Innovative Solutions and Support Inc. Q2 2023 Earnings Call

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

Thank you operator, and good afternoon, everyone I would remind our listeners that certain matters discussed in the conference call today, including information about new products and operational and financial results for future periods are forward looking statements that are subject to risks and uncertainties that could cause actual results to differ materially.

<unk>, either better or worse from those discussed including other risks and uncertainties reflected in our company's 10-K, which is on file with the SEC and other public filings.

Now I'll turn it over to our CEO , Sean I'm asking for.

Thank you, Mike and good afternoon, everyone.

I will begin today with remarks on our performance in the fiscal second quarter of 'twenty to 'twenty three.

Followed by comments on our long term growth plan.

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I will then turn the call over to Mike, who will take us through the financials.

Our second quarter results demonstrated continued momentum of our business and elevate good demand for innovative products.

Compared to the prior year, our net sales were up seven 2%.

Two $7.3 million.

This improvement was driven by the higher volume of our aftermarket products.

<unk> or Oracle for the King Air.

I would like to remind our investors and stakeholders not to over analyze our quarterly performance.

It can be subject to variation in purchase order timings.

Our aftermarket products.

Currently represent approximately 40% of our revenue.

While we are pleased with our strong performance. This quarter. It is crucial to take a more comprehensive and long term view of our financial performance and growth.

As we have reported on in the past our business is well positioned to benefit from significant operating leverage on higher sales, which was demonstrated again in the second quarter.

As such.

Gross margin expanded to 64% from 61% in the prior year, primarily due to leverage on higher volume and a favorable product mix.

Operating profit in the current quarter was $1 4 million, which was 380 K lower than the previous year.

The discrete the decrease in operating profit was primarily due to higher SG&A expenses, which were mostly one time in nature and related to noncash stock based compensation and relocation expenses.

Turning to net income.

We achieved $1 3 million, which is a slight decrease from the prior year of $1 4 million.

For the same reason.

As we continue to invest in our sales and business development and they should it's you are experiencing strong return indicated why our end of the quarter backlog of 14.8 million a significant increase from a year ago.

Driven by new orders up $13 6 million in the Florida.

Record in recent years.

Moving forward.

Our goals are clear.

We want to increase facility utilization to maximize a marginal margin potential.

Yeah, I have a two pronged approach to achieve this goal.

Through organic growth by driving new product introduction.

And through inorganic growth via M&A.

Support our organic growth, we continue to invest.

N D programs.

Although our R&D as a percentage of sales is still below our full year target of 13%.

Yeah anticipate meeting got hard that well not annualized basis.

We continue to expand our engineering department collectively with highly qualified and self motivated engineers.

We believe that investing in our R&D is critical for long term success and we remain committed to this approach.

Specifically, we remain focused and see our primary competitive advantage in the area of cockpit automation.

You have seen with the introduction of broad market success of our Oracle all the programs.

Our long term plan is to provide the industry with.

Mentor automation technology that would ultimately lead to reduction in number of pilots and aircraft.

Did that end I'm pleased to announce that we have shipped an initial order under our recently awarded S. T C for the thrusters Oracle for the Beechcraft King Air 200, or 300 aircrafts.

With the GOG cockpit.

He said application has a lab process to be installed.

Well not an additional 700 potential platforms.

On the inorganic side, you are actively seeking opportunities for M&A and not been working diligently to develop a robust pipeline.

During the quarter, the amazing proven important progress by obtaining shareholder approval.

A man our articles of incorporation.

Strategic action will enable us.

To secure the financing needed to implement a more aggressive M&A program and <unk>.

Execute to all.

Our long term goals.

Does. This then you are currently working closely with our banking team to evaluate the best structures for our needs.

And we plan to keep our investors informed of our progress in upcoming quarters.

And our M&A programs are focused on identifying and acquiring complementary products and technologies to our existing portfolio.

You are targeting smaller bolt on acquisitions that are under 25 million.

Our goal is to expand our portfolio and fill capacity in that facility.

We believe that these targeted acquisitions.

Allow us to do so efficiently and effectively.

We are constantly evaluating potential acquisition targets.

Look forward to providing incremental updates in the coming quarters.

In summary, we believe that our performance in the second quarter demonstrate continuous momentum and strong demand for innovative products.

Moving forward, we have clear goals to increase our facility utilization and maximize our margin potential through both organic and inorganic growth.

Thank you for your time and interest and we look forward to updating you with future details in the upcoming quarters.

I'll turn the call over to Mike for a closer look at the numbers.

Thank you Sir and thank you all for joining US today I will review our financial results for the second quarter of fiscal 2023.

Our revenues were seven 2% higher at seven 3 million in the second quarter compared to $6 eight in the second quarter of fiscal 2022.

The growth was largely driven by new orders from commercial air transport customers and the Boeing 757, and 767 aftermarket retrofit business.

An increase was also seen.

Due to new auto throttle installations.

As we noted during our last earnings call orders and the aftermarket retrofit business fluctuate from quarter to quarter.

Since it is approximately 40% of our business, our overall revenues may fluctuate from quarter to quarter.

This quarter results for example reflect certain orders that were carried forward into the second quarter, but were originally expected during the first quarter.

While we do not anticipate any significant changes in our long term organic growth trajectory of our business. We believe that our progress should be evaluated on an annualized basis.

Second quarter gross margin was 64, 6% compared to 61.1 in the second quarter period from a year ago. The.

The improvement in gross margin reflects an expansion in operating leverage as a result of higher product sales a.

Favorable product mix and.

An increase in inventory and a slight decline in direct material costs.

The gross margin improvement is very much in line with what we have previously mentioned our optimized operating model is based on a fixed cost platform with relatively low employee head count with operating leverage and margin profile well position to benefit from revenue growth.

We plan on continuing to see additional operating leverage as sales continue to grow.

Operating profit in the current quarter was $1 4 million or 19, 4% of sales, which was lower than the previous years 1.8 million or 25, 4% of sales.

Total operating expenses were $3 3 million in the second quarter versus $2 four in the prior year second quarter.

The rise in operating expenses were primarily primarily related to higher SG&A.

These expenses included noncash stock based long term incentive compensation.

<unk> were also higher as a result of additions made to the sales and business development teams as well as marketing Investor relations and investor facing related expenses.

Higher SG&A expenses were partially offset by higher interest income generated due to larger cash balance and higher interest rates compared to the same period in the prior year.

R&D expenses of 11, 8% of revenue.

And in line with a year ago second quarter levels, we still expect to spend 13% of our revenue on R&D by the end of the year and continue to hire engineers to support product development efforts.

Tax expense in the second quarter was zero point $3 million compared to zero point $4 million in the prior year quarter.

Second quarter net income was 1.3 or eight cents per share versus $1 4 million or <unk> 10 per share in the second quarter of fiscal 2022.

Net income was $1 3 million.

Or seven cents per diluted share down slightly from the prior year of $1 4 million or eight cents per diluted share.

Backlog was $14 8 million as of March 31, 2023 versus only 7.5 as of March 31 2022.

New orders for the second quarter were $13 6 million.

The increase was largely due to customers walking in orders for a longer period of time, such as pull out of who is order through late 2024. Additionally.

Additionally, Boeing has give us, giving us larger long term orders as well.

And these factors have largely contributed to the growth in our backlog.

Our customers' confidence in us as reflected in these longer term orders, which in turn also enhances our visibility for future performance.

We include only purchase orders in hand from the Pilatus PC 24, Textron King Air.

And the KC 46, eight long term programs in our total backlog.

We anticipate that these programs will remain in production for about a decade and should continue to add two production sales already included in the backlog.

We had $19 8 million of cash on hand as of March 31, 2023.

Up from $19 4 million of cash on hand as of December 31, 2022.

Cash on hand was $11 6 million as of March 31, 2022.

The company generated cash flow from operations of <unk> 4 million during the quarter.

Our cash generation was impacted by the new IRS section 174, R&D tax regulations that increased our estimated tax payment by approximately zero point $4 million.

An inventory build of 0.6 million zero point $3 million due to timing of accounts receivable payments received.

We continue to generate cash flow and grow our cash balance without any debt on our balance sheet.

This provided us with significant financial strength and flexibility as we seek to execute.

On our organic and inorganic opportunities going forward and deliver returns to our internal and external stakeholders.

For the remainder of fiscal 2023, we anticipated generating strong cash flows with similar or higher gross margin levels as capacity utilization and operating leverage expand against the backdrop of revenue growth from organic and inorganic opportunities.

With that operator, we are ready for questions.

Yeah.

Thank you.

Ill be conducting a question and answer session.

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One moment, please while I would pull for questions.

Our first question comes from Tim more lease D. F. Hilton. Please go ahead.

Thanks, and congratulations on the strong orders catch up in the quarter and it was nice to see the backlog up 74% sequentially from December and double from a year ago.

Impressive strong book to Bill you know I do appreciate you you're guiding to.

Thinking of everything maybe on a 12 month rolling basis, but it was still in passive.

So my first question is I know you elaborated a bit on the gross margin, which was amazing in the corner.

It was most of that caused by the mix was there more aftermarket sales there or was it more caused by the operating leverage benefit I'm just trying to wrap my head around maybe the main drivers of that margin expansion.

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

Great that's helpful.

And.

I just wanted to follow up on <unk>.

You were giving good clarity on this maybe.

SG&A expense from what I recall.

Paul.

There was a bit more pressure on it in the first half of the fiscal year.

Which you just reported.

Because there were some one off professional expenses you know banking fees may be legal fees.

And some catch up when you kind of think about the year as a whole for this this year.

We should probably expect SG&A as a percentage of revenues to drop in the second half of the year right compared to the first half of the year as you roll off a couple of things that that's that's correct here in Q1, you'll see a COO.

Q1, and Q2 and into the first six months, you'll see SG&A.

Roughly around the 30 low 30% of sales compared to our traditional run rate of about 26% in Q.

Q3, and Q4 that'll be closer to our historical run rate with the with the elimination of some of those one time impacts of what we will be roughly roughly running 27 ish percent, finishing the year, probably a few basis points a few points above our typical run rate of around 30%.

But definitely we see a relief coming in in Q3 and Q4.

Thanks, that's really helpful. As I do my modeling I just wanted to check that.

Yeah that will show up nicely.

Operating margin expansion.

What about.

You know I know that you're spending more on R&D and you're focusing still on your continued product development.

It's always been.

Core of innovative solutions to support can you speak to any kind of the timing of any developments I remember reading last month about the helix flight decks announcements and you know what I think theres probably could be some cargo.

Instruments and innovation coming do you kind of give us a sneak peek of maybe some new things are you know.

Adjacencies that are maybe in the pipeline over the next year.

Sure, Yeah, and actually to your to your first question also the.

It happened.

Investing in our business development and sales organization.

Two to essentially it starts there wherever they would go to the top line. So some of the increases in the SG&A.

From tradition.

It will be slightly higher because it was hot you know there's lots of good capable sales and marketing guys to help us grow the business.

With regards to product development again.

Our ultimate goal for probably like the hope then is to get to the point, where you start reducing number of pilots.

In our in the cockpit that that has that has it significantly lucrative business case.

And but but in order to get that we've taken that incremental approach that we would have rather would develop products that would get us there and in a series of steps and that way. We can we can continue to innovate.

And generate revenue.

By increasing yeah.

Automation in the cockpit, reducing the pilot workload to a point, where you will get that that that you know not maybe on some of these part 25 aircrafts that are it will be clear that there's no need for a second pilot and so so that's our goal and Meanwhile, we will generate new products and reduce pilot workload.

And increase safety.

And those are marketable product and that's our main strategy for product development.

Also look at developing products that will replace some of the existing.

Obsolete components in the aircraft we've done that traditionally right. So the closest thing I've coming which we believe we should get that certification completed that in this fiscal year is the.

Is the engine crew alerting system for the 75767.

We also continue.

Getting <unk>.

Certifications in terms of our installation team and we'd be expanding that part of our business.

What we call a mobile installation teams and adding.

The nations that we can do more and more of our products and maybe other people's products.

Installed.

And in this in this way that we're doing because my reaction, they're going to customers and doing it.

Their sight saving them a lot of trips back and forth.

And and saving them back a good amount of cost so our focus is on those areas.

We continue.

Developing new futures for Europe . So we are that that leave that recently also certified two of those which are aimed for the military side of the oral thrall and ER and that they they have resulted in a in some good interest from our.

From a military and government customers.

That's very helpful. I appreciate that color.

Another catalyst.

For your stock and your company and I know you mentioned this in your earlier remarks is increasing that capacity utilization have you or Mike come up with.

Maybe a rough estimate of how high maybe your incremental gross margins could be when you reach.

A larger sales inflection point, whether it's.

Through organic or inorganic you know when you get to something like a $40 million annual sales rate cause the incremental gross margins be.

About 70% 75%.

Yeah, Tim and that's.

It is sales.

Sales increase in the margin and will increase the right along with it.

We were just modeling this just last week and you know $50 million in sales is going to get us over 30% EBITDA. So that'll that'll continue to grow on that EBIT numbers only.

Around 20% projected for this year on them, you know roughly $20 million less in sales so.

We do see that increasing quite a bit as sales grow.

Great that's helpful. So.

50 million in sales, 30% EBITDA margins is that what I heard correctly.

Yes, I think we will approach 30% once we once we get about $50 million.

Great now that makes sense that you have so much incremental leverage on that facility. If I remember its something like a third utilized right now the levels.

Just my last my last question and I know.

Sure.

You've mentioned this some of your remarks, you know about acquisitions and it was really nice to see that that's shareholder approval go through last week for the majority vote for flexibility.

You mentioned, you know under $25 million bolt on targets given your cash balance you know it seems like.

Any acquisition we make.

Be accretive are nicely accretive.

I realize you're probably just in the early stages, maybe a pipeline, but are you starting to see are in counter.

Reasonable asking valuations out there or are you maybe not at that stage I'm. Just wondering you know as the economy cooled off a little bit last year that maybe some of the sellers are getting more reasonable what they want for multiples or valuations.

Well I think what we've seen is that kind of the high multiples is driven by a lot of the venture capital that's out there.

Gone by I guess.

People, who don't have to worry about.

Well, it's going to happen to yes to that product line.

They just kind of accumulating these things and then they're gonna send it off to somebody else it would be somebody else's problem.

We look at the long term are approaching them.

Obviously.

We are not going to do we're not going to try to compete with that unfortunately, it seems like in our products and.

The aerospace industry.

Even though the car.

Kind of the capital market is tightening up theres still a strong venture presents a bunch of money presence right.

In the aerospace industry, and that's because of the stability of the industry and the fact that today.

We have both.

The defense.

And.

Yeah, that's the kind of the.

Aerospace market.

Both of them are strong.

The Oems are.

Long waiting list for new aircraft.

Obviously, we are pumping a lot of money into defense.

And that gives us gives the I guess the yet.

There's some level of confidence that our that that they're not going to be too far off the mark and what the multiples are there I mean.

The average multiple now they talk about in our industry is about seven five times, even though.

Uh huh.

What kind of Oh.

That's yeah, that's where we are.

But there are a lot of the times finding the right product line.

What would help us with help us justify.

As long as we see that within our P&L that acquisition.

Yield a similar gross margins as our products do.

That kind of makes it beneficial to us.

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

Thank you Tim Thank you.

Sure.

There are no further questions at this time.

This concludes today's teleconference. You may disconnect. Your line at this time. Thank you for your participation and have a great day.

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