Innovative Solutions and Support, Inc. (NASDAQ:ISSC) Q3 2022 Earnings Conference Call August 11, 2022 10:00 AM ET
Company Participants
Shahram Askarpour – Chief Executive Officer
Mike Linacre – Chief Financial Officer
Conference Call Participants
John Moran – Robotti & Co.
David Campbell – Thompson Davis & Company
Craig Rose – Axiom
Operator
Good morning and welcome to the Innovative Solutions & Support Third Quarter 2022 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.
I would now like to turn the call over to Shahram Askarpour. 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 third quarter of fiscal 2022 and business conditions and outlook for coming years.
Joining me is Mike Linacre, our new CFO who joined us in July upon Rell’s retirement. We are excited to welcome Mike to IS&S. Mike not only has extensive financial experience in manufacturing environment, but he also has a strong track record of driving results.
Before we begin, I’d like Mike to read the safe harbor statement.
Mike Linacre
Thank you, Shahram, and good morning, everyone. I would remind our listeners that certain matters discussed in the conference call today, including new products and operational and financial results for future periods and forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially, 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 the call back to Shahram.
Shahram Askarpour
Thank you, Mike. In the third quarter, we continued our steady growth with revenues up 12% and operating income up 41%, ending the quarter with over $14 million of cash and no debt. Together with our strong first half, this is one of the best first nine months in many years.
The business continues to deliver attractive returns and generate significant free cash flow, as we grow revenues and generate operating leverage. As I have stated before, our winning formula starts with excellent products in attractive growing markets, including our award-winning autothrottle and our flat panel displays for a cargo conversions.
We have delivered over 500 cockpit upgrades in 757, 767 and 737 platforms and we are now rapidly growing our presence in general aviation. And IS&S has always been a valuable partner to our military, as well as other militaries around the world, continue to receive orders on our military products.
As this installed base grows, it creates opportunities in adjacent markets, while also delivering a steady demand for customer service, which is now running at approximately $1 million per quarter. On the price-for-performance basis, we remain an industry leader.
The business continues to be well balanced not only between the commercial transport, general aviation and military markets, but also within the OEM and retrofit markets, as our partner OEMs in general aviations markets are currently in a growth mode.
In the case of one of our OEMs, they have placed firm orders for deliveries further into the future than normal, to secure their supply chain and meet their own delivery commitments.
On the retrofit side, we continue receiving orders on the air cargo platforms from various airlines internationally, as well as domestically. This diverse mix of business provides a solid foundation for growth. And from this space we add other features and capabilities to our existing base.
Growth will not just come from new products, but also from a more aggressive sales and marketing effort. For instance, this quarter we saw an increase in our business development expenses, which we anticipate with increased future sales.
As we continue executing on our organic growth strategy, we are beginning to consider additional growth by acquiring similar product lines which would utilize our existing infrastructure.
Last quarter, I spoke about an anticipated certification from the FAA to introduce a product installation service for our King Air and PC-12 customers. I’m pleased to report that we have received our installation approval certificate and have performed two installation approvals.
We’re also broadening our product market potential by developing new autothrottle technology, not just other variations of the King Air, but other aircraft platforms in both commercial and military markets.
As we’re ramping up our several marketing activities post pandemic, we are attending more trade shows, meeting face-to-face with customers and performing more customer flight tests, resulting in an increased backlog compared to March 31.
Let me just quickly, touch on the impact of some of macroeconomic factors, as we are battling inflation, supply chain challenges and labor availability. On the contract side, we are protected by cost escalators that enable us to pass along some price increases, during periods of inflation. The supply chain side, we have added safety stock to our inventory and in some cases at a premium.
We are also battling the widely reported shortage of skilled technical professionals. Despite the challenges, our turnover has been very manageable and we have been able to bring on new highly qualified engineers and other skilled labor to support our growth.
Now, I’d like to turn it over to Mike, to review our financials in more detail.
Mike Linacre
Thank you, Shahram and thank you all for joining us this morning. I’d like to say, I’m very pleased to have joined Innovative Solutions & Support. I’m looking forward to working with Shahram, to provide the investment community with the continued outstanding disclosure and transparency for which the company is already known.
Turning to the results. For the third quarter, revenues were $6.9 million, up 12% from $6.2 million a year ago. Growth was primarily attributable to continued strength in the sales of flat panel displays for retrofit programs to commercial air transport customers, as well as Autothrottle sales to the general aviation market, especially Pilatus under the company’s PC-24 contract.
Textron and Pilatus both reported strong demand in their general aviation business, both of which we support with our Autothrottle. In addition, we have a third OEM production contract with Boeing for the KC-46A, which also continues to generate steady revenue. Finally, we generated over $1.3 million in customer service revenues this quarter, as a result of a growing portfolio of installed IS&S products.
Total new sales in the quarter were approximately $12 million, so that we ended the quarter with a backlog of $12.6 million up from $7.6 million, at the end of the last quarter. Third quarter orders include a large contract with one of our general aviation OEMs, that is looking — locking in their supply chain, beyond their normal advance order.
Note that all of our long-term OEM production contracts include escalator clauses, that provide for the passing along of any cost increases incurred as a result of inflationary pressures. Gross margin for the last quarter, were 58.5% up from 54.3% in a quarter a year ago. Increase in margins, is attributable to favorable leveraging of fixed costs resulting from the increased sales and production volume, lower employee headcount and a favorable product mix.
Our model produces attractive margins as we scale the business. Total operating expenses for the third quarter of fiscal 2022, were $2.4 million up from $2.2 million in the same quarter a year ago. The increase reflects an increase in professional fees and business development. The increase in business development expenses, as a result of ramping up sales and marketing efforts post pandemic as mentioned by Shahram.
We’re more frequently traveling to customer locations and prospect sites, as well as making additional in-person marketing appearances at aviation trade shows. Research and development was essentially in line with a year ago, as we continue to target 10% to 12% of revenue for R&D. Net income for the quarter was $1.4 million or $0.08 per share compared to $2.7 million or $0.16 per share a year ago, which included a $1.5 million tax benefit.
For the third quarter of 2022, we recorded $359,000 in taxes where in a year ago, we had a $1.5 million tax benefit due to the reversal of a deferred tax asset valuation allowance. Operating income of $1.7 million was up 41% from our $1.2 million, a year ago. Due to this tax anomaly, we believe the comparison of operating income better represents our improved performance this quarter.
We anticipate a 21% tax rate for the year. The company remains in a strong financial position. We generated $3 million of operating cash in the third quarter and $6.4 million, over the first nine months of fiscal year 2022. At quarter end June 30, we had $14.5 million of cash on hand. As previously discussed, the company anticipates that due to the ongoing supply chain issues and challenges as a result of COVID-19 pandemic, we will continue to maintain a slightly higher-than-normal level of inventory, as an added measure of precaution. The company is debt-free. We believe that the company has sufficient cash to fund operations in the foreseeable future.
Now, I’d like to turn it back to Shahram, for some closing remarks.
Shahram Askarpour
Thank you, Mike. The first nine months of 2022 are amongst the best in the company’s history. End markets are firming as the global economy is opening up. Our foundation of long-term OEM contracts, is with large global aircraft manufacturers that are experiencing rising demand and our flat panel displays continue to offer a compelling value proposition in the aftermarket. The company continues to generate, strong cash flow and has a solid balance sheet that provides us the resources to invest in growth opportunities, in the markets that are once again expanding. These are exciting times and we appreciate your continued support and encouragement.
We will now open the floor for questions.
Question-and-Answer Session
Operator
Thank you. At this time, we will open the floor for questions. [Operator Instructions] Our first question comes from John Moran with Robotti & Co. Please go ahead
John Moran
Hi, thanks for taking my question. Is there — can you elaborate at all on the large order that you received that you cited being responsible for that large increase in the backlog and new orders and — for example, what the delivery period would be for that and or even how large it was?
Shahram Askarpour
I mean that came from one of our OEM programs where we typically get maybe six months ahead orders and they kind of gave closer to one year not quite, but they went a little bit further out than normal. And that kind of — there was a good pop.
John Moran
Can you say whether the sort of the core business was up, flat, down ,or outside of that order?
Shahram Askarpour
It was in line with typically our quarterly orders that we received. Again from quarter-to-quarter, it varies. If you followed our backlog, the orders, the timing of them vary. And this was nothing unusual other than the kind of the extra orders that were received was from one customer with an OEM contract.
Mike Linacre
For the quarter from a sales perspective, as mentioned our commercial retrofits and our air cargo was up quite a bit that kind of drove the increase from on a comparative quarterly basis.
John Moran
Okay. Thank you very much.
Operator
[Operator Instructions] Our next question comes from Michael Weiser with Weiser Partners [ph]. Please go ahead.
Unidentified Analyst
Good morning gentlemen. Steve [ph] with more than $14 million in cash on the balance sheet, I’m wondering if you could give us some understanding of what — on an ongoing basis, you think you need in cash on the balance sheet to continue running the enterprise?
Certainly, I speak for the shareholders who are interested in — continue to be interested in dividends that company has issued in the past and would like to see again going forward? And so would you please help us set our expectations as to how much cash you feel you need on an ongoing basis? Thank you.
Shahram Askarpour
So, I mean, historically the company has been sitting on $40 million cash. So we’re nowhere near those numbers. But currently, I’m not aware of any plans for — eminent plans for dividends. Obviously, it’s a Board decision as how they would do that. But I’m not aware of any at the moment.
Unidentified Analyst
Could you comment please on what you feel your ongoing cash need is?
Shahram Askarpour
Yes. I mean for operations, we like to have less than $5 million available.
Mike Linacre
We’re– at a run rate now we’re generating about $2 million in cash every quarter. And from an operational standpoint that around three, two to — Shahram mentioned $2 million to $5 million is plenty to support our operations.
Unidentified Analyst
Okay. And the balance of the cash is being used for what purpose?
Shahram Askarpour
The balance of the cash is there for us to do investments in the growth of the company.
Unidentified Analyst
Well I appreciate the sentiment that you expressed, but the difference between the cash on the balance sheet and what you say you need to run the enterprise on an ongoing basis is a considerable margin for an entity that’s generating something in the order of $30 million a year in sales. So…
Shahram Askarpour
I’m sure the Board will take those things into consideration. And — really that decision as to whether they would be giving dividends not all of our shareholders are looking to get dividends and some of them would like to see investment in technology. So…
Unidentified Analyst
Thank you.
Operator
Our next question comes from David Campbell with Thompson Davis & Company. Please go ahead.
David Campbell
Thank you very much for taking my questions. And Mike, congratulations on your new appointment as Chief Financial Officer.
Mike Linacre
Thank you.
David Campbell
Looking forward to talking with you in the future.
Mike Linacre
Yeah. Thank you. Thank you.
David Campbell
I want to ask about the balance sheet as I commented the asset on the balance sheet at the end of June for $1.558 million assets held for sale. Are these the components of the order you’re talking about where the customer is trying to fix his expenses?
Mike Linacre
No this is an airplane that we have that we are selling.
David Campbell
That’s the King Air?
Mike Linacre
The King Air PC-12 aircraft that is for sale, yes.
David Campbell
Yes. I know. Jeff liked that plane, but he’s not here anymore so. So that’s what you said. So that will be presumably a capital gain on — and whenever you sell it?
Mike Linacre
That will be a fourth quarter event when the sale is finalized.
David Campbell
Okay. So it could be in the fourth quarter?
Mike Linacre
Yes, it could be.
David Campbell
More cash coming into the company?
Mike Linacre
Yes.
David Campbell
And you mentioned — you didn’t mention it in the press release, but you mentioned in the call that a significant amount of new business came from cargo conversions. So cargo conversions were a significant part of the increase in revenues?
Mike Linacre
Yes, I would say that along with steady and increased demand from our existing OEM customers buying our Autothrottle as well.
David Campbell
Right, right, right. So why is it that the backlog only reflects orders received for the — but not say, for example, that doesn’t include any backlog — any backlogs for cargo conversions. So I take it that’s not included in the backlog?
Mike Linacre
Yes. The backlog includes all the purchase orders that we have in hand at the moment. And as mentioned our backlog typically is for a few months to six months. But right now it includes orders from one of our OEM customers for a longer period of time almost up to a year.
David Campbell
But does it – is the backlog increase in backlog reflects the potential increase in revenues, or because of the timing of the backlog it doesn’t imply more revenues?
Mike Linacre
I would say not necessarily. It’s just based on when we received the purchase orders at a given point in time.
David Campbell
All right. All right. And I’d tell you there’s no engineering and development revenues this year like there was last year in the last quarter. Is that something unpredictable that you may get in a given quarter or not the next quarter?
Shahram Askarpour
Yes. I mean again the timing of that is – there’s two parts to it is when we book it and then when the completion is done so we can recognize the revenue.
David Campbell
Right.
Shahram Askarpour
So – but we do – I mean we do continue getting kind of engineering services orders in a steady form.
David Campbell
Can you tell us any more about what you’re looking for? You mentioned that you may – if you’re looking for acquisitions of products, new products including your catalog of sales what does that mean? What – are you going to buy new aerospace products or what?
Shahram Askarpour
We’ve done this in the past. We’ve acquired for example the GPS technology, we’ve acquired flight management system technology. And we continue looking for opportunities. The way the industry is going on right now, there’s a lot of consolidation happening at a larger organization.
As they do acquisitions of companies, sometimes there are product lines within that acquisition that doesn’t fall in line with the strategic plan and those will become targets for divestiture. So we’re kind of reviewing some of those opportunities to see if their products that fit within our strength of our organization for manufacturing and we could leverage it to grow our base. So we’re spending some more time than we did in the past reviewing those kind of opportunities.
David Campbell
These products will be products that are operable to what you already produce?
Shahram Askarpour
Exactly. Yes. And may open new contract for us with OEMs. Again it’s – we’re not trigger happy here to go buy something but we are looking.
David Campbell
Yes it had to be satisfied that you can sustain gross profit margins on these products that are comparable to what you already produce.
Shahram Askarpour
Absolutely.
David Campbell
Okay. Well you did have an excellent quarter and I suspect that – I’m hoping that the September quarter will also be a good one helped by the backlog to some extent but also by your sales. Do you have any comments on what to expect in the fourth quarter?
Shahram Askarpour
You know we don’t do that.
David Campbell
Excuse me?
Shahram Askarpour
We don’t give forward-looking comments.
David Campbell
Okay. Well, thank you very much for your help and I’ll be in touch.
Shahram Askarpour
Thank you very much.
Operator
The next question comes from Craig Rose with Axiom. Please go ahead
Craig Rose
Hey, guys. One clarification. The PC-12 is what’s being held-for-sale is that correct?
Shahram Askarpour
Yes. Right.
Craig Rose
Okay. The other thing is you mentioned you were looking to expand the Autothrottle into commercial and military. Could you explain how the development of that would work? And who would pay for it?
Shahram Askarpour
So that’s part of our own internal R&D that we’ve been supporting. There is an ongoing engineering activity, at the company in expanding the Autothrottle today.
We’re seeing interest from some of the military trainers as well as some other military platform where they see that the Autothrottle provides them with additional capability. And we’re developing some of those product lines, as we speak.
Some of them are actually expansions on the King Air — for the King Air platform and some of them are looking at other platforms.
Craig Rose
Okay. Also, sometime last year I believe the Eclipse Aviation was purchased from bankruptcy. Does that offer opportunity for us at any point in the future?
Shahram Askarpour
We have conversations with the Eclipse. I’m not 100% sure where that’s going to go with that platform. But we work closely with them. We support them, where they need help but they got challenges with starting up production engine challenges other part challenges.
But they — once they get their — once they get in foothold of where they’re going to go we’re there to support them. I mean, we’ve got good working relationship with them, but nothing in the card short-term.
Craig Rose
Okay. Thank you. That’s all for me. Guys thank you very much.
Shahram Askarpour
Thank you, Craig.
Operator
Our next question is a follow-up from John Moran with Robotti & Co. Please go ahead.
John Moran
Yeah. Hi. Could you just remind us, based on the company’s existing facilities and personnel et cetera how large of a business can this be? Like from organic growth, I mean, it seems to me add one point, when you had other products and it was quite a different business that you were for example generating $60 million in revenue or whatever. I know that that wouldn’t be comparable to the business that you guys have today. But could you speak to that?
Shahram Askarpour
So I mean within this facility, as you know, if you go back a few years we had over $60 million year revenue coming out of here. We’ve got all the capabilities in-house to do that, all the machinery, all the capabilities are here.
So I mean that’s one area where you would look at, if we do product acquisitions which are of the right mix that we could grow revenues that way. We have the capability here without any significant investment in infrastructure.
So that’s where finding that if we could find the right product mix it would make it. But like I said, it’s not like you go to, actually and buy some. You’ve got to find them, you got to evaluate them, and make sure it is the right product.
From a personnel standpoint our cost of direct labor is less than 5% of our sales price. So it doesn’t take a lot of direct labor increase to grow the revenue. We’ve designed — the company has been designed in such a way that, allow us to do that without incurring too much pain.
John Moran
Are the discussions on the autothrottle with military customers on aircraft that are not yet certified?
Shahram Askarpour
Some of them are. And as I mentioned some of them are on the PC-12 and the King Air platforms.
John Moran
But some, they are not.
Shahram Askarpour
Some they’re not because there is — I mean there is a fair amount of spending in the military side on new platforms. And some of those new platforms still use the PC-6 turboprop engine which have the limitations of protection and so — and our autothrottle has a good home on those. Also, some of the new features that we’re developing lend themselves to the way the military operates some of these aircrafts.
John Moran
Have you had a large fleet order yet for autothrottle?
Shahram Askarpour
Large fleet order on the aftermarket?
John Moran
Yes.
Shahram Askarpour
Yes. We’ve had. We’ve had. Not a largest, I’d like it to be. What we’ve had like a half a dozen orders that kind of size orders. There are not that many large fleets of business aviation aircraft. It’s not like air transport that somebody is going [indiscernible] so a lot of them are smaller fleets.
Operator
Our next question comes from Michael Friedrich [ph], a private investor. Please go ahead.
Q – Unidentified Analyst
Good morning. Yes just a follow-up on the last few calls, there’s been a few different sort of approaches on how the — you were going to try to market — to the aftermarket for the autothrottle. Where are things at that right now? Because it almost appears from the tone of this call that, the retrofit market on autothrottle is being a little bit, I don’t want to say deemphasize, but back burner compared to some of the other initiatives right now. Where do we stand on that? Are the — I know you guys were going to be maybe hiring a team that would go to different places and actually do these just what’s the most recent approach here?
Shahram Askarpour
We continue putting an effort into the sales and marketing of the autothrottle. We believe that the product has potential in the market. In our industry market acceptability is not an overnight thing and it takes time. And we don’t have much competition in the platforms that we provide the autothrottle with.
We have the OEMs approval. We’re seeing increase in military interest in that. So we will continue the sales and marketing efforts. And I will see – the way I see that is that, it’s another steady source of revenue for us. It took — on the five, 767 platform it took a few years before we get to a point where you’re just sitting there and getting orders on it because you’re known in that market for your product. And the autothrottle will get there.
Q – Unidentified Analyst
Okay. Thank you.
Operator
This concludes our question-and-answer session. The conference has also now concluded. Thank you for attending today’s presentation. You may now disconnect. Have a good day.
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