Innovative Aerosystems, Inc. (ISSC) Earnings Call Transcript

Good morning, and welcome to the Innovative Solutions & Support conference call to announce the acquisition of certain Honeywell product lines. [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 like to turn the conference over to Mike Linacre, Chief Financial Officer. Please go ahead.

Thank you, operator. Good morning. This is Mike Linacre, Chief Financial Officer of Innovative Solutions & Support. I'd like to welcome you to our conference call to discuss our acquisition of several Honeywell product lines. Joining me is Shahram Askarpour, our Chief Executive Officer and a member of our Board of Directors. Before we begin, 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-K, which is on file with the SEC and other public filings. Now I'll turn the call over to Shahram.

Thank you, Mike. Good morning, everyone. This is Shahram Askarpour, Chief Executive Officer of Innovative Solutions & Support. Welcome to our conference call to discuss our acquisition of several product lines from Honeywell Aerospace. On Friday, June 30, we signed an agreement with Honeywell Aerospace to acquire key assets and entered into an exclusive license agreement for certain of the inertial, communication and navigation product lines. This transaction provides us with exclusive intellectual property rights to manufacture, upgrade and repair certain nav/comm radios and inertial reference system products. This is a unique opportunity that enhances our current offering with product lines that can be found on literally thousands of aircraft in our target air transport and business aviation markets with potential to expand that market to the military platform. We believe that in fiscal 2024, this acquisition will increase our revenue by over 40%. In terms of gross margin, we believe that they will approximate our existing margins as we further integrate the operations into our P&L over the next several months. We see this acquisition as a unique opportunity to grow and diversify our organic navigation product portfolio with products that both cater to our existing customer base and help grow our customer portfolio. We also believe there are growth opportunities available both by marketing to a sizable, untapped repair and overhaul market and in acquiring a customer network representing potential new business opportunities for the acquired products as well as other products, IS&S products. In addition, there are potential cost synergies to be realized in better leveraging our skilled engineering teams and existing operations capacity in Exton. The acquired product lines have years of proven performance and are renowned for their reliability and dependability. The initial reference units are operational on thousands of air transport category aircraft, including Boeing 737, 747, 757, 767, Airbus A300, A310 as well as thousands of business aircraft, ranging from both Gulfstream Vs to Citations. The navigation and communication radios, transponders, radio management units and audio systems are also installed in thousands of prestigious business aviation aircraft. As part of this transaction, we have the exclusive, perpetual, free-of-charge license to all the IP that allows us to expand and complete our product offerings in the areas of inertial, communication and navigation, where we previously had limited capability. Let me now turn the call over to Mike for some additional commentary.

Thanks, Shahram. On June 30, IS&S closed on an asset purchase agreement in which we acquired the exclusive intellectual property rights to service the installed base Shahram just described. Honeywell sold, assigned or licensed certain assets related to its inertial, communication and navigation product lines, including a sale of certain inventory valued at approximately $12.5 million, equipment valued at approximately $6 million, customer-related documents and assignment of certain contracts and a grant of exclusive and nonexclusive licenses to use certain Honeywell intellectual property related to its inertial, communication and navigation product lines to repair, overhaul, manufacture, sell, import, export and distribute certain products to the company. These product lines have attractive margin profile characteristics that are similar to our current product portfolio, which is an essential element of our strategy. Consequently, once they've been integrated into our operations, we expect the transaction to materially contribute to our revenues and EBITDA. Revenues are expected to grow over 40% while EBITDA is expected to grow roughly 75%. We also expect the resulting EPS to be accretive in fiscal 2024 with the potential for additional net income increases in future years from various synergies. As Shahram noted, while the bulk of revenue is for manufacturing subassemblies, repair and maintenance of existing equipment, there is the potential for further growth and synergies in future years. The purchase price was $36 million, which included the aforementioned $18.5 million in hard assets, that's paid in cash in the time of closing. Coincident with this acquisition, we have amended our bank facilities to fund this acquisition as well as maintain ample liquidity for ongoing operations and potential future acquisitions. In particular, we have secured a $20 million term loan. The term loan has a floating rate 5-year amortization schedule and has a variable pricing structure with the current interest rate at approximately 7.66%. These funds, together with $20 million of cash we had on our balance sheet prior to the acquisition, released upon the acquisition. The amended loan agreement contains customary returns and covenants, which include a covenant requiring the company not to exceed the maximum ratio of funded debt-to-EBITDA, measured quarterly commencing with the quarter ending June 30, 2023. And we expect to satisfy that covenant. To the extent required, the company intends to file the pro forma financial information required by Item 9.01(b) as an amendment to this current report on Form 8-K as soon as practically practical, and in any event, no later than 71 days after the date on which this current report on Form 8-K is required to be filed pursuant to Item 2.01. I'd now like to open the call to questions.

[Operator Instructions] The first question is from Tim Moore of EF Hutton.

Congratulations on this acquisition and the licensing deal and being patient for something that seems like a home run. I mean, to quote one of my favorite movies, Rounders, I mean, definitely laid down a monster hand today. And thanks for providing all those details. I really appreciate it, I think investors do. I just was wondering if you can elaborate a little bit more on maybe a rough estimate of the end markets' sales mix. Is it mostly business jets? Or does it tilt more towards commercial cargo? It sounded like there was an opportunity for maybe military later on. But I'm just wondering maybe where the business mix sales split is. And is it more evenly split between retrofit, repair and new products?

So there were a lot of questions there, Tim. So in terms of the market, again, we bought two distinct product lines. One was the inertial product line. Those are, as I said -- there's a lot of synergies with what we do currently on our 757, 767 and 737 aftermarket product line. Some of those customers that we are going to be serving with the inertial reference units are existing customers. But I guess, the good thing about that is that just about everybody that flies those airplanes is going to become our customer. And that opens the door for us to gain a larger market share on our cockpit display systems as well. Those are mainly on the aftermarket repairs. We will be manufacturing some new units, they're not OEMs but for spares, and as well as we'll be making subassemblies here in Exton, Pennsylvania that we would sell to channel partners internationally for repair of these product lines. In terms of the larger market, it's the business aviation market, where some of these inertials as well as the navigation and communication product lines now. Those include transponders, navigation radios, communication radios, audio systems. And those are installed in Gulfstreams and go all the way down to Citations and thousands and thousands of high-end business aviation aircraft. Those [ private ] clients, also they go through some new sales. And we have -- having the IP for the radios and the audio systems and the transponders allow us to augment our offerings in the business aviation, where currently we have display systems, but we lacked communication and some of the navigation equipment. It allows us to complement those, where in the past, we would have had to go and partner with other avionics manufacturers and pay significantly higher prices to be able to complete our aftermarket offerings on the business aviation. We can -- now we will have our own products to offer in those markets. And the radios are such that they can be expanded into the military market because their frequency expands into the military frequencies. And that makes it very attractive. And in terms of inertials, also we actually announced -- we announced the deal. And we're already getting inquiries for new inertials for some of the government and military market platforms. So it's early stages right now. We're focused on successful integration of these product lines into our facility. And that's the key thing, is to be experienced, bring that in. We see a lot of synergies. We see a lot of cost savings. And we are heavily engaged in doing that in a rapid way, so we can quickly take advantage of the benefits.

You mentioned earlier, Shahram, in your opening remarks that you expect a 40% increase to fiscal 2024 sales from this. And Mike mentioned an impressive 75% increase to EBITDA. Does that 75% increase in EBITDA include the capacity utilization benefit synergies? I mean, I know you're not doing it all in-house in Pennsylvania. But where is that 75% of stand-alone figure pre synergies and getting more scale utilization out of your manufacturing facility?

So to be clear, the 40% I said, I'd say it's over 40%. And the 75% that Mike said, I think he said over 75%.

Yes. And that is really kind of as is, as acquired before synergies. So there's additional upside to that.

Wow, that's great. Thanks for clarifying that. I really appreciate that, investors will. And that's pre synergies. And do you have to do much hiring? Because I know when I visited the facility, I believe it was in March, I think you had some -- it seemed like you could scale up and you had ability to maybe not have to hire much and add extra cost on that front?

Just in terms of such labor, we will be hiring a few. And also, what we need to do is to strengthen -- our plan is to strengthen our product support group, hire two or three people in that area. There is a lot of good margin associated with some of this, powered by our agreements that we will be acquiring as part of this business. And that's an area where we've never played in. But we're learning that, that is an area that we also want to be probably looking at some of our existing product lines to take advantage of that market.

That sounds terrific. I'll ask one more question before hopping off and let other participants ask questions. I was just wondering, do you have an estimate of maybe the integration and the closing costs? I mean, I'm going to treat those as one-off. And so those all pretty much fall in this quarter, actually in the September quarter because it was signed June 30, you mentioned.

Yes. Pretty much all of the integration costs will be incurred during our fourth quarter. You can expect to see the bulk of them be recognized in fiscal 2023.

The next question is from Jeff Bronchick of Cove Street Capital.

Just Shahram, this may be -- I mean, obviously, this is a type of deal you wanted to do. But how did this specific one come about? Was it this is your relationship with Honeywell, someone on the Board, a banker? Maybe a little background about that.

Yes. So we have a business development person that essentially is scouring the industry for these type of acquisitions as well as the whole acquisitions of a company. This particular one comes through some of the relationships I've had with some of the Honeywell folks over the years and with the help of our business development guy. He's got a lot of experience in transaction in these kind of deals, which was an area that we needed strengthened. And he's proved to be very helpful and very useful to us in making sure that we get a deal that's very good for IS&S.

Got it. And I mean, were you looking for this specific product set and pried out of Honeywell? Or this was among the myriad of things that were available and this one made the most sense?

So this -- we've been looking at Honeywell divestitures over the past year. And this -- and we passed on some of them. This has been the best one for us so far that we've seen. In terms of what we're going to be doing for future acquisitions, there may be some additional acquisitions we will do down the similar product lines from Honeywell here. But we're also going to be looking at now in terms of more areas where we will bring in more technology into the company to complete our offerings. And that's very important for us to be able to do a full offering into the market, it will put us in a different category of suppliers.

Got it. And just to be clear, so there's no facilities coming with this. It's just people, IP and some machines and some inventory. Is that correct?

There's no people. So this is IP, inventory. And as part of that, there is -- we get a lot of training, where our people will be trained on these product lines. And what I did was that I actually hired the business development guy from Honeywell that actually ran some of these product lines to help us with the marketing side.

Got it. And obviously, whatever, integration costs. But I mean, is there -- do you need to spend CapEx money for equipment or additional facility or not at all, this is just getting into what you have?

Yes, we're doing some rearranging, internal rearranging here of our space, which is not -- it's in terms of tens of thousands of dollars. It's nothing big. We're not looking at doing any huge -- maybe getting just about everything that we need as part of these acquisitions. There is -- I mean, one of the things when we're looking at into the future is that typically Honeywell has outsourced a lot of these manufacturing of their subassembly. And there is opportunities there for us to take a look at some of the outsourcing they do because we have full in-house capability. Initially, we're going to continue with their existing suppliers. Long run, we're going to take a look to see whether it makes sense to bring some of that in and take more advantage of our kind of like our [indiscernible] technology facility as well and build some of these boards in-house. But it's too early to tell. We're going to do what makes sense.

And just, is there like -- what is the product name, I mean, in navigation management? Like is it called something? And maybe I missed that.

So we're not supposed to use Honeywell's brand names. That was -- to kind of use their name or their brand names in these product lines. But I mean, Honeywell's inertial reference units and air data inertial reference units are really well-renowned in the world in air transport category market. Obviously, we're not buying their latest and greatest.