Innovative Solutions and Support, Inc.

Good morning and welcome to the Innovative Solutions and Support First Quarter 2022 Earnings Conference Call. All participants will be in listen-only mode. So if you need assistance, please signal a conference specialist by pressing the Start key followed by 0. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press Start then 1 on your touched home phone keypad. To withdraw your question, please press Start then 2. Please note this event is being recorded. I'll now turn the call over to Sharam Askapur. Please go ahead.

Good morning. This is Sharam Askapur, Chief Executive Officer of Innovative Solutions and Support. Welcome to our conference call to discuss our performance for the first quarter of fiscal 2022, current business conditions and outlook for the coming year. Joining me is Raul Vinant, our CFO. Before we begin, I'd like Rael to read the safe harbor statement.

Rael Johnson Thank you, Chairman. 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, are 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 , which is on file with the SEC, and other public filings. Before Sharon begins, I will read a statement from the Board of Directors. The Board of IS&S mourns the loss of our dear friend and colleague, Jeff Hedrick, and our deepest sympathies remain with Jeff's immediate and extended IS&S family. Jeff dedicated his entire professional career to advancing the state of the art and safety avionics systems and flight controls. His extensive innovations included altimetry, flight deck display systems, and most recently, a full regime auto throttle for turboprops. Leading publications such as Flying Magazine and organizations such as the AOPA recognized Jeff's significant contributions to the industry. Several of Jet's innovations have proven truly transformational and have directly benefited air travel. We will miss his unique vision, tenacity, and humor. Dr. Sheram Askapur has been promoted to Chief Executive Officer and elected to the Board of Directors with our full faith, confidence, and support. Sheram started with IS&S as Vice President of Engineering in 2003. and was promoted to president in 2012. For almost two decades, Sharon worked closely with Jeff, fully engaged in managing the business while contributing to numerous key innovations fueling IS&S' success. Most recently, he is named the vendor for the signal processing technology behind IS&S' new ThreatSense autothrottle, adding to his numerous existing aviation patents. Prior to IS&S, Sherman held technical and managerial positions with Smith Aerospace and Marconi Avionics. While Jeff's loss is immeasurable, IS&S is fortunate to have experienced, long-tenured leadership and a robust portfolio of industry-unique products. We feel extremely privileged to have the continuity of leadership provided by Sherman and his team and are confident IS&S will continue to execute on the industry-unique products and market opportunities that it enjoys. Now I'll turn the call back to Sherman.

Thank you, Ralph. You all greatly miss Jeff Hedrick. His leadership, his vision, passion, and his humor. He founded and led the company for many years and was an inspirational leader. In the process, he built a very strong company dedicated to sustaining his vision and legacy over the long term. For nearly two decades, I was fortunate to have worked very closely with Jeff as head of engineering, and in the last 10 years as president, focused on strategy and planning. Together, we developed the plans and products that have driven three straight years of revenue growth, profitability, and positive cash flow. This has enabled us to return nearly $20 million in dividends to our shareholders in just the past couple of years. My goal is to carry on that collective vision to capitalize on our unique competitive advantages, continue to grow the business, and create value for our shareholders. I want to thank the board of directors for their confidence in me. Our goal is to reward that confidence by continuing to strengthen and improve the organization to grow the company while delivering strong financial results. We have excellent products in attractive growing markets, including our award-winning oral travel that has been adapted as a standard equipment by one of the largest, most respected general aviation manufacturers in the world. And we believe our innovative flat panel displays continue to be the cockpit retrofit choice for the many cargo carriers converting 75767 aircraft. Now, let me talk about our recent results and the future. The momentum generated over the last three years has carried over into the new year, with revenues in first quarter up 38 percent, leading to strong margins, profitability, and cash flow. Our success is based on a growing portfolio of products that continue to offer what we believe are some of the best price for performance value in the general aviation, commercial air transport, and military markets. We're also well diverse, offering products to both the OEM and retrofit markets. Our OEM production contracts offer a solid base of predictable recurring revenues, as was once again demonstrated this quarter. This is a strong foundation for growth. We will continue to innovate both our existing products and the development of new products. As our air transport display product line continues to experience strong demand, we are developing new features, functionality, and products to add to our existing portfolio serving that market. On the oral throttle front, we have developed a new installation process to reduce oral throttle installation time. Our marketing team and our technicians are training the Textron International Sales Force this month to take advantage of the new process that reduces downtime of the aircraft during modification. And as I announced at NBAA last quarter, we are broadening our products market potential by developing new oil throttle technology for turbofans, such as the CJ aircraft. As part of our overall strategy, we will continue to invest in research and development We plan to maintain our investment in R&D at the percentage of revenues at a level consistent with the past several years. To capitalize on the size of a retrofit market, we are growing our sales and marketing department. We have hired a new military program manager with background from the US Air Force and Sikorsky to help with our efforts in growing the military portion of our business. After a long period, where our marketing efforts were constrained due to the pandemic-level restrictions, we are ramping up our sales and marketing activity, attending more trade shows, meeting face-to-face with customers, and therefore adding new business development professions. While our OEM and aftermarket customer base remains enthusiastic supportive of our ability to deliver quality products, During these challenging times, we also see some opportunities on the military side of the business. Our strategy of developing industry-leading fries for performance products provide us with a competitive advantage in identifying new market opportunities. Operational efficiency is the key to our success, and we will continue to optimize our processes and personnel. in all areas of our business. This continuous improvement effort resulted in reduction of operating expenses at the percentage of revenue by 10% in the first quarter. In the first quarter, cash flow from operations exceeded net income. We judiciously used some of this cash to increase our inventory in areas where we see potential supply chain challenges to protect our ability to deliver to our customers in a timely basis. Since adopting this current strategy several years ago, our focus has enabled us to enjoy an extended period of success despite the pandemic, strained supply chains, inflation, and many other challenges. As some of our end markets begin to improve and pandemic-imposed restrictions are lifted, we are confident that we are well-positioned to build on this success and continue to generate steady financial results. I'd like to turn it over to Ralph to review our financial in more detail.

Thank you, Sheriff, and thank you all for joining us this morning. Looking at the first quarter, revenues were $6.7 million, up 38% from $4.9 million a year ago. Our general aviation and commercial air transport business each contributed to the quarter's growth. Our long-term PC-24 and King Air Autothrottle OEM production programs continued to provide steady, predictable revenue, and this quarter was no exception. Our revenues tend to follow customer production schedules with, for instance, Texon reported improved sales of both King Air 250-260s and 350-360s, while Pilatus continues to run at a high production rate. In our flat panel production line, air cargo revenues and orders remain strong. Total new orders in the quarter were approximately 3.8 million, and we exited the quarter with a backlog of 6.2 million which is up compared to 4.2 million in the same point a year ago. Gross margins for the quarter were 59.3 percent, up from 52.7 in the year-ago quarter, as well as up sequentially to 57.6 last quarter. Margin continues to trend in line with historical averages, with fluctuation quarter to quarter primarily attributable to product mix, as well as operating leverage resulting from the growth in revenues. For instance, our 38% revenue growth in the quarter helped to leverage our fixed manufacturing overhead and expand margins. Total operating expenses for the first quarter of fiscal 2022 were $2.5 million, which is up from a year ago on an absolute basis, but at 38% of revenue, down 10% from 48% a year ago. Due to both our growth over the past year, as well as some relaxation in public health restrictions, We have been strategically strengthening our organization in sales and marketing, as well as resuming marketing spend on in-person trade shows and customer visits. Research and development increased compared to a year ago, as we continued to target 10 to 12 percent of revenues for development of innovative new technologies and products. Selling general and administrative expenses were relatively unchanged from the year-ago quarter. We believe quarterly operating expense levels will remain in the current range. For the quarter, we generated operating income of $1.4 million, which is 21% of revenue, significantly from just $232,000 a year ago. We recorded taxes of $307,000 in the quarter as we have now fully utilized our tax NOLs. We anticipate that our tax rate will be approximately 21% going forward. Net income for the quarter was $1.1 million, or $0.07 per share. an increase from $240,000, or one cent per share, in a year-ago quarter. The company remains in a strong financial position. We generated $1.5 million of operating cash flow in the first quarter of fiscal 2022, so that at quarter end, December 31st, we had $9.7 million of cash on hand. As discussed on the fiscal year-end earnings call in December, the company anticipates that due to the ongoing supply chain issues and challenges resulting from COVID-19 From the 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 for the foreseeable future. Now I'd like to turn the call back to Sharon for some closing remarks. Thank you, Will.

The fiscal year 2022 has started strong, and we plan to continue that trend. We have built a strong operational team dedicated to creating value through product and technology innovation and customer service excellence. We will continue strengthening the organization as we grow the business. We possess an arsenal of great technology and products with an energetic and enthusiastic team that is fully dedicated to executing on our growth plans. We will now open the floor for questions.

At this time, we will open the floor for questions. If you would like to ask a question, you may press star then 1 on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble the roster. Our first question comes from David Campbell with Thompson Davis and Company. You may now go ahead.

Hi, Sharon. Hi, Roe. It's a great report, great start to the fiscal year. I did want to know if there are any problems with supply chain issues getting parts and information to you in time for your production. Have you had any trouble, issues with that delivery situation?

So far we've been fortunate not to have been bitten by that snake. We've taken a lot of measures, including earlier on we hired some additional procurement people to help us find parts. We've also taken steps in areas where we see the challenges may occur where we procure some parts ahead of time. So we have not had any situations where we have not been able to deliver to our customers due to supply chain.

That's good. That's good. And, Raul, the G&A is down as a percentage point. of sales, but it's up substantially from the prior two quarters.

Yeah, so Q1, typically, when we incur audit fees and things of that nature because of the financial audit, it's usually up. If you look over history, the first quarter is usually higher. We also have some trade shows in the Q1, so that bumps it up a little bit.

Yeah. Yeah. So, but you are expanding your, as you mentioned, your marketing and research staffs. Yes. That must have had some impact on that cost line, too.

You know, if you want apples to apples, they'll probably bump it up, you know, from past history, if you know what I'm saying.

Yeah. Yep. So the $1.8 million for the quarter is not necessarily... going to be 1.8 for future quarters. Yes.

I guess it will be maybe a little bit less than that. Yes, we have trade shows and all that. So it will be down a little bit going forward.

Right, right, right, right. The backlog is up nicely. The backlog reflects orders primarily for the King Air auto throttle equipment? Is that primarily where the growth is?

In all segments. We're seeing increased interest on all segments of the business, actually including some military where We're getting orders from the U.S. Navy. So overall, everything is tend to be moving up, which is a good sign.

Yeah. Well, it should be reflected in future revenues. Future revenue growth, that's good. I think the backlog is indicative of a lot of things, but I assume, you know, Jeff was the chief... I always thought of him as the chief salesman of the company. And I assume that you've added some sales personnel, marketing people, which will help replace that. Is that correct?

I will continue to do that, yes. And I've also always been very close to all of our customer base and continue keeping that relationship with them.

Right, right. Jeff must have had some close relationships. Okay, I'll let you go. Thanks for the help. Thanks for having such a good quarter.

Thank you.

Once again, you may press star then 1 if you would like to ask a question. One final time, as a reminder, you may press star then 1 if you would like to ask a question. Our next question comes from Michael Friedrich, retail. You may now go ahead.

Morning, guys.

Hey, good morning.

Morning. Certainly, my condolences out to Jeff and his family. Always enjoyed speaking with them, and it certainly seems like he's an incredible guy. Anyway, so my question, Sharam, was you discussed the – the innovation on the installation process to make it less time-consuming and maybe even less costly. Can you try to give us a little more color on that as far as how much shorter the process is and how much easier it will be for the Textron folks to be able to do this? And then also, do we expect the market for the retrofit to get going here?

So in terms of the... In terms of the installation time, we see more benefits in reduction of the installation time in terms of downtime of the aircraft and keep it within the confinement of such things like an annual, where it takes about two weeks to do an annual for the aircraft. And Textron believes that if we can keep the installation confined to that period of time, that they would be able to, it would be more attractive, so they don't have to hang onto those airplanes for longer than that. And we believe we've achieved that. It takes a while for their technicians to come up to speed with the new installation process. We've done improvements, for example, on calibration of the equipment. where there was some manual steps going on in calibrating things like the pitch roll and the heading of the standby instruments. We've automated that process, which takes about a day of time just out of that process. So there's a lot of areas where we've done improvements. I can't exactly say how much improvement that the reduction in time will be until we see Textron technicians perform the tasks and become proficient in it, and then we'll have a better color into exactly how much time we save.

Understood. Understood. Has the feedback been good from Textron? I mean, are they excited about this?

So they are. They are very excited about it. I mean, another thing we also did with them was that we actually – carrying some inventory in-house, because one of their issues also was that a lot of the time somebody comes in the shop with their airplane to do an annual or whatever, and they convince them to buy an autotravel, and now they're going to have to order one, and it takes time. So we started carrying inventory as of this month, So we can supply to them immediately. But end of this month, I think it's on the 25th, that our guys are going down to Textron. They have their annual international sales conference. And we're going to talk about with the international sales people about all of these, as well as our technicians are going down there. to provide classes to train Textron technicians in the new installation. And then we will continue doing that training to all our other installers that are non-Textron affiliated.

Got it, got it. Okay. And I know that there's been other talk, at least some discussion of the idea of potentially putting some of putting the autothrottle into some of the other Textron production lines. I'm sure you obviously have nothing to discuss, but is there right now currently in progress other OEMs that you're in discussion with?

We are currently in discussion with other OEMs for our autothrottle as well as some of our other product lines.

I understand, right? And just without giving away too much, has there been much more progress on some of the large military prop planes?

So that's a long-term view when we deal with the military. And there's a large field of KT-135, for example, that actually have our Some of our primary flight districts, we provide all the altimetry for that. And we're starting to communicate the idea of putting an aerosol on those aircraft. It doesn't happen overnight with the military.

I understand. I understand. Well, thanks a lot, guys. And, you know, obviously, best of luck going forward. And talk to you soon.

Thank you.

This concludes our Q&A session as well as the conference. You may now disconnect. Have a good day.