Innovative Aerosystems, Inc. (ISSC) Earnings Call Transcript & Summary

Solutions and support, Ticker ISSC. For those not been with the company, ISSC develops and manufactures flight guidance, autothrottle and cockpit display systems, largely for the aerospace market. We are fortunate to have with us today CEO, Shahram Askarpour and CFO, Mike Linacre. Sorry, Mike, I apologize. We'll have a presentation of roughly 20, 25 minutes. Following the presentation, there will be a time for Q&A. [Operator Instructions] With that said, gentlemen, thank you for being with us today. Floor is yours.

Thank you, John. Good morning, and welcome to Innovative Solutions and Support Investor Presentation. I'm Shahram Askarpour, CEO. We begin with our safe harbor statement since there may be some forward-looking statements here. So ISSC was founded in 1988 on an idea that aircraft operators frequently upgrade their avionics as electronic technology grows. We are an IP-rich company that generates an average of 7 patents per year to reflect the inventions and product technologies. We have 3 market segments with our product lines being business aviation, air transport and military. We also provide avionics and new aircraft production, which we refer to as OEM as well as aftermarket or retrofit. Our mission has been to improve safety and comfort of aviation through cost-effective application of technology and our vision is to become the recognized leader of certified autonomous flight systems. That doesn't necessarily mean to be the first, but the goal is to become a major supplier of enabling equipment. Previously, our growth strategy has been mainly focused on organic product development. For example, we initially developed and certified the utility management system for the Pilatus PC-24 and we plan to utilize this existing certified system as our platform for autonomous flight. We also plan to leverage our strong financial position and our underutilized infrastructure to augment the successful organic growth with targeted product acquisitions that help accelerate our growth as our current production infrastructure can triple our sales from little to non-CapEx requirement. In the past 5 years, we've had a top line CAGR of 15%. As a result of our organic growth strategy, we have a rich product portfolio that has been designed and certified to the highest level of safety or level A and is utilized in some of the world's most prestigious aircraft such as the Pilatus PC-24. We are vertically integrated in our facility in Exton, Pennsylvania. We internally perform all aspects of product development and qualification. We manufacture all products, including all sub assemblies in-house. We have an automated surface mount technology laboratory that produces all of our electronic circuit cards. We machine our own mechanical parts. We even paint our equipment in-house and our direct cost of labor is less than 5% of our revenue. We achieved this through innovation in product design and automation in the factory. The reduced labor content is what allows us to achieve attractive gross margins of 60% as well as enable us to significantly increase our revenue with a significant increase in skilled labor. As I mentioned before, we are currently at 30% capacity in our production. Our early products mainly consisted of individual primary flight instruments designed for military aircraft, such as our highly reliable and accurate data computers that sense and compute aircraft speed and altitude as well as engine instruments that measure and display critical aircraft engine parameters. In early 2000, there was a mandate by the FAA to reduce the vertical separation of aircraft from 2,000 feet to 1,000 feet when flying at and above 29,000 feet. The IS&S data products met and exceeded the accuracy requirements. We shared the market with 2 larger competitors and yet captured over 60% of the world's business aircraft. We generated $100 million in cash and invested that money over the years to grow our product portfolio. Today, our products portfolio ranges from integration of individual instruments inside the large LCD of displays, adding high-performance navigation systems for highly integrated cockpit solutions to highly accurate flight and navigation sensing computers. In the last 10 years, we have been developing products for flight controls, such as our utility management system and our autothrottle product. The utility management system and our autothrottle product line have provided us with unique actuation and monitoring technology and is the engine for our near-term growth strategy. We are currently in discussion with other aircraft manufacturers to incorporate our UMS product line in their various platforms as well as expanding the platforms or autothrottle product lines. So the organic growth would mainly be driven by a number of expansion projects such as the aftermarket autothrottle installations, aftermarket display system installation as well as expansion of the UMS to other aircraft platforms. The organic growth will also be realized through our aftermarket solutions that replace other obsolete and inadequate systems in all 3 market segments with advanced systems that allow for a significant amount of cockpit automation for pilot workload reduction, which eventually lead to reduction of number of pilots in the aircraft. The acquisition strategy is to incorporate established cockpit and cabin product lines in our production facility, gaining significant operating leverage. Last one, we obtained shareholder approvals to update our articles of incorporation. This significant milestone has allowed us to better execute on our acquisition strategy in terms of financing as well as the type of acquisitions we can perform in a more expedient way. So the future of aviation is an autonomous flight with 2 major milestones being first, reduce the pilot count to 1 and second, to eliminate the pilot in the aircraft. Our focus is on the lucrative near-term opportunity of reducing the pilot count on Part 25 aircraft. That is aircraft with growth rate of over 12,500 pounds, which covers most of the multi-engine aircrafts out there. These aircrafts are currently required to fly with 2 or more pilots on board. The business case is compelling, starting a larger business aircraft such as the Citation XLS and above, but the ROI is less than 2 years with passenger and cargo airline operations where a typical passenger airline has an average of 10 to 16 full-time pilots on staff per aircraft, and the ROI is less than a year. Reducing that count to half is highly attractive proposition for all operators of Part 25 aircraft. Aircraft operators have been demanding a solution that reduces pilot count from 2 to 1, and the certification authorities are reacting to that demand. The second milestone of pilotless commercial flight is out there somewhere. So our focus is on the initial phase of flight autonomy being one pilot in the aircraft with a fully autonomous system capable of performing all phases of flight and ground activities. The automated system communicates with a ground station that includes few pilots monitoring many aircraft and assisting the flying pilot through the automated flight system. We plan to reach this by incremental supply of cockpit automation to the industry that helped reduce pilot workload and enhance safety. What is our advantage over the competition? Two product lines developed by IS&S are the existing certified equipment that enable Phase 1 operations of autonomous flight, being the eclipse display system and the utility management system. There's a time line for our autonomous flight strategy with Phase 1 completion in 2027. As I mentioned, Phase 1 is an achievable and highly lucrative proposition for the market, and we are well positioned with our technology to take advantage of this opportunity. Mike will now give further details on our financials.

Thanks, Shahram. Turning over to our financials. I'd like to speak to the overall strong position of our income statement, balance sheet as well as cash flows. From a top line perspective, our sales have grown 4 years in a row with sales in 3 of the last 4 years, increasing 20% or more. Sales doubled since 2018. We have a very profitable business with strong margins, efficient processes and cost control, which utilize automation and minimizes labor. Gross profit was over 60% in 2022. Possibly our largest trend is the further financial growth as we've grown. Currently, we're only scratching the surface of our production potential at 30% capacity. As we grow, we can utilize our existing cost infrastructure, and will not have to invest in significant indirect overhead or SG&A costs. With sales growth seen in 2022 and lot of gross profit to grow over 30% and operating income 54%. Sales growth has been consistent over the last 4 years with a CAGR of nearly 15%. Growth has come from each segment of the business, including our OEM aftermarket as well as our repair business. We continue to work on new product development, acquiring new customers through sales and marketing, as well as penetrating and growing sales with existing customers. We have invested and added to our sales and marketing teams as well as business development. We are also actively hiring engineers to further our research and development efforts. Operating income has increased significantly with doubles in the sales volumes in 2018 and has created strong operating leverage. With increased sales and production utilization, the incremental margin drops right to the bottom line, further fueling the operating income leverage. This leverage is aided by our ability to pass through raw material cost increases through our customer contracts. It has also been aided by our process efficiencies as well as our product mix. In addition, our strong cash position enables the company to execute on organic and inorganic growth opportunities. Our cash of $17.3 million as of our most recent fiscal year-end has also more than doubled over the previous year. We generated $6.1 million in free cash flows and $8.7 million in cash overall. Our balance sheet is very liquid with the company also not having any long-term debt. With that, I'll turn it back over to you, Shahram.

Okay. I think we're ready for Q&A, John.

Okay. Thank you, everybody. If you have questions, you can enter in the Q&A section, chat section or e-mail me directly. Gentlemen, I had to start it off. You mentioned in your prepared remarks about the change in your articles of incorporation and the potential impact on M&A strategy. I wonder if you could go into that a little bit. Does that change the size of the acquisitions you might be targeting your ability to add leverage or how else you may want to finance? And any kind of additional color would be helpful.

So there's 2 sides to them was that the way our articles of incorporation were written, it prevented us to do any acquisition of any entity as a whole. So we couldn't go out and buy any companies of any size without 65% shareholder approval, which kind of put you out of the competitive market of going after those acquisitions. Another thing that was in our articles of incorporation was that we were not allowed to take on any debt including having a credit card for the business, without getting 65% shareholder approval. You've got to appreciate that typically, a lot of your shareholders that are retail, they don't vote. So getting that approval was kind of a near impossible task. So what those changes have allowed us now that we can get lines of credit that could potentially increase the size of the acquisitions that we could consider as before, we don't look at our cash position, for acquisitions, as well as allows us to actually buy LTV. So a lot of companies that maybe the owner is thinking about retirement and those businesses come up for sale or they don't have a diversified product range and they're not kind of getting their -- require more financing and investment allows us to look at those opportunities as well. So it expands our area both by acquisition.

Got it. Got it. And Mike, I believe you said in your remarks that you're only running at 30% capacity. Is that by design or can you talk a little bit about why you're running at such a low capacity level?

And that's really where our sales are at currently versus what our facility is capable of. So as we grow, we'll continue to leverage and improve our gross margins. As a public company, we have a fairly large fixed cost base and as we are able to grow, we're going to be absorbing more of that cost into our cost of sales, thus increasing our gross profit.

Okay. And you mentioned in your prepared remarks, gentlemen about the aftermarket revenue, and I imagine has a fair amount of impact on the P&L. What's aftermarket sales relative to an OE sales in a typical quarter annual basis?

Yes. So typically, the aftermarket sales is about 40% of our business and that margin tends to be just a little bit higher than our OEM business. But really, when you look at our OEM business and our repair business, that's about 60% of the business versus the aftermarket, which is approximately 40%.

Okay. I've been ignoring some of the questions from the audience, I'll get to some of those now. Another question on the M&A opportunities. Maybe if you want to just talk about general size or adjacencies that you might be looking at? Anything maybe additional to add on the M&A following what I asked already?

I mean, typically -- so we've been -- obviously, we've got a final map we've been developing and like the kind of -- within the limitations of what we could look at, which was mainly product diversities. Most of the things that we see or have that kind of are a fit for us, they're somewhere around -- if I pick a number in the middle, about $15 million in revenue per year. So now we have not -- now, I guess, we've kind of widened our scope and we're also looking at businesses that are out there. But I think somewhere between $10 million to $15 million in revenue, our first acquisition is going to be in that order. At least to me that's where it looks right now. We're going to take our time on that. And we're not just going to go buy something because we can, it's important that it's the right product, it's the right product mix, and it's something that we can digest reasonably in a short period of time. So they're really -- we like them to put a time frame on it because it's going to be the right acquisition.

Got it. One of our audience members has noticed that you've had fairly sizable growth margin expansion. Can you talk about what's been the principal driver there? And what's the long-term opportunity to improve those margins?