Innovative Solutions and Support, Inc.

or financial results conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on a touch-tone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Dr. Sharam Askapour, Chief Executive Officer and member of the Board of Directors. Please go ahead.

Good morning. This is Sharam Askapour, 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 Raoul Vinant, our CFO. Before we begin, I'd like Raoul to provide a cautionary statement about forward-looking information.

Thank you, Sharam, 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. 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 10Q, filed yesterday, which disclaimer, along with our public filings, represent it, 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 Sharam.

Thank you, Raoul. 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 turn the call back to Raoul, 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. Data side 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 markets, 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, Textron and Pilatus. These production contracts provide a growing base of reliable revenue that generates strong margin and strong cash flow. Margins this quarter were .3% and 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 the credit line balance will continue to be reduced throughout the fiscal year, borrowing another acquisition. We also maintain our commitment to research and development as evidenced by the increase in R&D expense. This increase includes our effort 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 UMS, a product we expect to be extended into additional airframes. 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 products but also for our legacy products. Many of the hundreds of customers that came along with the new products are new to ISNS, 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 the handoff of these products expected to occur by the end of the current 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 complimentary acquisitions should appropriate opportunities arise. Our goal now is to leverage this momentum to sustain this growth over both near and long 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 look forward to updating you in the upcoming quarter. I will turn the call over to Rell for a closer look

at numbers. Thank you, Sherim, and thank you all for joining today. Let me quickly review the highlights of our financial results for the first quarter of 2024. Revenue in the first quarter was up 43% due to the contribution of customer service sales on the product lines acquired and licensed from Honeywell. First quarter gross margin was .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 overhead absorption in customer service. In the first quarter of fiscal 2024, research and development expense was approximately $900,000 or .7% of net sales. Note that research and development expense have increased in absolute terms, but has decreased as a percentage of net sales. When the current engineering development contract is completed, the engineer is working on that development contract for 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 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 resultant 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 the 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, not only as interest rates are anticipated to fall, but also because we plan to use the majority of our cash flow to pay down debt. Taxes are being accrued at a rate of .8% versus the statutory rate of 21% reflecting increased state tax expense due to the gain on the sale of the King Air airplane. That income for the quarter was 1.1 million, or six cents per share, up from 700,000 or four cents 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 31st, 2023 was 10.6 million, down 8.9 million from 19.5 million as of September 30th, 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 31st, 2023, cash also benefited from the sale of our King Air aircraft for $2.3 million. With that operator, we're ready for questions.

We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you're using a speaker phone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. Again, it is star then one to ask a question. At this time, we will pause momentarily to assemble our roster. The first question comes from Theodore O'Neill with Litchfield Hills Research. Please go ahead.

Thank you very much. I just 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 might change and what would be the driver for it?

Some of it is seasonal. Some of it is we're introducing a new product line in that market, which we should begin, we should begin or finish the 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 we will see a slowdown in these updates, which, and because of that, we developed some additional products and put a larger emphasis on our military efforts, which were kind of not, in some ways, they were not a priority before. We were focusing on the oil throttle product lines. So we've put an emphasis over the last couple of years on the military side of things. We got the new OEM contract from Boeing on the T7 trainer. We continue to work on a lot of new opportunities that are coming, both OEM as well as the aftermarket on the military side. So we're looking at that over the next few years to essentially be a larger driver than the air transport side. On the air transport side, what we're doing is that we're offering a lot of upgrades, which as we talked before, leads to more automations within the cockpit and eventually to the single pilot operation for these part 25 airplanes. And the single pilot operation is the longer term strategy. Meanwhile, we will be seeing some revenue from some of these additional features that we're offering on these cockpits. 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.

Okay, yeah, 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?

Yeah, 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. And of course, as Sharon mentioned, the we've hired sales additional salespeople. So that's a big piece of it too. Okay, thanks very much.

Generally our auditing fees and legal fees have been higher. Quarter to quarter they were fine. As the acquisition is falling. Rides

down, yep. Okay, thanks guys. Thanks.

The next question comes from Andrew Rem with Odinson Partners. Please go ahead.

Morning gentlemen. I just had a question to start with. How should we think about gross margins within the customer service segment?

Well, in what way? Typically it's been higher.

Right, so if we look at fourth quarter, right? 68 and a half percent. And fiscal 23 year to date and it has been running 71%. And so, I don't know if, I mean, you mentioned some under absorption, but you had much higher revenue this quarter than first, second or third quarter of last year. Yeah, but I'm sorry.

Go ahead, sorry.

No, I'm just trying to understand some nuances.

Yeah, well you got. Andrew, can you repeat that please? You said we had gross margins of 71%.

Well, the year to date through the first three quarters of fiscal three was running 70, 71%. Then fourth quarter was 68 and a half. And then now you have 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 gonna end up with more overhead absorption into it. As well as we've seen material, as you can understand, has cost of material, the price has increased. So we have to keep increasing our standards. So it's, and it's mixed, depends on what you're repairing. But yeah, it is down from previous. But like I say, half of your sales almost is customer service. So that's gonna get a bigger piece of everything if that makes any sense to you.

Okay, and then on the cost material side, how long does it take you to kind of get some price recovery there?

To get some what? Can you repeat that? I missed that.

The on cost, on the cost of materials, how long does it take you to get this 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, it's gonna flow through to what we charge the customer.

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? Is this related to, are you excess inventory as you make these product transitions? Is that what's driving it?

Yeah, you have a couple things. So you have the Honeywell inventory coming in, right? So that's going up from the prepage. You can see the movement there into inventory. And we have some last time buys. We have items in flow. We're gonna need the inventory. In flow meaning production. And to produce ahead a little bit. So all that's gonna increase. And obviously as we see more Honeywell, you're gonna see that grow and grow and grow because the 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.

Did we expect in the second half of the year, kind of inventory kind of normalizes, you get the product transition, you get that behind you, you brought in all the Honeywell inventory. Is that reasonable?

Yeah, but it'll be a big number. I mean, because you got- It's

gonna be a big number, but it's gonna- It should

level off. Yeah, it

should level off.

Okay, and then do it on CapEx.

Go ahead. And you're

gonna order, you know that kind of thing,

right? All right, on CapEx, can you just comment on, it was pretty high this quarter. How should we think about that for the full year?

Let me look. CapEx, we've increased the building and done some work in the building, things like that. So that's gonna be a part of it. Well, I'm just looking

at 182,000 versus 300,000 for the full year fiscal 23.

Yeah, well, we've probably bought some machinery. Now we're working on having, it usually- We bought a lot of benches. Yeah, bought a lot of stuff for the Honeywell. So, fitting that out as well as making a upgrade a part of the building, the plant for that. So all that's adding into a little higher than normal in a period of time.

Yeah, that should all

- That should level itself.

That should stabilize.

Yeah, typically we don't have, we do 300,000 generally a year. It's always not a big number.

Right, yeah.

No,

an investment in our IT structure as well. Because as you know, this cyber security now is becoming a thing. And so we're doing some- Upgrading

servers.

A lot of upgrades as well as increasing our cyber security practices. And I think long-term it saves us money because that reduces your insurance costs as well.

Can you guys comment then on, 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 you've got a base CapEx send a couple hundred thousand and then how much incremental from these IT and Honeywell related?

Not a lot, 100K, 100, 150 maybe. We're pretty much done that, if you will. I guess like some more than others, 250 maybe, on average I guess. Going forward you're also gonna look at

air conditioning systems 20 years old. We'll get some room to hold differences. We're gonna be addressing.

All right, well I guess that's it for me but I did wanna say that you guys have done a pretty amazing job. You've generated good cash flow here. You've taken a turn and a half out of your debt. I had speculated that maybe you guys exit this fiscal year below one time so I think it looks like you maintain the current trajectory. You guys are gonna blow right through that. So kudos to you guys and the team for doing a great job improving the balance sheet so quickly. So anyway, thanks a lot, appreciate it.

Thank you, Doug Ruth.

The next question comes from Doug Ruth with Linux Financial Services. Please go ahead.

I wanna 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, do you folks now have the ability to buy stock?

Well, when the window's open,

yes. The window

opens actually on, for us, it's the third business day after Monday. So there's, and it closes a couple weeks before the end of the quarter. So as of Monday, there is an open window, yes. Okay,

I think the investment community would really appreciate if the board and some of the managers could buy some stock. I think it would really make a significant difference. And again, I wanna congratulate you on a really strong quarter. Thank you for what you're doing for the shareholders.

Thank you, thank you for your support.

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.