Earnings Call
Innovative Solutions & Support Inc (ISSC)
Earnings Call Transcript - ISSC Q4 2023
Operator, Operator
Welcome to the Innovative Solutions & Support Fourth Quarter and Year End Fiscal 2023 Financial Results Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to Shahram Askarpour, CEO. Please go ahead.
Shahram Askarpour, CEO
Good morning. This is Shahram Askarpour, Chief Executive Officer of Innovative Solutions & Support. Welcome to our conference call to discuss our performance for the fourth quarter and full year fiscal 2023, current business conditions and outlook for the coming year. Joining me is Rell Winand, our CFO. Before we begin, I'd like Rell to provide cautionary statements about forward-looking information.
Rell Winand, CFO
Thank you, Shahram, and good morning, everyone. I would remind our listeners that certain statements made and matters discussed in the conference call today, including those about new products and operational and financial results for future periods, contain forward-looking information. The forward-looking statements are subject to assumptions, risks, and uncertainties that could cause actual results to differ materially, either better or worse from those discussed. I specifically call our listeners' attention to our disclaimer regarding forward-looking statements at the end of the earnings release, which was included in a Form 8-K filed yesterday, which disclaimer, along with other public filings referred to describe these assumptions, risks, and uncertainties. I also remind our listeners that plans and expectations we express speak only as of today's date and listeners should not place undue reliance on any forward-looking statements. Now I'll turn the call back to Shahram.
Shahram Askarpour, CEO
Thank you, Rell. I will begin today with remarks on our performance in the fiscal fourth quarter and full year 2023, followed by comments on our long-term growth plan and strategy, including the recent Honeywell products purchased and licensed. I will then turn the call back to Rell, who will take us through the financials. For the quarter, revenues were up 79% with net income increasing 63% from a year ago. Our fiscal year 2023 results were driven by continued organic growth in our production contracts and aftermarket sales, as well as the full quarter of Honeywell product sales, which we acquired at the end of June. As anticipated, the Honeywell products supported our strong margins, which were up sequentially from the third quarter and similar to a year ago. We have also continued to generate strong cash flow, which contributed to reducing the borrowings used for our June acquisitions. This strong fourth quarter led to our fifth consecutive year of revenue growth, strong cash flow, and another increase in full-year earnings. Our cash has also enabled further paydown of our borrowings in the current quarter despite the heavy one-time significant expenses incurred for auditing fees, legal expenses, and the cost of hiring and training new technical personnel in relation to the acquired products. We are fortunate to have a great relationship with our bank PNC, and they have been very supportive of our growth strategy. This week, we converted our $20 million term loan to a revolving line of credit that has enabled us to reduce our total debt from $20 million to less than $12 million. It is noteworthy that we achieved the strong fourth quarter growth results despite the additional burdens under which we operated over the past year by amending our bylaws, negotiating the bank agreement, as well as facilitating and subsequently integrating a substantive acquisition. Despite these nonrecurring events, our team delivered financial performance that maintained our track record of steady profitable growth. Our goal now is to leverage this momentum to sustain this growth over both the near and longer term organically and through additional acquisitions. To that end, we have several plans in motion. Organically, we have plans to continue further product innovation and to sustain our high level of investment in research and development, especially in the area of cockpit automation that will ultimately lead to single-pilot operations in large transport aircraft. Our value proposition is to focus on products that continue to reduce pilot workload and improve safety. For instance, we plan to add capabilities to existing technologies, such as our flat panel displays to include automated emergency checklists and pilot alerting systems. We expect these technologies to serve as stepping stones that will help prepare the market for single-pilot flights in air transport aircraft. We were recently awarded a development contract for the second generation of UMS for Pilatus. We expect that second-generation technology will expand capabilities such as AI and improved versatility of the UMS. In the process, we anticipate this will create new platforms that can be adopted for other aircraft and eventually constitute another step along the path to autonomous flight. In order to maintain our leadership in the cargo retrofit business, we are in the process of adding new features to our products that we expect would allow an increase in content and selling price, protecting this business' overall revenue in the face of any potential slowdowns in the cargo conversion market. Our autothrottle OEM business has continued to do well with Textron, and we have continued to pursue additional platforms in the military and regional airline markets. Across the board, we are increasing our business development activities by working to grow our sales and marketing group, both domestically and internationally. The acquired Honeywell products have put us in front of a new set of buyers, which we believe our sales team can use that relationship to introduce them to our broader range of products. Secondly, we plan to leverage acquired technologies to enhance and expand our product offerings. As an example, with the Honeywell product lines, we now have our own radios and adjacent technology capabilities we previously had to buy on the open market to integrate into our products. Acquisitions such as this are complementary to our existing product portfolio and will likely accelerate our ability to develop new technologies needed to eventually achieve autonomous flight. As a direct result of this acquisition, we believe that we are on pace to achieve annualized 40% top-line growth once the Honeywell integration has been fully completed. Those integrations are making steady progress. As planned, this quarter and next we are moving inventory, installing the purchased equipment in our facility, and training our employees. Having anticipated some of the disruptions arising from the integration over the first and second quarters of FY 2024 and by customer requests, we accelerated some of the deliveries into the September 2023 quarter. Consequently, we expect results in the current quarter and the next to be weaker than the results of Q4 2023. As the second part of our growth strategy, we continue to evaluate other acquisitions and plan to execute additional complementary acquisitions as these opportunities arise. Thank you for your time and interest. We look forward to updating you in the upcoming quarters. Now I will turn the call over to Rell for a closer look at the numbers.
Rell Winand, CFO
Thank you, Shahram, and thank you all for joining today. I will review our financial results for the fourth quarter and full year of fiscal 2023. Revenue in the fourth quarter was up 79%, primarily due to the contribution from the sales of products purchased and licensed from Honeywell. As Shahram noted, revenues in the fourth quarter included the pull forward of Honeywell products, some of which would have otherwise been delivered in the first and second quarters of 2024. Work was accelerated in the September quarter to meet our delivery commitments before production that was anticipated to be slowed by the movements of inventory and equipment, as well as other disruptions that are typical when undertaking an integration of this size and complexity. As a result, we expect results in the current quarter and next to be weaker than the results of Q4 2023. Fourth quarter gross margin was 62%, a sequential improvement from the third quarter and unchanged from the same quarter a year ago. Margins reflect both the better absorption of our fixed overhead as a result of revenue growth as well as the impact of the margins of the Honeywell products. In the fourth quarter of fiscal 2023, research and development expense increased in absolute terms consistent with our commitment to innovation, but decreased relative to sales. As Shahram previously mentioned, we anticipate that research and development will continue to increase as the company works to develop new features and capabilities for our existing product base. As the Honeywell product line integration continues into the spring, we expect expenses to remain somewhat above what we would see as our normalized run rate. The fourth quarter of fiscal 2023 increase in selling, general, and administrative expenses reflects one-time costs associated with the Honeywell transaction, including the higher legal, accounting, professional fees, and amortization expense. In addition, selling, general, and administrative expenses in the fourth quarter of fiscal 2022 were reduced by $1.2 million due to a gain on the sale of the company's PC-12 aircraft. Interest income was up in the quarter due to an increase in interest rates on our interest-bearing cash deposits. Interest expense in the quarter reflects costs associated with the borrowings used to consummate the Honeywell transaction. We expect interest expense to trend down, not only as interest rates are anticipated to fall, but also due to our continued pay-down of these borrowings under the terms of the revolving facility. Tax expense in the fourth quarter of fiscal 2023 was $0.7 million compared to $0.76 million in the fourth quarter of 2022. Fourth quarter net income was $2.6 million or $0.15 per share, up from $1.7 million or $0.09 per share in the fourth quarter of fiscal 2022. Backlog at September 30, 2023 was $13.5 million and new orders in the fourth quarter of fiscal year 2023 were approximately $12.7 million. As always, quarterly orders can vary due to a number of factors that are not meant to provide an indicator of future revenues. Virtually all the Honeywell revenues are from intra-quarter book and ship orders that are not included in the backlog. Cash at September 30, 2023 was $3.1 million, up about $500,000 from June 30th. Over the three months ended September 30, 2023, we also reduced our term loan debt by $500,000. This week, the company converted its $20 million term loan into a $30 million revolving line of credit as it was combined with the company's $10 million revolving line of credit. Under the terms of the agreement, our cash balance will be swept daily against the outstanding revolver balance, thereby reducing interest expense. This revolving line of credit is expected to allow the company greater flexibility when the next acquisition opportunity presents itself. As previously noted, cash flow has continued to improve into the fiscal 2024 quarter, including the collection of a significant amount of receivables and the sale of the company's King Air aircraft for $2.3 million so that our current net debt position has been reduced to less than $12 million. For the year, the company generated $2.1 million of cash flow from operations. With that, operator, we're ready for questions.
Operator, Operator
The first question today comes from Theodore O'Neill from Litchfield Hills Research.
Theodore O'Neill, Analyst
A couple of questions, and you may have covered this first question in your presentation when you announced the acquisition of the Honeywell business. As I was looking through the unaudited pro forma combined statement of operation for the acquisition, there wasn't anything in there for R&D. And I was wondering what impact the acquisition is going to have on R&D expense going forward and then more broadly, its impact, the Honeywell integration impact on margins and SG&A?
Shahram Askarpour, CEO
I will address your first question. Initially, there will be a minor impact on R&D for the first year. As we modify some of the equipment designs to better align with our systems, this will require some R&D efforts. However, these will not be substantial amounts and will be included in our ongoing R&D programs.
Rell Winand, CFO
G&A will be slightly higher. We're still facing audit and legal fees. Although it's not as high as it was in the fourth quarter, it will still be a bit elevated.
Theodore O'Neill, Analyst
Rell, can I read anything into this increase in accounts receivable from year-over-year?
Rell Winand, CFO
Cash receivable depends on the timing of when we ship our products. We had a lot of shipments that went out later this quarter, and some of our vendors or customers have payment terms of 45 days. We've been collecting the receivables, which has positively impacted this quarter. However, this situation is somewhat unusual for us and primarily relates to timing.
Theodore O'Neill, Analyst
And then the customer concentration for the year, is that going to change much with the acquisition?
Shahram Askarpour, CEO
Concentration of the customers…
Theodore O'Neill, Analyst
Yes, like your top five customers…
Shahram Askarpour, CEO
Yes, to some extent, it will. I think there will be a couple of major customers that will serve as channel partners, and we will get everything approved. So it will change.
Operator, Operator
The next question comes from John Moran with Robotti & Co.
John Moran, Analyst
First question is just around the net debt number that you're reporting in your quarter. And is that a sustainable level relative to the new size of the business absent any acquisitions or is that going to go up and down…
Rell Winand, CFO
It depends. Yes, it will hopefully go down as we're profitable and generate more cash, which will continue to decrease. I just provided a snapshot of our current position. As we generate more cash, it will lower until we potentially borrow again. Our plan is to regularly manage our cash efficiently, so we expect it to keep decreasing.
Shahram Askarpour, CEO
I mean we still…
John Moran, Analyst
So am I oversimplifying it to read into it that you've generated $8 million in cash since the closing of the deal?
Rell Winand, CFO
This quarter, as I reviewed receivables, we sold a plane, which means you're transitioning from September 30 to the present.
Shahram Askarpour, CEO
Meanwhile, we're spending money like… lawyers and accounting on three years of Honeywell's books. Honeywell is a big company…
John Moran, Analyst
I had another question about the backlog and the orders you reported for the legacy business this quarter. It appears to have increased significantly compared to last year. Can you share what might be driving that change?
Shahram Askarpour, CEO
Our previous organic product lines still differ this year, and we've secured a significant new contract with Pilatus, which ensures our platform's stability for another 15 to 20 years.
Rell Winand, CFO
And some of the OEMs give us POs in advance…
Shahram Askarpour, CEO
And they gave us a PO. So it was this quarter.
John Moran, Analyst
But that number, I don't have it right for me. So they were $12 million and $13 million, I can't remember what's backlog and new orders or something like that. I mean that was running at 7%, 8%, 9%, that's mostly related to Pilatus?
Rell Winand, CFO
A lot of it is.
Shahram Askarpour, CEO
A lot of it is, not all of course, but…
Rell Winand, CFO
You got Textron. I mean it's a combination, but volume is modest.
Operator, Operator
The next question comes from Andrew Rem with Odinson Partners.
Andrew Rem, Analyst
Can you provide more detail on the revenue? Specifically, how much of it came from legacy sources versus the contribution from Honeywell?
Shahram Askarpour, CEO
It's kind of hard to do that on this call right now. I think our…
Rell Winand, CFO
Yes, we'll have to break it up…
Shahram Askarpour, CEO
There will be note within that as to the exact contribution of the Honeywell.
Andrew Rem, Analyst
You guys can break that out in the 10-K, is that…
Shahram Askarpour, CEO
That's right, that’s where it's going to go…
Rell Winand, CFO
Yes, we need to finalize the 10-K for this year, and I believe that moving forward, everything will be unified.
Shahram Askarpour, CEO
Believe it or not, the auditors are still working on it. So I never imagined it would be that hard.
Rell Winand, CFO
Everything is hard…
Andrew Rem, Analyst
On R&D, can you guys maybe just give updated guidance. Last year, I think you guys said you wanted to kind of push R&D to kind of 13%, 14%. But given the Honeywell, it doesn't sound like it will necessarily consume a lot of R&D resources. But can you maybe just reframe how you're thinking about R&D?
Shahram Askarpour, CEO
So I guess 13% of a certain amount is still less than 10% of around $40 million. Therefore, as a percentage of revenue, our R&D percentage will decrease, which in dollar terms means we will be increasing the size of our engineering department and using some of the revenues from these Honeywell products to support our internal growth strategy.
Rell Winand, CFO
So it will go higher in absolute terms. But as a percentage of sales growing, that's going to be faster than the increase than you would see. So you'll see that relationship go down.
Andrew Rem, Analyst
In the fourth quarter, could you provide a breakdown of what appears to be some short-term or one-time related items?
Rell Winand, CFO
Well, it's kind of what I said here, but yes, a little bit more detail. In the MD&A, the comparison, it will be addressed in there, yes.
Shahram Askarpour, CEO
I think the Q4 was just over $1 million of one-time expenses in this Q4…
Rell Winand, CFO
And so really if you look at it, as the difference, if you add $1.2 million back and look at it, that's really the…
Shahram Askarpour, CEO
It's $5 million. And I can imagine the quarter that we are in is not going to be any better either.
Rell Winand, CFO
It will be as high but it will be more than…
Andrew Rem, Analyst
And then can you guys give an update in terms of on the integration kind of what have you completed and what is left to do?
Shahram Askarpour, CEO
One of the product lines is fully operational. Our team is trained and we are actively executing on the radio side. For the IRU side, the transfer of equipment and training will take place after the holidays because that product line primarily serves the air transport market. Airlines were hesitant to proceed in November and December, fearing it could disrupt their peak season. Our team collaborates daily with the Honeywell integration team, assessing customer requests constantly to ensure smooth operations. The slowdown this quarter was partly due to the need to pack and move test equipment and inventory, ensuring proper setup here. Our team will finalize training during this period without any activity occurring.
Rell Winand, CFO
Which is why the pull forward in Q4.
Shahram Askarpour, CEO
And the same thing is going to happen next quarter in the January to March quarter with the IRU stuff, where, again, they have to be act and set up over here, that's the process.
Operator, Operator
Next question comes from Doug Ruth with Lenox Financial Services.
Doug Ruth, Analyst
I have three questions. What is the company's relationship now with the Hedrick family?
Shahram Askarpour, CEO
So they have the dependent trust that are managed by different people within the Hedrick's family that each own some number of shares. And the state also owns some shares. But none of them are, I guess, significant enough to have reporting requirement on them, they're below the threshold and they all managed by different people. So that's the way it is.
Doug Ruth, Analyst
So there's no representation on the Board of Directors, and there’s not too much of a relationship with any family member at this point then?
Shahram Askarpour, CEO
No, Geoff passed already…
Doug Ruth, Analyst
And then the second question is the relationship with the large shareholder, Christopher Herborne. Is he involved, is he asking for a Board seat or is there any interaction with the company and his entity?
Shahram Askarpour, CEO
No, it hasn't… business relationship… but if we ever have any conversation it's always regards to that business.
Doug Ruth, Analyst
And then the final question. Are the Board members and the management team, are you folks eligible to buy stock at this point in time or are you in a blackout period, maybe you could offer some advice there?
Rell Winand, CFO
The blackout period lasts for 15 days before the end of the quarter, and it is lifted on the third business day after the quarter ends, at which point earnings are disclosed.
Operator, Operator
Your next question comes from Roger Goldman, a Private Investor.
Unidentified Analyst, Analyst
First of all, congratulations, really well done. This seems like it's going exactly according to the way you told us it would go. And in that connection, any surprises so far with the integration, either good news or bad news?
Shahram Askarpour, CEO
Surprises, from my end, it's navigating a large company and the level of difficulty it builds, I knew it was going to be a challenge, but it's internal communications within Honeywell. You're talking to a group of people that you signed an agreement with and we all understand what it is. But then at the end of the day, you're getting information from some guys down there some and they have their own opinion.
Rell Winand, CFO
A lot of levels, a lot of layers…
Shahram Askarpour, CEO
A little bit harder. But I think we've learned a lot of lessons here this time around that in better ways of making this happen smoothly. Having said that, we're told by folks at Honeywell that this has been by far the smoothest transition that they've done with any of these.
Unidentified Analyst, Analyst
Well, a lot of people and companies have made a lot of money doing just what you're doing, which is unencumbering a division from all the corporate, I don't want to say nonsense, but all the corporate structure inherent in being a small division of a big company. And sometimes, there are financial surprises, sometimes good, sometimes bad, that don't rise to the level of, oh, we've got to redo the contract or we've got to walk away. But nonetheless, they're kind of shocking. And what I'm hearing you say is it's more difficult managerially, but financially, it's right on target.
Shahram Askarpour, CEO
We have not had any negative surprises on the finance.
Unidentified Analyst, Analyst
That's a good way to say it, I understand. Also, I wanted to ask about the bank financing. It seems like you're generating a lot of cash and using it to reduce a significant amount of debt. The bank would likely be supportive if you pursued another acquisition, even if your debt increased substantially again.
Shahram Askarpour, CEO
Yes, actually, the conversation with them, they would be very happy to provide us based on the EBITDA of the next business that we will... term loan for that EBITDA that then later on we can convert to the line of credit. So they've been very supportive.
Unidentified Analyst, Analyst
And you're going to save probably $0.5 million to $1 million in interest this year. So good job on that. And do you feel that you have the management to make another acquisition in the next year?
Shahram Askarpour, CEO
Yes, we do.
Unidentified Analyst, Analyst
I was hoping for a really simple answer like that. And last question is, I know Mike left, anything there we should know or…
Shahram Askarpour, CEO
I think related to the company, it was a personal decision.
Unidentified Analyst, Analyst
All right. Good. And thanks for stepping back in, this is a critical time for the company. Critical, critical time. Anyway, I just want to end by saying, as you guys know, I've been, first, my dad and now my sister and I have been longtime shareholders, and this is what we've been hoping for, for years and years. So just well done. Well done, you guys are on your way to something really building a fabulous company here.
Rell Winand, CFO
Thank you for your support.
Shahram Askarpour, CEO
Thank you very much.
Rell Winand, CFO
Have a good one. Happy holidays.
Operator, Operator
This concludes our question-and-answer session and concludes the conference call. Thank you for attending today's presentation. You may now disconnect.