Innovative Solutions and Support, Inc. (NASDAQ:ISSC) Q4 2023 Earnings Call Transcript December 21, 2023
Innovative Solutions and Support, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
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: 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: 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: 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 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 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.
Rell Winand: 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 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 the 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 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.
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Q&A Session
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Operator: [Operator Instructions]. The first question today comes from Theodore O’Neill from Litchfield Hills Research.
Theodore O’Neill: 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: 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 equipments 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.
Rell Winand: 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: Rell, can I read anything into this increase in accounts receivable from year-over-year?
Rell Winand: 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: And then the customer concentration for the year, is that going to change much with the acquisition?
Shahram Askarpour: Concentration of the customers…
Theodore O’Neill: Yes, like your top five customers…
Shahram Askarpour: 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: 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: 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 until we — 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: I mean we still [Multiple Speakers]…
John Moran: 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: 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: Meanwhile, we’re spending money like [Multiple Speakers] on lawyers and account [Technical Difficulty] on three years of Honeywell’s books. Honeywell is a big company [Multiple Speakers].
John Moran: 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 or…
Shahram Askarpour: 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…
Rell Winand: And some of the OEMs give us POs in advance…
Shahram Askarpour: And they gave us PO. So it’s this is what it was this quarter.
John Moran: 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: A lot of it is.
Shahram Askarpour: A lot of it is, not all of course, but…
Rell Winand: 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: 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: It’s kind of hard to do that on this call right now. I think our…
Rell Winand: Yes, we’ll have to break it up…
Shahram Askarpour: There will be note within that as to exact contribution of the Honeywell.
Andrew Rem: You guys can break that out in the 10-K, is that…
Shahram Askarpour: That’s right, that’s where it’s going to go…
