||||||
| (Level 1) |
| (Level 2) |
| (Level 3) | ||||
Assets | |||||||||
Cash and cash equivalents: | |||||||||
Money market funds |
| $ | |
| $ | — |
| $ | — |
Fair Value Measurement on September 30, 2022 | |||||||||
Quoted Price in | Significant Other | Significant | |||||||
Active Markets for | Observable | Unobservable | |||||||
Identical Assets | Inputs | Inputs | |||||||
| (Level 1) |
| (Level 2) |
| (Level 3) | ||||
Assets | |||||||||
Cash and cash equivalents: | |||||||||
Money market funds |
| $ | |
| $ | — |
| $ | — |
Revenue Recognition
The Company enters into sales arrangements with customers that, in general, provide for the Company to design, develop, manufacture and deliver large flat-panel display systems, flight information computers, autothrottles and advanced monitoring systems that measure and display critical flight information, including data relative to aircraft separation, airspeed, altitude, and engine and fuel data measurements.
Revenue from Contracts with Customers
The Company accounts for revenue in accordance with ASC 606, Revenue from Contracts with Customers (“ASC 606”). The core principle of ASC 606 is that an entity recognizes revenue when a customer obtains control of promised goods or services. The amount of revenue recognized reflects the consideration to which the Company expects to be entitled to receive in exchange for these goods or services. To achieve this core principle, the Company applies the following five steps:
1) | Identify the contract with a customer |
The Company’s contract with its customers typically is the form of a purchase order issued to the Company by its customers and, to a lesser degree, in the form of a purchase order issued in connection with a formal contract executed with a customer. For the purpose of accounting for revenue under ASC 606, a contract with a customer exists when (i) the Company enters into an enforceable contract with a customer that defines each party’s rights regarding the goods or services to be transferred and identifies the payment terms
9
related to these goods or services, (ii) the contract has commercial substance and, (iii) the Company determines that collection of substantially all consideration for goods or services that are transferred is probable based on the customer’s intent and ability to pay the promised consideration. The Company applies judgment in determining the customer’s ability and intention to pay, which is based on a variety of factors including the customer’s historical payment experience or, in the case of a new customer, published credit and financial information pertaining to the customer.
2) | Identify the performance obligations in the contract |
Performance obligations promised in a contract are identified based on the goods or services that will be transferred to the customer that are both capable of being distinct, whereby the customer can benefit from the good or service either on its own or together with other resources that are readily available from third parties or from the Company, and are distinct in the context of the contract, whereby the transfer of the goods or services is separately identifiable from other promises in the contract. Most of our revenue is derived from purchases under which we provide a specific product or service and, as a result, there is only performance obligation. In the event that a contract includes multiple promised goods or services, such as an EDC contract which includes both engineering services and a resulting product shipment, the Company must apply judgment to determine whether promised goods or services are capable of being distinct in the context of the contract. In these cases, the Company considers whether the customer could, on its own, or together with other resources that are readily available from third parties, produce the physical product using only the output resulting from the Company’s completion of engineering services. If the customer cannot produce the physical product, then the promised goods or services are accounted for as a combined performance obligation.
3) | Determine the transaction price |
The transaction price is determined based on the consideration to which the Company will be entitled in exchange for transferring goods or services to the customer. To the extent the transaction price includes variable consideration, the Company estimates the amount of variable consideration that should be included in the transaction price utilizing either the expected value method or the most likely amount method depending on the nature of the variable consideration. Variable consideration is included in the transaction price if, in the Company’s judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur.
4) | Allocate the transaction price to performance obligations in the contract |
If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. The Company determines standalone selling price based on the price at which the performance obligation is sold separately. If the standalone selling price is not observable through past transactions, the Company estimates the standalone selling price by taking into account available information such as market conditions as well as the cost of the goods or services and the Company’s normal margins for similar performance obligations.
| 5) | Recognize revenue when or as the Company satisfies a performance obligation |
The Company satisfies performance obligations either over time or at a point in time as discussed in further detail below. Revenue is recognized at the time the related performance obligation is satisfied by transferring a promised good or service to a customer. Historically, the Company has also recognized revenue from EDC contracts and is recognized over time using an input measure (e.g., costs incurred to date relative to total estimated costs at completion) to measure progress. Contract costs include material, components and third-party avionics purchased from suppliers, direct labor, and overhead costs.
Contract Estimates
Accounting for performance obligations in long-term contracts that are satisfied over time involves the use of various techniques to estimate progress towards satisfaction of the performance obligation. The Company typically measures progress based on costs incurred compared to estimated total contract costs. Contract cost estimates are based on various assumptions to project the outcome of future events that often span more than a single year. These assumptions include the amount of labor and labor costs, the quantity and cost of raw materials used in the completion of the performance obligation, and the complexity of the work to be performed.
As a significant change in one or more of these estimates could affect the profitability of our contracts, we review and update our contract-related estimates regularly. We recognize adjustments in estimated profit on contracts under the cumulative catch-up method. Under this method, the impact of the adjustment on profit recorded to date is recognized in the period the adjustment is identified.
10
Revenue and profit in future periods of contract performance is recognized using the adjusted estimate. If at any time the estimate of contract profitability indicates an anticipated loss on the contract, we recognize the total loss in the quarter in which it is identified.
The impact of adjustments in contract estimates on our operating earnings can be reflected in either operating costs and expenses or revenue. The aggregate impact of adjustments in contract estimates did not change our revenue and operating earnings (and diluted earnings per share) for the three-and nine-month periods ended June 30, 2023 and 2022, respectively.
Contract Balances
Contract assets consist of the right to consideration in exchange for product offerings that we have transferred to a customer under the contract. Contract liabilities primarily relate to consideration received in advance of performance under the contract. The following table reflects the Company’s contract assets and contract liabilities:
Contract | Contract | |||||
| Assets |
| Liabilities | |||
September 30, 2022 | $ | | $ | | ||
Amount transferred to receivables from contract assets | — | — | ||||
Contract asset additions | | — | ||||
Performance obligations satisfied during the period that were included in the contract liability balance at the beginning of the period | — | ( | ||||
Increases due to invoicing prior to satisfaction of performance obligations | — | | ||||
June 30, 2023 | $ | | $ | | ||
Customer Service Revenue
The Company enters into sales arrangements with customers for the repair or upgrade of its various products that are not under warranty. The Company’s customer service revenue and cost of sales are included in product sales and product cost of sales, respectively, on the accompanying consolidated statements of operations. The Company’s customer service revenue and cost of sales for the three-and nine-month periods ended June 30, 2023 and 2022 respectively are as follows:
For the Three Months Ended June 30, |
| For the Nine Months Ended June 30, | ||||||||||
| 2023 |
| 2022 |
| 2023 |
| 2022 | |||||
Customer Service Sales |
| $ | |
| $ | | $ | | $ | | ||
Customer Service Cost of Sales | | | | | ||||||||
Gross Profit | $ | | $ | | $ | | $ | | ||||
Lease Recognition
The Company accounts for leases in accordance with ASU 2016-02, Leases (Topic 842). At the inception of an arrangement, the Company determines whether the arrangement is or contains a lease based on the unique facts and circumstances present in the arrangement. Leases with a term greater than one year are recognized on the balance sheet as right-of-use assets and short-term and long-term lease liabilities, as applicable. The Company does not have any financing leases that are material in nature.
Income Taxes
Income taxes are recorded in accordance with ASC Topic 740, “Income Taxes” (“ASC Topic 740”), which utilizes a balance sheet approach to provide for income taxes. Under this method, the Company recognizes deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of the Company’s assets, liabilities, and expected benefits of utilizing NOLs and tax credit carryforwards. The impact on deferred taxes of changes in tax rates and laws, if any, are applied to the years during which temporary differences are expected to be settled and are reflected in the consolidated financial statements in the period of enactment. At the end of each interim reporting period, the Company prepares an estimate of the annual effective income tax rate and applies that annual effective income tax rate to ordinary year-to-date pre-tax income for the interim period. Specific tax items discrete to a particular quarter are recorded in income tax expense for that quarter. The estimated annual effective tax rate used in providing for income taxes on a year-to-date basis may change in subsequent periods.
11
Deferred tax assets are reduced by a valuation allowance if, based on the consideration of all available evidence, it is more likely than not that some portion of the deferred tax asset will not be realized. Significant weight is given to evidence that can be verified objectively, and significant management judgment is required in determining any valuation allowance recorded against net deferred tax assets. The Company evaluates deferred income taxes on a quarterly basis to determine if a valuation allowance is required by considering available evidence. Deferred tax assets are recognized when expected future taxable income is sufficient to allow the related tax benefits to reduce taxes that would otherwise be payable. The sources of taxable income that may be available to realize the benefit of deferred tax assets are future reversals of existing taxable temporary differences, future taxable income exclusive of reversing temporary differences and credit carryforwards, taxable income in carry-back years, and tax planning strategies which are both prudent and feasible. The Company will continue to assess all available evidence during future periods to evaluate any changes to the realization of its deferred tax assets. If the Company were to determine that it would be able to realize additional state deferred tax assets in the future, it would make an adjustment to the valuation allowance which would reduce the provision for income taxes.
The accounting for uncertainty in income taxes requires a more likely than not threshold for financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. The Company records a liability for the difference between the (i) benefit recognized and measured for financial statement purposes and (ii) the tax position taken or expected to be taken on the Company’s tax return. To the extent that the Company’s assessment of such tax positions changes, the change in estimate is recorded in the period in which the determination is made. The Company has elected to record any interest or penalties associated with uncertain tax positions as income tax expense.
The Company files a consolidated U.S. federal income tax return. The Company prepares and files tax returns based on the interpretation of tax laws and regulations, and records estimates based on these judgments and interpretations. In the normal course of business, the tax returns are subject to examination by various taxing authorities. Such examinations may result in future tax and interest assessments by these taxing authorities, and the Company records a liability when it is probable that there will be an assessment. The Company adjusts the estimates periodically as a result of ongoing examinations by and settlements with the various taxing authorities, and changes in tax laws, regulations and precedent. The consolidated tax provision of any given year includes adjustments to prior years’ income tax accruals that are considered appropriate, and any related estimated interest. Management believes that it has made adequate accruals for income taxes. Differences between estimated and actual amounts determined upon ultimate resolution, individually or in the aggregate, are not expected to have a material effect on the Company’s consolidated financial position but could possibly be material to its consolidated results of operations or cash flow of any one period.
Engineering Development
The Company invests a significant percentage of its sales on engineering development, both Research & Development (“R&D”) and EDC. At June 30, 2023, approximately
Treasury Stock
We account for treasury stock purchased under the cost method and include treasury stock as a component of shareholders’ equity. Treasury stock purchased with intent to retire (whether or not the retirement is actually accomplished) is charged to common stock.
Share-Based Compensation
The Company accounts for share-based compensation under ASC Topic 718, “Stock Compensation” (“ASC Topic 718”), which requires the Company to measure the cost of employee or non-employee director services received in exchange for an award of equity instruments based on the grant-date fair value of the award using an option pricing model. The Company recognizes such cost over the period during which an employee or non-employee director is required to provide service in exchange for the award. Our policy is to recognize forfeitures as incurred.
12
Accordingly, adoption of ASC Topic 718’s fair value method results in recording compensation costs under the Company’s stock-based compensation plans. The Company determined the fair value of its stock option awards at the date of grant using the Black-Scholes option pricing model. Option pricing models and generally accepted valuation techniques require management to make assumptions and to apply judgment to determine the fair value of its awards. These assumptions and judgments include estimating future volatility of the Company’s stock price, expected dividend yield, future employee turnover rates, and future employee stock option exercise behaviors. Changes in these assumptions can materially affect fair value estimates. The Company does not believe that a reasonable likelihood exists that there will be a material change in future estimates or assumptions used to determine share-based compensation expense. However, if actual results are not consistent with the Company’s estimates or assumptions, the Company would adjust its estimates. Such adjustments could have a material impact on the Company’s financial position.
Warranty Reserves
The Company offers warranties on some products of various lengths, however the standard warranty period is
Self-Insurance Reserves
Since January 1, 2014, the Company has self-insured a significant portion of its employee medical insurance. The Company maintains a stop-loss insurance policy that limits its losses both on a per employee basis and an aggregate basis. Liabilities associated with the risks that are retained by the Company are estimated based upon actuarial assumptions such as historical claims experience and demographic factors. The Company estimated the total medical claims incurred but not reported and the Company believes that it has adequate reserves for these claims at June 30, 2023 and September 30, 2022, respectively. However, the actual value of such claims could be significantly affected if future occurrences and claims differ from these assumptions. At June 30, 2023 and September 30, 2022, the estimated liability for medical claims incurred but not reported was $
Concentrations
Major Customers and Products
In the three-month period ended June 30, 2023,
In the three-month period ended June 30, 2022,
Major Suppliers
The Company buys several of its components from sole source suppliers. Although there are a limited number of suppliers of particular components, management believes other suppliers could provide similar components on comparable terms.
For the three- and nine-month periods ended June 30, 2023, the Company had four suppliers, respectively, that were individually responsible for greater than 10% of the Company’s total inventory related purchases.
For the three- and nine-month periods ended June 30, 2022, the Company had
13
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentration of credit risk consist principally of cash balances and accounts receivable. The Company invests its excess cash where preservation of principal is the major consideration. Cash balances are maintained with
Recent Accounting Pronouncements
In June 2016, FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instrument (“ASU 2016-13”). ASU 2016-13 replaces the incurred loss impairment methodology in current U.S. GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. ASU 2016-13 is effective for SEC small business filers for fiscal years beginning after December 15, 2022. The adoption of this standard is not expected to have a material impact on our consolidated financial statements or related disclosures.
2. Supplemental Balance Sheet Disclosures
Acquisition
On June 30, 2023, the Company entered into an Asset Purchase and License Agreement with Honeywell whereby Honeywell sold certain assets and granted perpetual license rights to manufacture and sell licensed products related to its inertial, communication and navigation product lines to the Company. The Transaction involves a sale of certain inventory, equipment and customer-related documents; an assignment of certain customer contracts; and a grant of exclusive and non-exclusive licenses to use certain Honeywell intellectual property related to its inertial, communication and navigation product lines to repair, overhaul, manufacture sell, import, export and distribute certain products to the Company. The Transaction allows the Company to diversify its product offerings in the aerospace industry. The Company determined that the Transaction met the definition of a business under ASC 805; therefore, the Company accounted for the Transaction as a business combination and applied the acquisition method of accounting.
In connection with the Transaction, the Company entered into a term loan with PNC Bank, National Association for $
The allocation of the purchase price is based upon certain preliminary valuations and other analyses that have not been finalized as of the date of this filing. Specifically, the purchase price amount for the Transaction and the allocation of the purchase consideration for
14
prepaid inventory, equipment, construction in progress, intangible assets, and goodwill are preliminary estimates, which may be subject to change within the measurement period.
The preliminary allocation of the purchase consideration as of the Acquisition Date is as follows:
Cash consideration |
| $ | |
Total consideration | $ | | |
Prepaid inventory | $ | | |
Equipment |
| | |
Construction in progress |
| | |
Intangible assets (a) |
| | |
Goodwill (b) |
| | |
Assets acquired |
| | |
Accrued expenses |
| ( | |
Liabilities assumed |
| ( | |
Net assets acquired | $ | |
| (a) | Intangible assets consist of license agreements related to the license rights to use certain Honeywell intellectual property and customer relationships and are recorded at provisional estimated fair values. The provisional estimated fair value of the license agreement is based on a variation of the income valuation approach and is determined using the relief from royalty method. The provisional estimated fair value of the customer relationships is based on a variation of the income valuation approach known as the multi-period excess earnings method. Refer to Note, “Intangible assets” for further details. |
| (b) | Goodwill represents the excess of the preliminary purchase consideration over the provisional fair value of the assets acquired and liabilities assumed. The goodwill recognized is primarily attributable to the expected synergies from the Transaction. Goodwill resulting from the Transaction has been provisionally assigned to the Company’s one operating segment; the assignment of goodwill to reporting units is not complete. The goodwill is not expected to be deductible for income tax purposes. Further, the Company determined that the preliminary goodwill was not impaired as of June 30, 2023 and as such, no impairment charges have been recorded for the three-and nine-month periods ended June 30, 2023. |
Transition services agreement
Concurrent with the Transaction, the Company entered into a transition services agreement (the “TSA”) with Honeywell, at no additional costs, to receive certain transitional services and technical support during the transition service period. The Company accounted for the TSA separate from business combination and have recognized $
Acquisition and related costs
For the three and nine months ended June 30, 2023, the Company incurred acquisition costs of $
Unaudited actual and pro forma information
Since the acquisition date of the Transaction was on June 30, 2023, the Company did not recognize any revenues and net income related to the Product Lines in the consolidated statements of operations.
The following unaudited pro forma summary presents consolidated information of the Company, including the Product Lines, as if the Transaction had occurred on October 1, 2021, the earliest period presented herein:
Three Months Ended June 30, | Nine Months Ended June 30, | |||||||||||
| 2023 |
| 2022 |
| 2023 |
| 2022 | |||||
15
Net sales | $ | | $ | | $ | | $ | | ||||
Net income | $ | | $ | | $ | | $ | |
These pro forma results are for illustrative purposes and are not indicative of the actual results of operations that would have been achieved nor are they indicative of future results of operations. The unaudited pro forma information for all periods presented was adjusted to give effect to pro forma events that are directly attributable to the Transaction and is factually supportable. The adjustments are based on information available to the Company at this time. Accordingly, the adjustments are subject to change, and the impact of such changes may be material. The unaudited pro forma results do not include any incremental cost savings that may result from the integration.
Significant adjustments to the pro forma information above include recognition of non-recurring direct incremental acquisition costs in the nine months ended June 30, 2022 and exclusion of those costs from all other periods presented; increase in interest expense related to the Term Loan; increase in amortization expense associated with the estimate of the acquired intangible assets; increase in depreciation expense related to the fair value adjustment of the acquired equipment; and increase in cost of sales related to the fair value adjustment of the acquired inventory.
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or net realizable value, net of write-downs for excess and obsolete inventory, and consist of the following:
June 30, | September 30, | |||||
| 2023 |
| 2022 | |||
Raw materials |
| $ | |
| $ | |
Work-in-process |
| |
| | ||
Finished goods |
| |
| | ||
| $ | |
| $ | | |
Prepaid expenses and other current assets
Prepaid expenses and other current assets consist of the following:
June 30, | September 30, | |||||
| 2023 |
| 2022 | |||
Prepaid insurance |
| $ | | $ | | |
Other |
| |
| | ||
| $ | | $ | | ||
16
Intangible assets
The Company’s intangible assets other than goodwill are as follows:
| As of June 30, 2023 | |||||||||||
| Gross Carrying |
| Accumulated |
| Accumulated |
| Net Carrying | |||||
Value |
| Impairment |
| Amortization |
| Value | ||||||
License agreement acquired from the Transaction (a) | $ | | $ | — | $ | — | $ | | ||||
Customer relationships acquired from the Transaction (a) |
| |
| — |
| — |
| | ||||
Licensing and certification rights (b) |
| |
| ( |
| ( |
| | ||||
Total | $ | | $ | ( | $ | ( | $ | | ||||
As of September 30, 2022 | ||||||||||||
| Gross Carrying |
| Accumulated |
| Accumulated |
| Net Carrying | |||||
| Value |
| Impairment |
| Amortization |
| Value | |||||
Licensing and certification rights (b) | $ | | $ | — | $ | ( | $ | | ||||
Total | $ | | $ | — | $ | ( | $ | | ||||
(a) | As part of the Transaction, the Company acquired intangible assets related to the license agreement for the license rights to use certain Honeywell intellectual property, and customer relationships. The gross carrying values are preliminary estimates and may be subject to change within the measurement period – refer to Note, “Acquisition” for further details. The license agreement has an indefinite life and is not subject to amortization; the customer relationships have an estimated weighted average life of |
(b) | The licensing and certification rights are amortized over a defined number of units. An impairment charge of $ |
Intangible asset amortization expense was $
The timing of future amortization expense is not determinable for the licensing and certification rights because they are amortized over a defined number of units. The expected future amortization expense related to the customer relationships as of June 30, 2023 is as follows:
2023 (three months remaining) |
| $ | |
2024 | | ||
2025 | | ||
2026 |
| | |
2027 |
| | |
Thereafter |
| | |
Total | $ | |
17
Property and equipment
Property and equipment, net consists of the following:
June 30, | September 30, | |||||
| 2023 |
| 2022 | |||
Computer equipment | $ | | $ | | ||
Corporate airplanes |
| |
| | ||
Furniture and office equipment |
| |
| | ||
Manufacturing facility |
| |
| | ||
Equipment |
| |
| | ||
Land | | | ||||
Construction in progress | | — | ||||
| |
| | |||
Less: accumulated depreciation and amortization |
| ( |
| ( | ||
| $ | |
| $ | | |
Depreciation and amortization related to property and equipment was $
Depreciation and amortization related to property and equipment was approximately $
Other assets
Other assets consist of the following:
June 30, | September 30, | |||||
| 2023 |
| 2022 | |||
Operating lease right-of-use asset | $ | | $ | | ||
Other non-current assets | |
| | |||
| $ | |
| $ | | |
Other non-current assets as of June 30, 2023 and September 30, 2022 include the security deposit for an airplane hangar, supplier credit from one of our suppliers and a deposit for medical claims required under the Company’s medical plan. In addition, other non-current assets as of June 30, 2023 and September 30, 2022 includes $
Accrued expenses
Accrued expenses consist of the following:
June 30, | September 30, | |||||
| 2023 |
| 2022 | |||
Warranty |
| $ | |
| $ | |
Salary, benefits and payroll taxes |
| |
| | ||
Professional fees |
| |
| | ||
Operating lease | | | ||||
Supplier purchase orders | | — | ||||
Other | | | ||||
| $ | |
| $ | | |
18
Warranty cost and accrual information for the three-and nine-month periods ended June 30, 2023 is highlighted below:
Three Months Ending | Nine Months Ending | |||||
| June 30, 2023 |
| June 30, 2023 | |||
Warranty accrual, beginning of period |
| $ | | $ | | |
Accrued expense |
| |
| | ||
Warranty cost |
| ( |
| ( | ||
Warranty accrual, end of period |
| $ | | $ | | |
3. Income Taxes
The Company will continue to assess all available evidence during future periods to evaluate any changes to the realization of its deferred tax assets. If the Company were to determine that it would be able to realize additional state deferred tax assets in the future, it would make an adjustment to the valuation allowance which would reduce the provision for income taxes.
As a result of the 2017 Tax Cuts and Jobs Act, the Company must amortize amounts paid or incurred for specified research and development expenditures, including software development expenses, ratably over 60 months, beginning at the mid-point of the tax year in which the expenditures are paid or incurred.
The effective tax rate for the three-month and nine-month periods ended June 30, 2023 was
The effective tax rate for the three-month and nine -month periods ended June 30, 2022 was
4. Shareholders’ Equity and Share-Based Payments
At June 30, 2023, the Company’s Amended and Restated Articles of Incorporation provides the Company authority to issue
Share-Based compensation
The Company accounts for share-based compensation under the provisions of ASC Topic 718 by using the fair value method for expensing stock options and stock awards.
2019 Stock-Based Incentive Compensation Plan
The 2019 Plan was approved by the Company’s shareholders at the Company’s Annual Meeting of Shareholders held on April 2, 2019. The 2019 Plan authorizes the grant of stock appreciation rights, restricted stock, options and other equity-based awards. Options granted under the 2019 Plan may be either “incentive stock options” as defined in section 422 of the Code or nonqualified stock options, as determined by the Compensation Committee.
Subject to an adjustment necessary upon a stock dividend, recapitalization, forward split or reverse split, reorganization, merger, consolidation, spin-off, combination, repurchase or share exchange, extraordinary or unusual cash distribution, or similar corporate transaction or event, the maximum number of shares of common stock available for awards under the 2019 Plan is
If any award is forfeited, terminates or otherwise is settled for any reason without an actual distribution of shares to the participant, the related shares of common stock subject to such award will again be available for future grant. Any shares tendered by a participant in payment of the exercise price of an option or the tax liability with respect to an award (including, in any case, shares withheld from any such award) will not be available for future grant under the 2019 Plan. If there is any change in the Company’s corporate capitalization, the Compensation Committee must proportionately and equitably adjust the number and kind of shares of common stock which may be issued in connection with future awards, the number and kind of shares of common stock covered by awards then outstanding under the 2019 Plan, the aggregate number and kind of shares of common stock available under the 2019 Plan, any
19
applicable individual limits on the number of shares of common stock available for awards under the 2019 Plan, the exercise or grant price of any award, or if deemed appropriate, make provision for a cash payment with respect to any outstanding award. In addition, the Compensation Committee may make adjustments in the terms and conditions of any awards, including any performance goals, in recognition of unusual or nonrecurring events affecting the Company or any subsidiary, or in response to changes in applicable laws, regulations, or accounting principles.
The compensation expense related to stock options and awards issued to employees under the 2019 Plan was $
The compensation expense under the 2019 Plan related to stock awards issued to non-employee members of the Board was $
Total compensation expense associated with the 2019 Plan was $
At June 30, 2023, unrecognized compensation expense of approximately $
5. Earnings Per Share
Three Months Ended June 30, | Nine Months Ended June 30, | |||||||||||
| 2023 |
| 2022 |
| 2023 |
| 2022 | |||||
Numerator: | ||||||||||||
Net income |
| $ | |
| $ | | $ | |
| $ | | |
Denominator: | ||||||||||||
Basic weighted average shares |
| |
| |
| |
| | ||||
Dilutive effect of share-based awards |
| |
| |
| |
| | ||||
Diluted weighted average shares |
| |
| |
| |
| | ||||
Earnings per common share: | ||||||||||||
Basic EPS |
| $ | |
| $ | | $ | | $ | | ||
Diluted EPS |
| $ | |
| $ | | $ | | $ | | ||
Net income per share is calculated pursuant to ASC Topic 260, “Earnings per Share” (“ASC Topic 260”). Basic earnings per share (“EPS”) excludes potentially dilutive securities and is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS is computed assuming the conversion or exercise of all dilutive securities such as employee stock options and restricted stock units (“RSUs”).
The number of incremental shares from the assumed exercise of stock options and RSUs is calculated by using the treasury stock method. As of June 30, 2023 and 2022, there were
For the three-month periods ended June 30, 2023 and 2022, respectively,
For the nine-month periods ended June 30, 2023 and 2022, respectively,
20
6. Contingencies
In the ordinary course of business, the Company is at times subject to various legal proceedings and claims. The Company does not believe any such matters that are currently pending will, individually or in aggregate, have a material effect on the results of operations or financial position.
7. Related Party Transactions
In recent years, the Company has had sales to AML Global Eclipse, LLC, (“Eclipse”), whose principal shareholder is also a principal shareholder in the Company. Eclipse is a new related party for fiscal year 2022 due to their president acquiring more that
Sales to Eclipse amounted to approximately $
8. Leases
The Company accounts for leases in accordance with ASU 2016-02 and records “right-of-use” assets and corresponding lease liabilities on the balance sheet for most leases with an initial term of greater than one year. Consistent with previous accounting guidance, we will recognize payments for leases with a term of less than one year in the statement of operations on a straight-line basis over the lease term.
We lease real estate and equipment under various operating leases. A lease exists when a contract or part of a contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration. In determining whether a lease exists, we consider whether a contract provides us with both: (a) the right to obtain substantially all of the economic benefits from the use of the identified asset and (b) the right to direct the use of the identified asset.
Some of our leases include base rental periods coupled with options to renew or terminate the lease, generally at our discretion. In evaluating the lease term, we consider whether we are reasonably certain to exercise such options. To the extent a significant economic incentive exists to exercise an option, that option is included within the lease term. However, based on the nature of our lease arrangements, options generally do not provide us with a significant economic incentive and are therefore excluded from the lease term for the majority of our arrangements.
Our leases typically include a combination of fixed and variable payments. Fixed payments are generally included when measuring the right-of-use asset and lease liability. Variable payments, which primarily represent payments based on usage of the underlying asset, are generally excluded from such measurement and expensed as incurred. In addition, certain of our lease arrangements may contain a lease coupled with an arrangement to provide other services, such as maintenance, or may require us to make other payments on behalf of the lessor related to the leased asset, such as payments for taxes or insurance. As permitted by ASU 2016-02, we have elected to account for these non-lease components together with the associated lease component if included in the lease payments. This election has been made for each of our asset classes.
The measurement of “right-of-use” assets and lease liabilities requires us to estimate appropriate discount rates. To the extent the rate implicit in the lease is readily determinable, such rate is utilized. However, based on information available at lease commencement for our leases, the rate implicit in the lease is not known. In these instances, we utilize an incremental borrowing rate, which represents the rate of interest that we would pay to borrow on a collateralized basis over a similar term.
21
The following table presents the lease-related assets and liabilities reported in the Consolidated Balance Sheet as of June 30, 2023:
Classification on the Consolidated Balance Sheet on June 30, 2023 | |||||
Assets |
|
|
|
| |
Operating leases |
| $ | | ||
Liabilities |
|
|
| ||
Operating leases- current |
| $ | | ||
Operating leases – noncurrent |
| $ | | ||
Total lease liabilities | $ | | |||
Rent expense and cash paid for various operating leases in aggregate are $
Future minimum lease payments under operating leases are as follows at June 30, 2023:
Twelve Months |
| ||||
Ending | Operating | ||||
| June 30, |
| Leases | ||
| 2024 | $ | | ||
| 2025 |
| | ||
Total minimum lease payments | $ | | |||
Amount representing interest | ( | ||||
Present value of minimum lease payments |
|
| | ||
Current portion |
|
| ( | ||
Long-term portion of lease obligations |
| $ | | ||
9. Loan Agreement
On June 28, 2023, the Company and one of its subsidiaries entered into an Amendment to Loan Documents (the “Loan Amendment”) with PNC Bank, National Association (the “PNC”), which amends certain terms of that certain Loan Agreement entered into by the parties on May 11, 2023 (the “Loan Agreement” and, as amended, the “Amended Loan Agreement”) and (ii) a corresponding Term Note in favor of PNC (the “Term Note”), which together provide for a senior secured term loan in an aggregate principal amount of $
Future interest payments on the Term Loan, based on current interest rates, are expected to approximate $
In addition to providing for the Term Loan, the Loan Agreement, together with a corresponding Revolving Line of Credit Note in favor of PNC, executed May 11, 2023 (“Line of Credit Note”), provides for a senior secured revolving line of credit in an aggregate principal amount of $
The interest rate applicable to loans outstanding under the Revolving Line of Credit is a rate per annum equal to the sum of (A) Daily SOFR (as defined in the Line of Credit Note) plus (B) an unadjusted spread of Applicable SOFR Margin plus (C) a SOFR adjustment of
22
The Company was in compliance with all applicable covenants throughout and at June 30, 2023. As of June 30, 2023, the term loan balance amounted to $
Fixed mandatory principal repayments due on the outstanding Term Loan are as follows:
Twelve Months | ||
Ending |
| |
June 30, |
| |
2024 |
| |
2025 |
| |
2026 |
| |
2027 |
| |
2028 |
| |
| |
23
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements within the meaning of the federal securities laws. These forward-looking statements are based largely on current expectations and projections about future events and trends affecting the business, are not guarantees of future performance, and involve a number of risks, uncertainties and assumptions that are difficult to predict. In this report, the words “anticipates,” “believes,” “may,” “will,” “estimates,” “continues,” “anticipates,” “intends,” “forecasts,” “expects,” “plans,” “could,” “should,” “would,” “is likely”, “projected”, “might”, “potential”, “preliminary”, “provisionally” and similar expressions, as they relate to the business or to its management, are intended to identify forward-looking statements, but they are not exclusive means of identifying them. Unless the context otherwise requires, all references herein to “IS&S,” the “Registrant,” the “Company,” “we,” “us” or “our” are to Innovative Solutions and Support, Inc. and its consolidated subsidiaries.
The forward-looking statements in this report are only predictions, and actual events or results may differ materially. In evaluating such statements, a number of risks, uncertainties and other factors could cause actual results, performance, financial condition, cash flows, prospects and opportunities to differ materially from those expressed in, or implied by, the forward-looking statements. These risks, uncertainties and other factors include those set forth in Item 1A (Risk Factors) of our Annual Report on Form 10-K for the fiscal year ended September 30, 2022 and in Item 1A (Risk Factors) to Part II of this Quarterly Report on Form 10-Q, as well as the following factors:
| ● | market acceptance of the Company’s ThrustSense® full-regime Autothrottle, Vmca Mitigation, FPDS, NextGen Flight Deck and COCKPIT/IP® or other planned products or product enhancements; |
| ● | continued market acceptance of the Company’s air data systems and products; |
| ● | the competitive environment and new product offerings from competitors; |
| ● | difficulties in developing, producing or improving the Company’s planned products or product enhancements; |
| ● | the deferral or termination of programs or contracts for convenience by customers; |
| ● | the ability to service the international market; |
| ● | the availability of government funding; |
| ● | the availability and efficacy of vaccines (including vaccine boosters) and their global deployment in response to the COVID-19 pandemic (including as a result of the impact of any newer variants or strains of SARS-CoV-2); |
| ● | the impact of general economic trends (such as rising interest rates and recent bank failures in the United States) on the Company’s business and operations; |
| ● | disruptions in the Company’s supply chain, customer base and workforce, including as a result of the COVID-19 pandemic; |
| ● | the ability to gain regulatory approval of products in a timely manner; |
| ● | delays in receiving components from third-party suppliers; |
| ● | the bankruptcy or insolvency of one or more key customers; |
| ● | protection of intellectual property rights; |
| ● | the ability to respond to technological change; |
| ● | failure to retain/recruit key personnel; |
| ● | risks related to succession planning; |
| ● | a cyber security incident; |
| ● | risks related to our self-insurance program; |
| ● | ability to successfully manage and integrate key acquisitions, mergers, and other transactions, such as the recent asset acquisition of certain Inertial, Communication and Navigation product lines from Honeywell International, Inc., as well as the failure to realize expected synergies and benefits anticipated when we make an acquisition; |
| ● | potential future acquisitions or dispositions; |
| ● | the costs of compliance with present and future laws and regulations; |
| ● | changes in law, including changes to corporate tax laws in the United States and the availability of certain tax credits; and |
| ● | other factors disclosed from time to time in the Company’s filings with the United States Securities and Exchange Commission (the “SEC”). |
Except as expressly required by the federal securities laws, the Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise after the date of this report. Results of
24
operations in any past period should not be considered indicative of the results to be expected for future periods. Fluctuations in operating results may result in fluctuations in the price of the Company’s common stock.
Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. The Company does not undertake any obligation to publicly release any revisions to these forward-looking statements to reflect events, circumstances or changes in expectations after the date of this report, or to reflect the occurrence of unanticipated events. The forward-looking statements in this document are intended to be subject to the safe harbor protection provided by Sections 27A of the Securities Act of 1933, as amended (the “Securities Act”), and 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
Investors should also be aware that while the Company, from time to time, communicates with securities analysts, it is against its policy to disclose any material non-public information or other confidential commercial information. Accordingly, shareholders should not assume that the Company agrees with any statement or report issued by any analyst irrespective of the content of the statement or report. Furthermore, the Company has a policy against issuing or confirming financial forecasts or projections issued by others. Thus, to the extent that reports issued by securities analysts contain any projections, forecasts or opinions, such reports are not the responsibility of the Company.
Company Overview
Innovative Solutions and Support, Inc. (the “Company,” “IS&S,” “we” or “us”) was incorporated in Pennsylvania on February 12, 1988. The Company operates in one business segment as a systems integrator that designs, develops, manufactures, sells and services air data equipment, engine display systems, standby equipment, primary flight guidance, autothrottles and cockpit display systems for retrofit applications and original equipment manufacturers (“OEMs”). The Company supplies integrated Flight Management Systems (“FMS”), Flat Panel Display Systems (“FPDS”), FPDS with Autothrottle, air data equipment, Integrated Standby Units (“ISU”), ISU with Autothrottle and advanced GPS receivers that enable reduced carbon footprint navigation.
The Company has continued to position itself as a system integrator, which capability provides the Company with the potential to generate more substantive orders over a broader product base. This strategy, as both a manufacturer and integrator, is designed to leverage the latest technologies developed for the computer and telecommunications industries into advanced and cost-effective solutions for the general aviation, commercial air transport, United States Department of Defense (“DoD”)/governmental and foreign military markets. This approach, combined with the Company’s industry experience, is designed to enable IS&S to develop high-quality products and systems, to reduce product time to market, and to achieve cost advantages over products offered by its competitors.
For several years the Company has been working with advances in technology to provide pilots with more information to enhance both the safety and efficiency of flying, and has developed its COCKPIT/IP® Cockpit Information Portal (“CIP”) product line, that incorporates proprietary technology, low cost, reduced power consumption, decreased weight, and increased functionality. The Company has incorporated Electronic Flight Bag (“EFB”) functionality, such as charting and mapping systems, into its FPDS product line.
The Company has developed an FMS that combines the savings long associated with in-flight fuel optimization in enroute flight management combined with the precision of satellite-based navigation required to comply with the regulatory environments of both domestic and international markets. The Company believes that the FMS, alongside its FPDS and CIP product lines, is well suited to address market demand driven by certain regulatory mandates, new technologies, and the high cost of maintaining aging and obsolete equipment on aircraft that will be in service for up to fifty years. The shift in the regulatory and technological environment is illustrated by the dramatic increase in the number of Space Based Augmentation System (“SBAS”) or Wide Area Augmentation System (“WAAS”) approach qualified airports, particularly as realized through Localizer Performance with Vertical guidance (“LPV”) navigation procedures. Aircraft equipped with the Company’s FMS, FPDS and SBAS/WAAS/LPV enabled navigator, will be qualified to land at such airports and will comply with Federal Aviation Administration (“FAA”) mandates for Required Navigation Performance, and Automatic Dependent Surveillance-Broadcast navigation. IS&S believes this will further increase the demand for the Company’s products. The Company’s FMS/FPDS product line is designed for new production and retrofit applications into general aviation, commercial air transport and military transport aircraft. In addition, the Company offers what we believe to be a state-of-the-art ISU, integrating the full functionality of the primary and navigation displays into a small backup-powered unit. This ISU builds on the Company’s legacy air data computer to form a complete next-generation cockpit display and navigation upgrade offering to the commercial and military markets.
25
The Company has developed and received certification from the FAA on its NextGen Flight Deck featuring its ThrustSense® Integrated PT6 Autothrottle (“ThrustSense® Autothrottle”) for retrofit in the Pilatus PC-12. The NextGen Flight Deck features Primary Flight and Multi-Function Displays and ISUs, as well as an Integrated FMS and EFB System. The innovative avionics suite includes dual flight management systems, autothrottles, synthetic vision and enhanced vision. The NextGen enhanced avionics suite is available for integration into other business aircraft with Non-FADEC and FADEC engines.
The Company has developed, its FAA-certified ThrustSense® Autothrottle for retrofit in the King Air, dual turbo prop PT6 powered aircraft. The autothrottle is designed to automate the power management for speed and power control including go-around. ThrustSense® also ensures aircraft envelope protection and engine protection during all phases of flight thereby reducing pilot workload and increasing safety. The Company has signed a multi-year agreement with Textron to supply ThrustSense® on the King Air 360 and King Air 260. ThrustSense® is also available for retrofit on King Airs aircraft through Textron service centers and third-party service centers. The Company has also developed an FAA-certified safety mode feature for its King Airs aircraft ThrustSense® Autothrottle, LifeGuard™, which provides critical Vmca protection that proportionally reduces engine power to maintain directional control during an engine-out condition.
We believe the ThrustSense® Autothrottle is innovative in that it is the first autothrottle developed for a turbo prop that allows a pilot to automatically control the power setting of the engine. The autothrottle computes and controls appropriate power levels thereby reducing overall pilot workload. The system computes thrust, holds selected speed/torque, and implements appropriate speed and engine limit protection. When engaged by the pilot, the autothrottle system adjusts the throttles automatically to achieve and hold the selected airspeed guarded by a torque/temperature limit mode. The autothrottle system takes full advantage of the integrated cockpit and utilizes weight and balance information to determine optimal control settings and enable safety functions like a turbulence control mode.
The Company sells to both the OEM and the retrofit markets. Customers include various OEMs, commercial air transport carriers and corporate/general aviation companies, DoD and its commercial contractors, aircraft operators, aircraft modification centers, government agencies, and foreign militaries. Occasionally, IS&S sells its products directly to DoD; however, the Company sells its products primarily to commercial customers for end use in DoD programs. Sales to defense contractors are generally made on commercial terms, although some of the termination and other provisions of government contracts are applicable to these contracts. The Company’s retrofit projects are generally pursuant to either a direct contract with a customer or a subcontract with a general contractor to a customer (including government agencies).
On the other hand, the Company believes that in adverse economic conditions, customers that may have otherwise elected to purchase newly manufactured aircraft may be interested instead in retrofitting existing aircraft as a cost-effective alternative, thereby creating a market opportunity for IS&S.
Cost of sales related to product sales comprises material, components and third-party avionics purchased from suppliers, direct labor, and overhead costs. Many of the components are standard, although certain parts are manufactured to meet IS&S specifications. The overhead portion of cost of sales primarily comprises salaries and benefits, building occupancy costs, supplies, and outside service costs related to production, purchasing, material control, and quality control. Cost of sales includes warranty costs.
Cost of sales related to Engineering Development Contracts (“EDC”) sales comprises engineering labor, consulting services, and other costs associated with specific design and development projects. These costs are incurred pursuant to contractual arrangements and are accounted for typically as contract costs within cost of sales, with the reimbursement accounted for as a sale in accordance with the percentage-of-completion method or completed contract method of accounting. Company funded research and development (“R&D”) expenditures relate to internally-funded efforts for the development of new products and the improvement of existing products. These costs are expensed as incurred and reported as R&D expenses. The Company intends to continue investing in the development of new products that complement current product offerings and to expense associated R&D costs as they are incurred.
Selling, general and administrative expenses consist of sales, marketing, business development, professional services, salaries and benefits for executive and administrative personnel, facility costs, recruiting, legal, accounting and other general corporate expenses.
Critical Accounting Policies and Estimates
The discussion and analysis of financial condition and consolidated results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The
26
preparation of these consolidated financial statements requires estimates and assumptions that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. Management has determined that the most critical accounting estimates are those related to revenue recognition, valuation of tangible and intangible assets acquired, long term contracts, the useful lives of long-lived assets for depreciation and amortization, the recoverability of long-lived assets, evaluation of goodwill impairment and contingencies. On an ongoing basis, IS&S management evaluates its estimates based upon historical experience and various other assumptions that it believes to be reasonable in the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.
The Company believes that its critical accounting policies affect its more significant estimates and judgments used in the preparation of its consolidated financial statements. The Annual Report on Form 10-K for the fiscal year ended September 30, 2022 contains a discussion of these critical accounting policies. There have been no significant changes in the Company’s critical accounting policies since September 30, 2022, except new critical accounting policies in acquisition, intangible assets and goodwill. See also Note 1 to the unaudited consolidated financial statements for the three-and nine-month periods ended June 30, 2023 as set forth herein.
Acquisitions
The Company accounts for business acquisitions using the acquisition method of accounting. Under this method of accounting, assets acquired and liabilities assumed are recorded at their respective fair values at the date of the acquisition. When determining the fair values of assets acquired and liabilities assumed, management makes significant estimates and assumptions. The Company’s estimates of fair value are based upon assumptions believed to be reasonable, but are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Any excess of the purchase price over the fair value of the net assets acquired is recognized as goodwill. The Company also uses best estimates and assumptions to determine the useful lives of those acquired intangible assets with a finite life.
Critical estimates in valuing certain of the intangible assets and goodwill acquired include:
| ● | future expected cash flows from customer contracts and license agreements; |
| ● | historical and expected customer attrition rates and anticipated growth in revenue from acquired customers; |
| ● | estimated replacement costs for equipment acquired; |
| ● | obsolescence rate applied to finished goods and raw materials acquired; and |
| ● | discount rates. |
Intangible Assets
Intangible assets consist of customer relationship, license agreements, and licensing and certification rights, and these assets are carried at cost less accumulated amortization and any impairment charge.
Intangible assets with a finite life are amortized over their estimated useful life and are reported net of accumulated amortization. An impairment assessment for intangible assets with a finite life is only required when an event or change in circumstances indicates that the carrying amount of the asset may not be recoverable. Determining the useful life of an intangible asset with a finite life also requires judgment.
Indefinite-lived intangible assets are not amortized, but are subject to an annual impairment test, or when events or circumstances dictate, more frequently. The impairment review for indefinite-lived intangible assets can be performed using a qualitative or quantitative impairment assessment. The quantitative assessment consists of a comparison of the fair value of the indefinite-lived intangible asset with its carrying amount. If the carrying amount exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. If the fair value exceeds its carrying amount, the indefinite-lived intangible asset is not considered impaired.
Impairment of Goodwill
The Company evaluates the carrying amount of goodwill annually or more frequently if events or circumstances indicate that the goodwill may be impaired. Factors that could trigger an impairment review include significant underperformance relative to historical or forecasted operating results, a significant decrease in the market value of an asset or significant negative industry or economic trends. Assumptions used in the impairment evaluations, such as forecasted growth rates and cost of capital, are consistent with
27
internal projections and operating plans. The Company believes these estimates and assumptions are reasonable and comparable to those that would be used by other marketplace participants.
RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED
JUNE 30, 2023 AND 2022
The following table sets forth the statements of operations data expressed as a percentage of total net sales for the periods indicated (some items may not add due to rounding):
Three Months Ended June 30, |
| Nine Months Ended June 30, |
| ||||||
| 2023 |
| 2022 |
| 2023 |
| 2022 |
| |
Net sales: |
|
|
|
|
|
|
| ||
Product |
| 99.2 | % | 100.0 | % | 98.0 | % | 99.0 | % |
Engineering development contracts |
| 0.8 | % | 0.0 | % | 2.0 | % | 1.0 | % |
Total net sales |
| 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % |
Cost of sales: |
|
|
|
|
|
| |||
Product |
| 40.2 | % | 41.5 | % | 39.1 | % | 40.3 | % |
Engineering development contracts |
| 0.3 | % | 0.0 | % | 0.4 | % | 0.1 | % |
Total cost of sales |
| 40.5 | % | 41.5 | % | 39.5 | % | 40.4 | % |
Gross profit |
| 59.5 | % | 58.5 | % | 60.5 | % | 59.6 | % |
Operating expenses: |
|
|
|
|
|
|
| ||
Research and development |
| 10.7 | % | 9.8 | % | 10.9 | % | 10.1 | % |
Selling, general and administrative |
| 30.1 | % | 24.4 | % | 32.6 | % | 25.5 | % |
Total operating expenses |
| 40.8 | % | 34.2 | % | 43.5 | % | 35.6 | % |
Operating income |
| 18.7 | % | 24.3 | % | 17.0 | % | 24.0 | % |
Interest income |
| 2.3 | % | 0.2 | % | 2.0 | % | 0.1 | % |
Other income |
| 1.1 | % | 0.3 | % | 0.6 | % | 0.2 | % |
Income before income taxes |
| 22.2 | % | 24.8 | % | 19.6 | % | 24.3 | % |
Income tax expense |
| 4.3 | % | 5.2 | % | 4.0 | % | 5.2 | % |
Net income |
| 17.9 | % | 19.6 | % | 15.6 | % | 19.2 | % |
Three Months Ended June 30, 2023 Compared to the Three Months Ended June 30, 2022
Net sales. Net sales were $8.0 million for the three months ended June 30, 2023 compared to $6.9 million for the three months ended June 30, 2022, an increase of 14.8%. Product sales increased $1.0 million and customer service sales remained flat compared to the year ago quarter. This increase in product sales for the three months ended June 30, 2023 was primarily the result of additional shipments of displays for retrofit programs to commercial air transport customers. The increase was also due to increase of shipments of OEM sales to Boeing under the KC-46A platform.
Cost of sales. Cost of sales increased by $345,000, or 12.0%, to $3.2 million, or 40.5% of net sales, in the three months ended June 30, 2023, compared to $2.9 million or 41.5% of net sales, in the three months ended June 30, 2022. The increase in cost of sales was primarily the result of an increase in product sales volume for the three months ended June 30, 2023 compared to the three months ended June 30, 2022. The Company’s overall gross margin was 59.5% and 58.5% for the three months ended June 30, 2023 and 2022, respectively. The increase in gross margin percentage for the three months ended June 30, 2023 is attributable to favorable leveraging of fixed costs resulting from the increased sales and production volume and a favorable sales mix.
Research and development. R&D expense increased $175,000 or 25.9% in the three months ended June 30, 2023 from $676,000 in the three months ended June 30, 2022. As a percentage of net sales, R&D expense increased to 10.7% of net sales in the three months
28
ended June 30, 2023 from 9.8% of net sales in the three months ended June 30, 2022 reflecting the hiring of engineers, related product development and increased R&D projects.
Selling, general and administrative. Selling, general and administrative expense increased by $632,000 or 37.3% to $2.3 million in the three months ended June 30, 2023 from $1.7 million in the three months ended June 30, 2022. As a percentage of net sales, selling, general and administrative expenses was 30.1% in the three months ended June 30, 2023 compared to 24.4% for the prior year period. The overall increase in selling, general and administrative expense in the quarter was primarily the result of increased sales and marketing costs, legal and professional fees incurred as part of the Honeywell asset acquisition, as well as non-cash executive stock awards.
Interest income. Interest income increased by $175,000 to $186,000 in the three months ended June 30, 2023 from $10,000 in the three months ended June 30, 2022, mainly a result of increased cash balance and higher interest rates earned during the current year period compared to the same period in the prior year.
Other income. Other income is mainly composed of royalties earned and increased by $68,000 to $90,000 in the three months ended June 30, 2023 compared to the same period in the prior year.
Income tax expense. The income tax expense for the three months ended June 30, 2023 was $340,000 as compared to $359,000 for the three months ended June 30, 2022.
The effective tax rate for the three-month period ended June 30, 2023 was 19.3% and differs from the statutory tax rate primarily due to permanent items and state taxes.
Net income. The Company reported net income for the three months ended June 30, 2023 of $1.4 million and remained flat compared to net income of $1.4 for the three months ended June 30, 2022. On a diluted basis, the net income per share was $0.08 for the three months ended June 30, 2023 and remained flat compared to net income per share of $0.08 for the three months ended June 30, 2022.
Nine Months Ended June 30, 2023 Compared to the Nine Months Ended June 30, 2022
Net sales. Net sales were $21.8 million for the nine months ended June 30, 2023 compared to $20.5 million for the nine months ended June 30, 2022, an increase of 6.5%. Product sales increased $1.1 million, customer service was flat, and EDC sales doubled to $234,000 in the nine months ended June 30, 2023 compared to the same period in the prior year.This increase in product sales for the nine months ended June 30, 2023 primarily resulted from increased sales to our OEM customers, which include Pilatus, Textron and Boeing. Sales increases were also seen in our new auto-throttle installations.
Cost of sales. Cost of sales increased $347,000, or 4.2%, to $8.6 million, or 39.5% of net sales, in the nine months ended June 30, 2023, compared to $8.3 million or 40.4% of net sales, in the nine months ended June 30, 2022. The increase in cost of sales was primarily the result of an increase in product sales volume for the nine months ended June 30, 2023 compared to the nine months ended June 30, 2022. The Company’s overall gross margin was 60.5% and 59.6% for the nine months ended June 30, 2023 and 2022, respectively. The increase in gross margin percentage for the nine months ended June 30, 2023 is attributable to favorable leveraging of fixed costs resulting from the increased sales and production volume and a favorable sales mix.
Research and development. R&D expense increased $325,000, or 15.8%, to $2.4 million in the nine months ended June 30, 2023 from $2.1 million in the nine months ended June 30, 2022. As a percentage of net sales, R&D expense increased to 10.9% of net sales in the nine months ended June 30, 2023 from 10.1% of net sales in the nine months ended June 30, 2022 reflecting an increase in hiring engineers and working on product development and related programs/internal projects.
Selling, general and administrative. Selling, general and administrative expenses increased by $1.8 million to $7.0 million in the nine months ended June 30, 2023 from $5.2 million in the nine months ended June 30, 2022. As a percentage of net sales, selling, general and administrative expenses increased to 32.6% of net sales in the nine months ended June 30, 2023 from 25.5% of net sales in the nine months ended June 30, 2022. The increase in selling, general and administrative expense in the period was primarily the result of personnel additions in sales and marketing, legal and business development related to the acquisition, investor relations and investor facing activities and non-cash long-term compensations post COVID.
29
Interest income. Interest income increased by $422,000 to $432,000 in the nine months ended June 30, 2023 from $11,000 in the nine months ended June 30, 2022, mainly a result of increased cash on hand and higher interest rates compared to the same period in the prior year.
Other income. Other income is mainly composed of royalties earned and increased by $82,000 to $132,000 in the nine months ended June 30, 2023 compared to the same period in the prior year.
Income tax expense. The income tax expense for the nine months ended June 30, 2023 was $877,000 as compared to $1.1 million the nine months ended June 30, 2021.
The effective tax rate for the nine-month period ended June 30, 2022 was 20.5% and differs from the statutory tax rate primarily due to permanent items and state taxes.
Net income. The Company reported net income for the nine months ended June 30, 2023 of $3.4 million compared to net income of $3.9 million for the nine months ended June 30, 2022. On a diluted basis, the net income per share was $0.19 for the nine months ended June 30, 2023 compared to net income per share of $0.23 for the nine months ended June 30, 2022.
Liquidity and Capital Resources
The following table highlights key financial measurements of the Company:
June 30, | September 30, | |||||
| 2023 |
| 2022 | |||
Cash and cash equivalents | $ | 2,572,233 | $ | 17,250,546 | ||
Accounts receivable |
| 5,944,015 |
| 4,297,457 | ||
Current assets |
| 25,937,217 |
| 28,202,319 | ||
Current liabilities |
| 8,145,090 |
| 3,940,303 | ||
Contract liability |
| 102,953 |
| 259,183 | ||
Other non-current liabilities (1) |
| 18,420,949 |
| 15,065 | ||
Quick ratio (2) |
| 1.05 |
| 5.47 | ||
Current ratio (3) |
| 3.18 |
| 7.16 | ||
Nine Months Ended June 30, | ||||||
| 2023 |
| 2022 | |||
Cash flow activities: |
|
|
|
| ||
Net cash provided by operating activities | $ | 937,925 | $ | 6,420,371 | ||
Net cash used in investing activities |
| (36,025,084) |
| (161,230) | ||
Net cash provided by financing activities |
| 20,408,846 |
| 17,154 | ||
| (1) | Excludes contract liability |
| (2) | Calculated as: the sum of cash and cash equivalents plus accounts receivable, net, divided by current liabilities |
| (3) | Calculated as: current assets divided by current liabilities |
The Company’s principal source of liquidity has been cash flows from current year operations and cash accumulated from prior years’ operations, supplemented with borrowings under our term loan and revolving credit facility. Cash is used principally to finance inventory, accounts receivable, contract assets, payroll, debt service, and acquisitions, as well as the Company’s known contractual and other commitments (including those described in Note 8, “Leases”). The Company’s existing cash balances and anticipated cash flows from operations, together with borrowings under our term loan and revolving credit facility, are expected to be adequate to satisfy the Company’s liquidity needs for at least the next 12 months. Apart from what has been disclosed in this Management’s Discussion and Analysis, management is not aware of any trends, events or uncertainties that have had or are likely to have a material impact on our liquidity, financial condition and capital resources.
The declaration and payment of any dividend in the future will be at the discretion of the Company’s Board of Directors.
30
Operating activities
Net cash provided by operating activities was $0.9 million for the nine-month period ended June 30, 2023 and consisted primarily of funding from net income of $3.4 million, offset by an increase in accounts receivable of $1.6 million and a decrease in accrued expenses of $0.9 million.
Net cash provided by operating activities of $6.4 million for the nine-month period ended June 30, 2022 resulted primarily from funding from net income of $3.9 million, a decrease in accounts receivables of $1.0 million and a decrease in deferred income taxes of $0.8 million.
Investing activities
Net cash used in investing activities was $36.0 million for the nine-month period ended June 30, 2023 and consisted primarily of the asset purchase acquisition of Honeywell.
Net cash used in investing activities was $0.2 million for the nine-month period ended June 30, 2022 and consisted primarily of the purchase of laboratory test equipment and computer hardware.
Financing activities
Net cash provided by financing activities was $20.4 million for the nine-month period ended June 30, 2023 and consisted of proceeds from a new credit facility of $20.0 million and the exercise of stock options.
Net cash provided by financing activities was $0.02 million for the nine-month period ended June 30, 2022 and consisted of proceeds from the exercise of stock options.
Summary
Future capital requirements depend upon numerous factors, including market acceptance of the Company’s products, the timing and rate of expansion of business, acquisitions, joint ventures and other factors. IS&S has experienced increases in expenditures since its inception and anticipates that expenditures will continue in the foreseeable future. The Company believes that its cash and cash equivalents will provide sufficient capital to fund operations for at least the next twelve months. However, the Company may need to develop and introduce new or enhanced products, respond to competitive pressures, invest in or acquire businesses or technologies, or respond to unanticipated requirements or developments. If insufficient funds are available, the Company may not be able to introduce new products or compete effectively.
Environmental, Social and Governance Considerations
In recent years, environmental, social and governance (“ESG”) issues have become an increasing area of focus for some of our shareholders, customers and suppliers. Management and the Company’s Board of Directors are committed to identifying, assessing, and understanding the potential impact of ESG issues and related risks on the Company’s business model, as well as potential areas of improvement.
We are committed to recruiting, motivating and developing a diversity of talent. We are an equal opportunity employer and a Vietnam Era Veterans’ Readjustment Assistance Act federal contractor. All qualified applicants receive consideration for employment without regard to race, color, religion, sex, sexual orientation, gender identity, national origin, disability status, protected veteran status, or any other characteristic protected by law.
The nature of our business also supports long-term sustainability. Historically, a majority of the Company’s sales have come from the retrofit market, in which the Company, by making upgrades to improve the functionality and safety of existing machinery, facilitates the re-use and recycling of aircraft and equipment that might otherwise be scrapped as obsolete. The Company’s GPS receivers also facilitate reduced carbon footprint navigation. The Company also plans to enhance its focus on the environmental impact of its operations.
31
Backlog
Backlog represents the value of contracts and purchase orders, less the revenue recognized to date on those contracts and purchase orders. Backlog activity for the three- and nine-month periods ended June 30, 2023:
| Three Months Ended |
| Six Months Ended | |||
June 30, 2023 | ||||||
Backlog, beginning of period | $ | 14,780,588 | $ | 11,778,988 | ||
Bookings, net |
| 6,942,680 |
| 23,800,989 | ||
Recognized in revenue |
| (7,959,208) |
| (21,815,917) | ||
Backlog, end of period | $ | 13,764,060 | $ | 13,764,060 | ||
At June 30, 2023, the majority of the Company’s backlog is expected to be filled within the next twelve months. To the extent new business orders do not continue to equal or exceed sales recognized in the future from the Company’s existing backlog, future operating results may be impacted negatively.
Off-Balance Sheet Arrangements
The Company has no relationships with unconsolidated entities or financial partnerships, such as Special Purpose Entities or Variable Interest Entities, established for the purpose of facilitating off-balance sheet arrangements or other limited purposes.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company’s operations are exposed to market risks primarily as a result of changes in interest rates. The Company does not use derivative financial instruments for speculative or trading purposes. The Company’s exposure to market risk for changes in interest rates relates to its cash equivalents. The Company’s cash equivalents consist of funds invested in money market accounts, which bear interest at a variable rate. The Company does not participate in interest rate hedging. Cash balances are maintained with two major banks. Balances on deposit with certain money market accounts and operating accounts may exceed the Federal Deposit Insurance Corporation limits. A change in interest rates earned on the cash equivalents would impact interest income and cash flows but would not impact the fair market value of the related underlying instruments. Assuming that the balances during the nine-month period ended June 30, 2023 were to remain constant and the Company did not act to alter the existing interest rate sensitivity, a hypothetical 1% increase in variable interest rates would have affected interest income by approximately $23,600 and $70,000 with a resulting impact on cash flows of approximately $23,600 and $70,000 for the three- and nine-month periods ended June 30, 2023, respectively.
Item 4. Controls and Procedures
(a) | We carried out an evaluation under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Exchange Act of 1934. Based on that evaluation, our chief executive officer and chief financial officer concluded that these controls and procedures were effective as of June 30, 2023 to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported, within the time periods specified in the rules and forms of the Securities and Exchange Commission and accumulated and communicated to our management including our chief executive and financial officers, as appropriate, to allow timely decisions regarding required disclosure. |
(b) | There were no changes in the Company’s internal control over financial reporting identified in connection with the evaluation of such controls that occurred during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. |
32
PART II–OTHER INFORMATION
Item 1. Legal Proceedings
In the ordinary course of business, the Company is at times subject to various legal proceedings and claims. The Company does not believe any such matters that are currently pending will, individually or in the aggregate, have a material effect on the results of operations or financial position.
Item 1A. Risk Factors
Except as set forth below, there have been no material changes to our principal risks that we believe are material to our business, results of operations and financial condition, from the risk factors previously disclosed in the Annual Report on Form 10-K for the fiscal year ended September 30, 2022 (the “2022 Form 10-K”). The information set forth in this report should be read in conjunction with the risk factors described under Item 1A of the Company’s 2022 Form 10-K and in our other filings with the Securities and Exchange Commission. Such risks are not the only risks facing the Company. Additional risks and uncertainties not currently known to the Company or that the Company currently deems to be immaterial could materially and adversely affect the Company’s business, operating results, financial condition, cash flows, prospects, and the value of an investment in IS&S common stock.
We may pursue strategic acquisitions, investments, strategic partnerships or other ventures, and our business could be materially harmed if we fail to successfully identify, evaluate, complete, and integrate such transactions. Acquisitions involve inherent risks that may adversely affect our operating results and financial condition.
Our growth strategy includes evaluating acquisition opportunities and opportunities to make investments in complementary businesses, technologies, services or products, or to enter into strategic partnerships with parties who can provide access to those assets, additional product or services offerings, additional distribution or marketing synergies or additional industry expertise. One example is the recent asset acquisition of certain Inertial, Communication and Navigation product lines from Honeywell International, Inc. We may not be able to identify suitable acquisition, investment or strategic partnership candidates, or if we do identify suitable candidates in the future, we may not be able to complete those transactions on commercially favorable terms, or at all.
Acquisitions involve various inherent risks, such as: our ability to assess accurately the value, strengths, weaknesses, internal controls, contingent and other liabilities and potential profitability of acquisition candidates; difficulties in integrating acquired businesses, including the potential loss of key personnel from an acquired business, our potential inability to achieve identified financial, operating and other synergies anticipated to result from an acquisition, and integration issues associated with internal controls of acquired businesses; the diversion of management’s attention from our existing businesses; the potential impairment of assets; potential unknown liabilities associated with a business that we acquire or in which we invest, including environmental liabilities; new and proposed regulations limiting the enforcement of noncompetition and nonsolicitation agreements; and production delays associated with consolidating acquired facilities and manufacturing operations. Any past or future acquisition could also result in such risks. Due diligence performed prior to closing acquisitions may not uncover certain risks or liabilities that could materially impact our business and financial results. We may not successfully integrate business, operational, and financial activities such as internal controls, Sarbanes-Oxley Act of 2002 compliance, cyber security measures, the GDPR and other corporate governance and regulatory matters, operations, personnel or products related to acquisitions we may make in the future. If we fail to successfully integrate such transactions, our business could be materially harmed. In connection with our acquisitions, including those acquisitions that we do not complete, we may incur significant transaction costs. We are required to expense such transaction costs as incurred, which may have a material adverse impact on our financial results.
There are risks associated with our outstanding and future indebtedness.
On June 28, 2023, the Company and one of its subsidiaries entered into an Amendment to Loan Documents (the “Loan Amendment”) with PNC Bank, National Association (the “PNC”), which amends certain terms of that certain Loan Agreement entered into by the parties on May 11, 2023 (the “Loan Agreement” and, as amended, the “Amended Loan Agreement”) and (ii) a corresponding Term Note in favor of PNC (the “Term Note”), which together provide for a senior secured term loan in an aggregate principal amount of $20.0 million, with a maturity date of June 28, 2028 (the “Term Loan”). In addition to providing for the Term Loan, the Loan Agreement, together with a corresponding Revolving Line of Credit Note in favor of PNC, executed May 11, 2023 (“Line of Credit Note”), provides for a senior secured revolving line of credit in an aggregate principal amount of $10.0 million, with an expiration
33
date of May 11, 2028 (the “Revolving Line of Credit”). As of June 30, 2023, the balance of the Term Loan amounted to $20.0 million. There was no balance drawn on the Revolving Line of Credit as of June 30, 2023.
We may incur additional indebtedness in the future under these existing credit facilities and/or enter into new financing arrangements. We may fail to pay these or additional future obligations, as and when required. Specifically, if we are unable to generate sufficient cash flows from operations or to borrow sufficient funds in the future to service or refinance our debt, our business, operating results, financial condition and cash flows will be harmed. Any downgrades from credit rating agencies such as Moody’s Investors Service or Standard & Poor’s Rating Services may adversely impact our ability to obtain additional financing or the terms of such financing and reduce the market capacity for our commercial paper. Furthermore, if prevailing interest rates or other factors result in higher interest rates upon any potential future financing, then interest expense related to the refinance indebtedness would increase.
In addition, all the agreements governing our indebtedness subject us to continued compliance with certain financial and negative covenants. The Company was in compliance with all applicable covenants throughout and at June 30, 2023. If we are unable to meet our debt service obligations or should we fail to comply with our financial and other negative covenants contained in the agreements governing our indebtedness, we may be required to refinance all or part of our debt, sell strategic assets at unfavorable prices, incur additional indebtedness or issue common stock or other equity securities. We may not be able to, at any given time, refinance our debt, sell assets, incur additional indebtedness or issue equity securities on terms acceptable to us, in amounts sufficient to meet our needs. If we are able to raise additional funds through the issuance of equity securities, such issuance would also result in dilution to our stockholders. Our inability to service our obligations or refinance our debt could have a material and adverse effect on our business, financial condition or operating results.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None
Item 3. Defaults upon Senior Securities
None
Item 4. Mine Safety Disclosures
Not applicable
Item 5. Other Information
None.
34
Item 6. Exhibits
(a) Exhibits
2.1 | |
3.3 | |
10.1 | |
10.2 | |
10.3 | |
10.4 | |
31.1 | Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) (1) |
31.2 | Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) (1) |
32.1 | |
101.INS | XBRL Instance Document (1) |
101.SCH | XBRL Taxonomy Extension Scheme Document (1) |
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document (1) |
101.DEF | XBRL Taxonomy Extension Definition Linkbase Document (1) |
101.LAB | XBRL Taxonomy Extension Label Linkbase Document (1) |
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document (1) |
104 | Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101) |
(1) | Filed herewith |
(2) | Furnished herewith |
35
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
INNOVATIVE SOLUTIONS AND SUPPORT, INC. | ||
Date: August 11, 2023 | By: | /s/ MICHAEL LINACRE |
MICHAEL LINACRE | ||
CHIEF FINANCIAL OFFICER | ||
36