Innovative Solutions and Support Inc

NASDAQ:ISSC

Earnings Call Analysis

Strong Q4 Revenue Growth and Optimism Despite Challenges

This quarter witnessed a stellar revenue increase of 79% with net income growing by 63%, marking the fifth consecutive year of revenue expansion. The gains are credited to organic growth, strong sales, and the strategic acquisition of Honeywell products, fueling consistent cash flow and enabling a substantial debt reduction from $20 million to less than $12 million. Looking ahead, the integration of Honeywell is expected to slow down output in the next two quarters, yielding weaker results compared to Q4 2023. Nevertheless, management is optimistic, projecting an annualized 40% top line growth following the completion of the Honeywell integration.

Robust Revenue Growth and Cash Flow

The company has experienced a remarkable revenue increase of 79% for the quarter, buoyed by organic growth and a full quarter of Honeywell product sales. This strategic acquisition not only contributed to top-line growth but also supported strong margins comparable to last year. Net income climbed by 63% from the previous year, marking the fifth consecutive year of growth, solid cash generation, and increased earnings.

Strategic Acquisition of Honeywell Products

The acquisition of Honeywell's product lines is a significant milestone, propelling the company into new markets and expanding its product portfolio. The company now possesses its own radios and adjacent technology that were previously sourced externally. By integrating these products, the company is on track for an annualized top-line growth of 40%.

Financial Flexibility and Debt Reduction

Management has maintained strong financial discipline, converting a $20 million term loan into a revolving line of credit and reducing total debt to less than $12 million, underlining their strategic financial management. The company's cash position stands at $3.1 million, an increase of $500,000 from the previous period. Additionally, term loan debt was reduced by $500,000 over the recent quarter. Operational cash flow for the year was $2.1 million.

Short-term Disruptions Anticipated

The company foresees weaker financials in the forthcoming quarter and the next due to the integration of Honeywell products and the deliberate acceleration of deliveries to preempt integration disruptions. With significant upfront costs incurred for legal fees, auditing, and training related to the acquisition, G&A expenses have risen, and similar elevated costs are anticipated in the current quarter.

Maintaining Innovative Edge

Continuous innovation is central to the company's strategy, aiming to improve aircraft automation and safety, which would serve as a precursor to single-pilot flights. The company is also enhancing existing products to maintain its leadership in the cargo retrofit business and is actively expanding its sales and marketing to bolster growth.

Good News on Integration, Management Confident for Future Acquisitions

Integration of Honeywell product lines is pushing ahead smoothly, without financial hiccups. The management team feels equipped to pursue another acquisition if opportunities arise, further indicating their confidence in the company's strategic trajectory.

Guidance for R&D and G&A Expenses

R&D expenses are set to grow in dollar terms but decrease as a percentage of revenue, thanks to the growth provided by the Honeywell products. G&A expenses will be somewhat elevated due to ongoing costs associated with Honeywell's integration but are not expected to be as high as in the previous quarter.

Earnings Call Transcript 2023-Q4

[Operator]

Welcome to the Innovative Solutions & Support Fourth Quarter and Year-End Fiscal 2023 Financial Results Conference Call. [Operator Instructions]. 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, executive]

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.

[Relland Winand, executive]

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 in it describes 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, executive]

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 reduce 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 the full year earnings. Our cash has also enabled further paydown of our borrowings in the current quarter despite the heavy onetime significant expenses incurred for auditing fees, legal expenses, and 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 on the 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 improved 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 cargo retrofit business, we are in the process of adding new features to our products that we expect would allow 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 the Q4 2023.

As the second part of our growth strategy, we continue to evaluate other acquisitions, opportunities 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.

[Relland Winand, executive]

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 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 the 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 to 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 reflect onetime costs associated with the Honeywell transaction, including higher legal, accounting, professional fees and amortization expense. In addition, selling, general and administrative expense in the fourth quarter of fiscal 2022 was 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 revolver 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 30. Over the 3 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 our $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 Instructions]. 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, it's impact the Honeywell integration impact on margins and SG&A?

[Shahram Askarpour, executive]

So I'll get your first question. It's going to be very -- at least initially for the first year is a little impact on the R&D. Going forward, as we're going to modify some of these equipment that we -- let me put this, we're going to modify some of the designs to make it more suitable to work closely with our equipment. It will require some R&D, and those are not significant amount of dollars. There will be part of our R&D programs that we run .

[Relland Winand, executive]

The G&A. Yes. So G&A will be up a little bit. We're still incurring audit fees, legal fees relative to -- it's not what it was in the fourth quarter, but it will still be somewhat a little bit elevated, yes.

[Theodore O'Neill, analyst]

Okay. Rell, can I read anything into this increase in accounts receivable from year-over-year?

[Relland Winand, executive]

Yes. So the cash receivable is -- it all depends on when you ship things out, right? So we had a lot of later shipments. We had a big quarter and the shipments went out later and some vendors or customers are 45 days. So we've been collecting it all. So that's really, as I said, helped in this quarter, but it's a little atypical for us, but it's a matter of timing. .

[Theodore O'Neill, analyst]

Okay. Yes, it makes sense. And then the customer concentration for the year, is that going to change much with the acquisition?

[Relland Winand, executive]

Concentration of the customers?

[Theodore O'Neill, analyst]

Yes, like your top 5 customers.

[Shahram Askarpour, executive]

Yes. To some extent, it will. I think there's going to be a couple of major customers being the channel partners that are going to -- that we're going to get it all approved. So it will change.

[Operator]

The next question comes from John Moran with Robotti & Co.

[John Moran, analyst]

The 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 up and down...

[Relland Winand, executive]

It depends. Yes, it will go hopefully down as we're profitable and generate more cash, it's going to continue to come down. So I just gave you a snapshot of where we are relatively now. But as we generate more cash, it's going to become lower and lower if we borrow again. But to sweep our account, our cash and just net-net-net all the time. So we expect it to keep decreasing.

[Shahram Askarpour, executive]

Yes. 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?

[Relland Winand, executive]

Mostly this now, this quarter now. When I recollected receivables, we sold a plane. So it's really -- you're taking it from 9/30 into the now.

[Shahram Askarpour, executive]

Meanwhile, we're spending money like [indiscernible] on lawyers and account [indiscernible] on 3 years of Honeywell's books. Honeywell is a big company [indiscernible].

[John Moran, analyst]

The other question I had was around the backlog and the orders in there that you're reporting in the quarter for the legacy business. That does seem up fairly dramatically from where you were a year, just what that's been -- I know it's gone up and down. But is there something driving that, in particular?

[Shahram Askarpour, executive]

I mean, our kind of the previous organic product lines, they yet to have a different -- this year, we've got a big new contract from Pilatus, which actually kind of guarantees us for another 15, 20 years on the platform...

[Relland Winand, executive]

And some of the OEMs, they give us POs in advance.

[Shahram Askarpour, executive]

And they gave us PO. So it's this is what it was this quarter.

[John Moran, analyst]

Yes. I'm sorry. So 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?

[Relland Winand, executive]

A lot of it is.

[Shahram Askarpour, executive]

A lot of it is.

[Relland Winand, executive]

You got Textron. I mean it's a combination, but volume is modest.

[Operator]

The next question comes from Andrew Rem with Odinson Partners.

[Andrew Rem, analyst]

Gentlemen, just on the kind of can you guys break out or provide a little bit more detail on the revenue? How much was kind of legacy versus the Honeywell contribution.

[Shahram Askarpour, executive]

It's kind of hard to do that on this call right now. I think our.....

[Relland Winand, executive]

Yes, we'll have to break it up.

[Shahram Askarpour, executive]

There will be note within that as to exact contribution of the Honeywell.

[Andrew Rem, analyst]

You guys can break that out in the 10-K. Is that?

[Shahram Askarpour, executive]

That's where it's going to go...

[Relland Winand, executive]

Yes, you have to -- I think the 10-K, we have to ending this year. And then going forward, I believe it will all be one.

[Shahram Askarpour, executive]

Believe it or not, the auditors are still working on it. So I never imagine it will be that hard.

[Relland Winand, executive]

Everything is hard.

[Andrew Rem, analyst]

Okay. Perfect. 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, executive]

Yes. So I guess 13% of [indiscernible] million is still less than 10% of $40-odd million. So as a percentage of revenue, our R&D percentage is going to go down, which in terms of dollar value, increasing the size of our engineering department and using some of the revenues that come from these Honeywell products to further our internal growth strategy.

[Relland Winand, executive]

Yes. 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]

Okay. And then also in the Q, will you guys break out some of these what sounds like kind of either short term or onetime related items, both in -- I guess in the fourth quarter specifically?

[Relland Winand, executive]

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, executive]

I think the Q4 was just over $1 million of onetime expenses in this Q4.

[Relland Winand, executive]

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, executive]

It's $5 million. And I can imagine the quarter that we are in is not going to be any better either.

[Relland Winand, executive]

It will be as high but it will be more than any of [indiscernible] sitting here [indiscernible].

[Andrew Rem, analyst]

Okay. 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, executive]

Sure. So one of the product lines is completely here. We've got our people train and we are actually performing on. And that's on the radio side. On the IRU side, we're going to do that in the transfer of move the equipment and the training and all of that, it's going to occur after the holidays. And the reason for that is that, that product line is mainly for the air transport market. And the airlines were very nervous in doing that in November, December time period because they felt that it may impact their busy period.

So we work -- our team works on a daily base with the Honeywell integration team. And we evaluate each one of these requests from the customers on a daily basis to make sure there's no disruptions in the operation. Obviously, this slowdown that occurred during this quarter because on the radio side, when you think about it, they had to pack all of these test equipment, inventory then make sure they were right, shift them here, unpack them here. There has to be a -- [indiscernible] team come here, make sure everything works, right? I'm doing on the final stage of training all people, during that period, nothing happens.

[Relland Winand, executive]

Which is why the pull forward in Q4.

[Shahram Askarpour, executive]

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.

[Andrew Rem, analyst]

Okay. All right. Well, great quarter, gentlemen. Thanks a lot.

[Operator]

Next question comes from Doug Ruth with Lenox Financial Services.

[Douglas Ruth, analyst]

Congratulations on the strong quarter. I have 3 questions. What is the company's relationship now with the Hendrick family?

[Shahram Askarpour, executive]

They have the dependent trusts that are managed by different people within the Hendrick's family that each owns 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.

[Douglas Ruth, analyst]

There's no representation on the Board of Directors, and they're not too much of a relationship with any family member at this point then?

[Shahram Askarpour, executive]

No, Geoff passed already from the [indiscernible] or be represented on the Board.

[Douglas Ruth, analyst]

All right. 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, executive]

No, it hasn't. I said [indiscernible] business relationship with [indiscernible] companies, whether supplier [indiscernible] but if we ever have any conversation it's always regards to the [indiscernible].

[Douglas Ruth, analyst]

Okay. 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?

[Relland Winand, executive]

On the blackout period, so 15 days before the end of the quarter is a blackout period and then you can -- blackout period is lifted the third business day and the earnings begin [indiscernible] you don't get anything until....

[Operator]

Your next question comes from Roger Goldman with Private Investor.

[Roger Goldman]

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, executive]

Surprises, from my end, it's navigating a large company and the level of [indiscernible]. 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.

[Relland Winand, executive]

A lot of levels, a lot of layers…

[Shahram Askarpour, executive]

[indiscernible] a little bit harder. But I think we've learned a lot of lessons here this time around out of this 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 [indiscernible].

[Roger Goldman]

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 -- 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, executive]

We have not had any negative surprises on the [ finance ].

[Roger Goldman]

That's a good way to say it. I hear you. Secondly, just I think the bank -- I was going to ask you a question about the bank financing. It sounds like you're generating a ton of cash and you're using it to pay down a ton of debt. The bank would be cooperative if you made another acquisition, and that debt went up again substantially.

[Shahram Askarpour, executive]

Yes. Actually, the conversation with them they would be very happy to provide us based on the EBITDA of the next business that we refine [indiscernible] loan for that EBITDA that then later on, we can convert [indiscernible]. So they've been very supportive.

[Roger Goldman]

Right. And you're going to save probably $0.5 million to $1 million in interest this year. So good job about that. And do you feel that you have the management to make another acquisition in the next year?

[Shahram Askarpour, executive]

Yes, we do.

[Roger Goldman]

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, executive]

I think related to the company, it was a personal decision.

[Roger Goldman]

Okay. 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.

[Relland Winand, executive]

Thank you for your support.

[Shahram Askarpour, executive]

Thank you very much.

[Relland Winand, executive]

Have a good one. Happy holidays.

[Operator]

This concludes our question-and-answer session and concludes the conference call. Thank you for attending today's presentation. You may now disconnect.