Q1 2024 Innovative Solutions and Support Inc Earnings Call
Participants
Theodore O'Neill; Analyst; Litchfield Hills Research LLC
Andrew Rem; Analyst; Odinson Partners LLC
Doug Ruth; Analyst; Lenox Financial Services, Inc.
Presentation
Operator
Good day and welcome to the Innovative Solutions and Support first quarter fiscal 2024 financial results conference call. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Dr. Shahram Askarpour, Chief Executive Officer and Member of the Board of Directors. Please go ahead.
Good morning. This is Shahram Askarpour, Chief Executive Officer of Innovative Solutions and Support. Welcome to our conference call to discuss our performance for the first quarter of fiscal 2024 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 the cautionary statement about forward looking information.
Thank you, Shahram, and good morning, everyone. I would remind our listeners that certain statements made in matters discussed in the conference call today, including those about new products and operational and financial results for future periods contain forward-looking information.
These 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 in our Form 10-K, 10-Q filed yesterday, which disclaimer along with our public filings representative describe these assumptions, risks and uncertainties.
I also remind our listeners that plans and expectations we express speak only as of today's date, and listeners should not place undue reliance on any forward looking statements.
Now I'll turn the call back to Shahram.
Thank you Rell. I will begin today with remarks on our performance in the first quarter of fiscal 2024, followed by comments on our long-term growth plan and strategy, including the ongoing integration of the products acquired and licensed from Honeywell. I will then I'll turn the call back to Rell, who will take us through the financials.
For the quarter, revenues were up 43% with net income increasing 51% from a year ago. This increase has us on pace to meet our goal of increasing revenues by 40% of the organic fiscal 2023 revenues due to the addition of the Honeywell product lines.
At this time, we expect full integration of the Honeywell product lines to be nearly completed this fiscal year. First quarter results were in line with the expectations expressed previously. Satisfied results once again demonstrate the strength of our strategy addressing the diversified military, commercial air transport and business aviation markets.
Although we have experienced an anticipated slowdown in commercial air transport and cargo markets. We have counted the slowdown by renewed strength in the military market with the addition of the Honeywell product lines, an increasing proportion of our revenues are now recurring in nature, including our OEM production contracts with Boeing, Aixtron and Pilatus.
These production contracts provide a growing base of reliable revenue that generates strong margin and strong cash flow. Margins this quarter were 59.3%, an improvement from the first quarter of fiscal year 2023. Cash flow was strong in the quarter, enabling us to reduce our debt position by nearly $9 million in the quarter.
We expect that credit line balance will continue to be reduced throughout the fiscal year, barring another acquisition. We also maintain our commitment to research and development as evidenced by the increase in R&D expense. This increase includes our efforts to develop new products and to add new capabilities to existing technologies and to integrate the acquired Honeywell product lines.
This work is directed at our long-term vision where we believe there is increasing demand for technologies that reduce pilot workload and would ultimately lead to single pilot flights in air transport aircraft. Our funded R&D represents a contract with Pilatus to develop a second generation.
You amass a product. We expect to be extended into additional airframe. This is further evidence of our strong value proposition and the confidence we gained with our customers. Part of the increase in selling, general and administration expense in the quarter was the increase in staffing our sales organization.
While we have always enjoyed a good reputation internationally, the Honeywell acquisition provided us an experienced established global sales footprint which we believe opens large new markets, not only for the Honeywell prospects, but also our legacy drug.
Many of the hundreds of customers that came along with new products are new to IS&S representing another new market, we believe offers great promise. Quickly updating the status of the Honeywell product line, all the test equipment and inventory is arriving and the Honeywell training associated with the products have been completed.
We are now processing maintenance and repair of radios in house. Meanwhile, the transfer of the IRU inventory is progressing with a handoff of these products expected to occur by the end of the second quarter.
We expect the top and bottom line benefit of these new products to begin to gradually ramp up. As I mentioned, we have increased our sales and marketing investment to support the sales of these products. As we begin to develop strategies to fully recognize the inherent synergies and potential of these products, we believe that we will realize growth from such synergies, and strategies.
For these reasons, we will continue to opportunistically evaluate and make plans to execute additional complementary acquisitions should appropriate opportunities arise. Our goal now is to leverage this momentum to sustain this growth over both near and long longer term organically and through additional acquisitions.
Finally, I want to update you on our ongoing search for a permanent CFO. We have retained an executive search firm, and we have already completed a round of interviews that yielded several highly qualified candidates.
Thank you for your time and interest, and we'll look forward to updating you in the upcoming quarters. I will turn the call over to Rell for a closer look at numbers.
Thank you, Shahram, and thank you all for joining today. Let me quickly review the highlights of our financial results for the first quarter of fiscal 2024. Revenue in the first quarter was up 43% due to the contribution of customer service sales of the product lines acquired and licensed from Honeywell.
First quarter gross margin was 59.3% up from a year ago, but down slightly on a sequential basis in the fourth quarter, primarily due to the impact of increased material costs and overheads, overhead absorption and customer service.
In the first quarter of fiscal 2024 research and development expense was approximately $900,000 or 9.7% of net sales. Note that research and development expense have increased in absolute terms, but has decreased as a percentage of net sales.
From the current engineering development contract is completed, the engineers working on that development contract will return to research and development efforts. This will result in increased research and development expense in subsequent quarters.
First quarter fiscal 2024 selling, general and administrative expenses increased from a year ago, primarily due to an increase in sales and marketing expense, the quarterly amortization of the intangible asset associated with the Honeywell product line license and acquisition and professional and consulting fees.
I will note that we sold the King Air airplane in the quarter for $2.3 million, and the resulting gain on the sale was used to reduce total selling, general and administrative expenses, the gain was approximately $162,000. Interest income was down in a quarter, consistent with our new PNC Bank line of credit account that uses daily cash balance to reduce debt at the end of every day.
Interest expense in the quarter was up from zero a year ago although we do not expect interest expense, although we do expect interest expense to trend down only as interest rates are anticipated to fall, but also because we're planning to use the majority of our cash flow to pay down debt.
Taxes are being accrued at a rate of 12.8% versus the statutory rate of 21%, reflecting increased state tax expense due to the gain on the sale of the King Air airplane. Net income for the quarter was $1.1 million, or $0.06 per share, up from $700,000 or $0.04 per share in the year ago quarter.
New orders in the quarter were approximately $10.4 million, so that we ended the quarter with a backlog of approximately $14.6 million. As always, quarterly orders can vary due to a number of factors and 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. For the first quarter of fiscal 2024 the company generated $4.2 million of cash flow from operations. The company's debt on December 31, 2023, was $10.6 million, down $8.9 million from $19.5 million as of September 30, 2023.
As a result of the daily cash balance sweep component of the company's line of credit is required to be classified as a current liability on the balance sheet. During the three months ended December 31, 2023, cash also benefited from the sale of our King our aircraft for $2.3 million. With that, operator, we're ready for questions.
Question and Answer Session
Operator
(Operator Instructions) Theodore O'Neill, Litchfield Hills Research. Please go ahead.
Theodore O'Neill
Thank you very much. I have two questions. The first one is about on the sales side. The reduced shipments of displays for the retrofit in the commercial market. Do you have a view on if and when that, why change and what would be the driver for it.
So it's up some of it is seasonal. Some of it is we're introducing a new product line in that market. Rich share with Richard began, we should begin of finishing certification this quarter and we should begin to see some revenues from it from next quarter.
But we've anticipated that on the cargo market as these airplanes get older and older and that eventually you will see a slowdown in these upgrades, which and because of that, we developed some additional products and put a larger emphasis on our military efforts, which were kind of that, not as in some ways, there was another priority before we were focusing on the oral from product lines.
So we've put an emphasis over the last couple of years on the military side of things we got because the OEM new OEM contract from Boeing on the seven train. And we continue to work on a lot of new opportunities that are coming both OEM as well as the aftermarket and the military side. So we're looking at that over the next few years to get to essentially be a larger driver.
Then the then the air transport side on the air transport side, what we're doing is we're offering a upgrades, which, as we talked before, leads to more automations within the cockpit and eventually to the add to the single pilot operation for this part 25 airplanes at that single pilot operation in the longer term strategy.
And meanwhile, we will be seeing some revenue from some of these additional features that we are offering on these cockpits. And but the big ticket items of completely retrofitting a cockpit of a five, seven, six, seven aircraft that has slowed down. And like I said, we had anticipated.
Theodore O'Neill
Okay that makes sense. And on the SG&A expense, the amortization of the customer relationships that was in the SGA in the quarter, is it a significant part of the increase? And does it continue on for many more quarters?
Yes, it goes. So this is a 10 year amortization. It's about $268,000 quarterly. It will continue, obviously. So that's a big driver of the increase. Of course, as Shahram mentioned, is the we've hired sales additional salespeople. So that's a big piece of it, too.
Theodore O'Neill
Okay. Thanks very much.
But generally, our auditing fees and legal fees have been volatile
(multiple speakers) quarter to quarter, they were fine.
(inaudible)
Theodore O'Neill
Okay, thanks, guys.
Thank you.
Operator
Andrew Rem, Odinson Partners.
Andrew Rem
Morning, gentlemen. I just had a question to start with how should we think about gross margins within the customer service segment?
But in what way typically it was been higher.
Andrew Rem
Right? So your fourth quarter right is 68.5%. And prior to fiscal '23 year to date, it has been running 71%. And so I don't I don't know if I mean, you mentioned some under-absorption, but you had much higher revenue this quarter than a first, second, or third quarter of last year.
But I'm so right, so it's good. Sorry.
Andrew Rem
Yes, I'm just trying to understand the nuances.
Yes. Well, you got.
So as Andrew, can you repeat that, please? You said, we have gross margins of 71%?
Andrew Rem
While the year to date through the first three quarters of fiscal oh three was running 70%, 71%. Then fourth quarter was 68.5%, and then now you're at 59%. So I'm just trying to understand the nuance what moves the gross margin around and this quarter's revenue in customer service was higher than the revenue run rate in the first three quarters of last year.
Right? But the customer service revenue is a bigger piece of the whole. So it's going to end up with more overhead absorption into it as well as we've seen material, as you can understand, as cost of material, the price has increased. So we have to keep increasing our standard solids.
And it's mix depends on what you're repairing, but yes, it is down from previous. Well, I guess you you're half of your sales while almost is customer service. I just want to get a bigger piece of everything if that makes any sense to you.
Andrew Rem
Okay. And then on the cost materials side, how long does it take you to kind of get some price recovery there.
It gets somewhat. Can you repeat that? I missed that.
Andrew Rem
But on costs on the cost of materials, how long does that take you to get its recovery.
It doesn't take on the customer service side, not too much because a lot of what we do other than warranty is cost up. So as we've been increasing, those were is going to flow through to what we charge a customer, so.
Andrew Rem
Okay. And then on inventories, obviously, you had a pickup in the fourth quarter due to Honeywell, but you also had another pickup this quarter about $1.7 million. Can you just help us understand what's going on? And is this related to are you excess inventory as you make these product transitions is that's what's driving it?
Yes, you have a couple of things. So yes, the Honeywell inventory coming in, right so that's going up from the prepaid. You can see the movement there and to inventory. And we have some last time buys. We have three items of flow.
The we're going to need the inventory inflow, meaning production of it's going to produce ahead a little bit. So all that's going to increasingly, obviously, as we take more Honeywell and you're going to see that grow and grow and grow because prepaid Honeywell inventory was $12 million. As you receive that, it comes out of there and comes into your normal inventory. If that makes sense.
Andrew Rem
We expect in the second half of the year kind of inventory to kind of normalize as you get up the product transition, we get that behind you. You brought in all of the Honeywell inventory. Is that reasonable?
Yes, but it will be a big number because.
It is going to be a big number, but it's done and.
It should level up.
It should level up.
Andrew Rem
Okay. And then on CapEx, go ahead.
And you're going to order and that kind of thing, right?
Andrew Rem
Alright. And on CapEx, can you just comment on it was pretty high this quarter. And how should we think about that for the full year?
And what does that mean there? We've got CapEx, we've got increased ability and done some work in the building, things like that. So it's going to be a part of it was kind of quantum.
Andrew Rem
just looking at 182,000 versus 300,000 for the full year fiscal 2023?
Yes. Well, we've probably bought some machinery and now we're working on haven't it usually (multiple speakers) But a lot of stuff for the Honeywell. So fitting that out as well as making a upgrade is a part of the building the plant for that. So all that's adding into lower higher than normal in a in a period of time.
That should stabilize.
Yeah, typically we don't have to $200,000, $300,000 generally year. It's always not a big number.
Know on some investment in IT structure as well as certain because as you know, this cyber security nice becoming I think you shouldn't and won't continue.
So we are doing some upgrading server.
A lot of upgrades as well as include increasing our cyber security practices. And I think long term, it saves us money because averages, are you altering the cost as well.
Andrew Rem
Can you guys comment then on like if we just think about CapEx and what the incremental components? So you mentioned IT infrastructure would be incremental for this year and then some incremental CapEx related to everything that you're doing around Honeywell, can you kind of so if we if you've got a base CapEx spend a couple of hundred thousand and then how much incremental from these IT and Honeywell related.
Not a lot $100,000 on the case on the $150,000 maybe we're pretty much in pretty much done that, if you will. I guess I would break it out some more than others $250,000 maybe on average.
Going forward. also there air conditioning systems, engineers all know, gets all moved, and that's a whole different sort of success. We're going to be addressing.
Andrew Rem
Alright. Well, I guess it's better for me, but I did want to say that you guys have done a pretty amazing job to generate generated good cash flow here. We've taken a turning point for out of your debt. I had speculated that maybe you guys could exit this fiscal year and below one times.
I think it looks like you maintained the current trajectory you guys are going to flow right through that. So kudos to you guys and the team for doing a great job of improving the balance sheet so quickly. So anyway, thanks a lot. Appreciate it.
Thank you, Andrew.
Operator
Doug Ruth, Lenox Financial Services.
Doug Ruth
I wanted to start off by congratulating you on a really strong quarter. You've done a wonderful job. I had a question. Is the management team and the Board of Directors to do you folks now have the ability to buy stock?
Well, when the window is open window, the window opens actually on for us is the third business day after earnings Monday. So there's and it's and it closes a couple of weeks before the end of the quarter. So it did. So as of Monday, there is an open window. Yes.
Doug Ruth
Okay. I think the investment community would really appreciate that thought if the Board and some of the managers could buy some stock, I think it would really make a significant difference. And again, I want to congratulate you on a really strong quarter. Thank you for what you're doing for the shareholders.
Thank you. Thank you for your support.
Operator
And this concludes the question and answer session and the Innovative Solutions and Support conference. Thank you for attending today's presentation. You may now disconnect.
