Innovative Aerosystems, Inc. (ISSC) Earnings Call Transcript

Greetings, and welcome to Innovative Aerosystems Third Quarter 2026 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Paul Bartolai. Thank you. You may begin.

Thank you. Good morning, everyone, and welcome to Innovative Aerosystems Third Quarter Fiscal 2026 Results Conference Call. Leading the call today are our CEO, Shahram Askarpour; and CFO, Jeff DiGiovanni. This morning, we issued a press release detailing our fiscal 2026 third quarter operational and financial results. This release is publicly available in the Investor Relations section of our corporate website at www.iascorp.com. I would like to remind you that management's commentary and responses to questions on today's conference call may include forward-looking statements, which, by their nature, are uncertain and outside of the company's control. Although these forward-looking statements are based on management's current expectations and beliefs, actual results could differ materially. Our management believes that these forward-looking statements are reasonable. However, you should not place undue reliance on any such forward-looking statements because such statements speak only as of today's date. We do not undertake any obligations to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. In addition, forward-looking statements are subject to certain risks and uncertainties that could cause actual results, events and developments to differ materially from our historical experience and our present expectations or projections. These risks and uncertainties include, but are not limited to, those described in the reports which we file with the SEC. For a discussion of some of the factors that could cause actual results to differ, please refer to the Risk Factors section of our latest reports filed with the SEC. During the call, we will reference certain non-GAAP financial measures. A reconciliation of these measurements to the most directly comparable measure calculated in accordance with GAAP is provided in the press release, which is also available on our website. Today's call will begin with prepared remarks from Shahram, who will provide a review of our recent business performance and an update on our strategic framework, followed by a financial update from Jeff. At the conclusion of these prepared remarks, we will open the line for your questions. And with that, I'll turn the call over to Shahram.

Thank you, Paul, and good morning to everyone joining us on the call today. During the third quarter, the IA team delivered another strong operational and financial performance, driven by continued organic growth, improved margin realization and free cash flow conversion. Importantly, beyond our strong financial performance, we made meaningful progress advancing the key strategic priorities that we believe will drive sustainable long-term value creation. These progress points include some recent developments such as the acquisition of Aydin Displays and a new OEM contract with a leading developer of electric vertical takeoff and landing aircraft, which represents the first major award based on our Liberty Flight Deck. I will discuss each of these important items later in my remarks. We are excited by the strong momentum in our business, and we are confident we are well positioned for a solid finish to fiscal 2026 while building momentum into fiscal 2027. I will now discuss third quarter results in greater detail. Despite a difficult prior year comparison, I'm pleased to state that we were able to generate approximately 11% revenue growth in the third quarter, highlighting what remains a period of increased demand across our commercial aftermarket and business aviation markets. Our disciplined execution, combined with a more favorable business mix and improved operating leverage contributed to third quarter net income of $4.5 million or $0.25 per diluted share compared to $0.14 a year ago. Gross margin of nearly 52% compared to 36% last year and adjusted EBITDA growth of approximately 75% from a year ago, highlighting the strength and scalability of our business model. These results reflect our disciplined execution of IA Next, our long-term value creation strategy focused on organic growth through innovation and integrated solutions, operational excellence and disciplined returns-focused capital allocation. I'll now provide additional details on our recent progress and the strategic priorities that will drive our performance going forward. In July, we announced the acquisition of Aydin Displays, a leading developer and manufacturer of rugged display technologies serving defense, industrial and other mission-critical aerospace applications. Aydin is located right up the road from Exton in Birdsboro, PA and currently supports over 20 military platforms across more than 80 countries. Aydin brings with it a leased vertical integrated manufacturing facility. Together with our Exton facility, we will be able to serve our customers more efficiently and further grow our business with the expanded footprint. Aydin enhances our display technology capabilities, bringing us additional engineering talent, proven display technologies and a respected product portfolio that aligns closely with our integrated avionics solutions. Aydin further strengthens our position in our traditional military avionics markets through exposure to new defense platforms. Additionally, the acquisition expands our military business into naval and ground programs and also diversifies our business into industrial applications, including the medical instrument market. This is our first acquisition of an operating business and demonstrates the broadening scope of our M&A strategy beyond the product line acquisitions we've historically pursued. Looking ahead, we will continue to target aerospace and defense component product lines and businesses with significant aftermarket potential proprietary content, above-market growth, strong cash generation and profitability. Our acquisition pipeline remains very active. As we build the business through accretive acquisitions, we also remain highly focused on continuing to drive organic growth through new product introductions, cross-selling initiatives and contract wins. To that end, in August, we announced an exciting new contract win with a leading Japanese developer of electric vertical takeoff and landing aircraft. Under the agreement, IA will develop the main display and avionics architecture for an eVTOL aircraft program. This is the first OEM program based on our Liberty Flight Deck, highlighting the growing commercial validation of our technology. We expect early engineering work to begin in Q4 2026 with initial production targeted for late 2027. We currently expect to progress towards full production during 2028, in support of customer's targeted 2028 full-scale commercial launch. The program currently holds a total of over 400 eVTOL orders from partners in Japan and overseas. The advanced air mobility market represents one of the most exciting frontiers in aviation and our flexible integrated avionics platforms are ideally suited for this market. This program reflects our continued focus on developing next-generation systems that enable safer, smarter and more capable flight across both traditional and emerging aviation platforms. As previously discussed, we completed the development and certification of the UMS Version 2. Production began in June of this year and Q3 revenues benefited from this product line. The Radio Management Unit contract with L3 is at its final certification phase and production deliveries will commence in Q1 of our fiscal 2027. The KC-767 contract with Boeing is progressing per plan and production deliveries will commence in Q2 of our fiscal 2027. In addition to progress on our strategic initiatives, we recently made meaningful strides in our corporate rebranding and efforts to expand market visibility. Last October, we announced our rebranding to Innovative Aerosystems, a pivotal step in our broader strategic evolution. Building on that momentum, we are pleased to announce our planned NASDAQ ticker symbol change to IA, better aligning our public market identity with our corporate name, brand and long-term strategy. The company will cease trading under the NASDAQ ticker symbol, ISSC and begin trading under the symbol IA, effective at the U.S. market open on August 18. To mark this milestone, members of our leadership team will be in New York to ring the NASDAQ closing bell on August 18. Additionally, on June 29, IA was added as a member of the U.S. Small Cap Russell 2000 Index as part of the 2026 Russell Indexes reconstitution. This is an important milestone in our company's evolution and is a direct reflection of the important progress we have made against our strategic priorities and long-term investments we have been making to scale our business. In summary, we are excited by our strong third quarter results as well as the important progress towards our strategic plan. Based on our strong business momentum and successful execution, we are confident we remain well on track to achieve our long-term $250 million revenue target. As before, we remain focused on our strategy, energized by the opportunities ahead and committed to creating long-term value for our shareholders in the years ahead. With that, I'll turn the call over to Jeff for his prepared remarks.

Thank you, Shahram, and good morning to all those joining us. Today, I will provide a high-level overview of our third quarter performance, including a discussion of our balance sheet and our liquidity profile at quarter end and conclude with comments on our outlook for the business, which remains positive given current demand conditions. We generated net revenues of $26.7 million in the third quarter, up approximately 11% from the third quarter last year, driven by another quarter of strong organic growth in our commercial aviation and business jet markets, partially offset by an elevated prior year comparison within our F-16 business. As a reminder, in the third quarter of 2025, F-16 revenues were $12.6 million as there was a pull forward of revenue due to the transition of manufacturing into an Exton facility as compared to $5.7 million in the current quarter. Excluding the F-16 revenue from both periods and the new acquisitions, our business grew by over 40% during the third quarter. Product sales were $17.5 million during the third quarter, up from $16.6 million during the same period last year, driven by strong sales into our commercial and business aviation markets. Service revenue was $9.2 million, up from $7.5 million in the same period last year due to growth in service volumes related to the IRUs and autopilot product lines. Gross profit was $13.8 million during the third quarter, up 61% from $8.6 million in the same period last year. The improvement was driven by revenue growth and a favorable sales mix given the strong commercial aftermarket growth. As we've discussed previously, we experienced some lumpiness in the timing of expense recognition during the manufacturing transition from Honeywell that impacted our quarterly results. Last year's third quarter results were impacted by elevated costs on the F-16 product line as Honeywell incurred extra expenses in order to expedite the building of safety stock ahead of fully transitioning production to us. As a result, our third quarter gross margin was 51.7%, up from 35.6% last year. This is our fourth consecutive quarter with gross margins of at least 50%. Operating expense during the third quarter of 2026 was $7.8 million, an increase from $5.1 million during the same period last year. R&D expense increased by approximately $1 million as compared to the prior year. As previously discussed, the company is accelerating investments in R&D to drive long-term growth for the next-gen capabilities that support multiple platforms and end markets. As such, we continue to expect elevated R&D spending to support our growth initiatives. Net income was $4.5 million or $0.25 per diluted share during the third quarter compared to net income of $2.4 million or $0.14 per share in the third quarter of last year. Adjusted net income, which includes the same adjustments made to adjusted EBITDA in addition to an adjustment for the amortization of acquired intangibles, was $6 million for the quarter as compared to $2.9 million last year. Adjusted earnings per diluted share were $0.33 versus $0.16 last year. Adjusted EBITDA was $7.7 million during the third quarter, up from $4.4 million in the third quarter of last year due to the solid revenue growth and more favorable revenue mix, partially offset by the continued investments in R&D to drive long-term growth for the next-gen capabilities that support multiple platforms and end markets. Moving on to backlog. New orders in the third quarter of fiscal 2026 were $22.7 million and backlog as of June 30 was approximately $83 million, an increase of approximately $5.5 million over the comparable prior year period. Backlog represents the value of contracts and purchase orders less revenue recognized to date on those contracts and purchase orders. The backlog includes committed purchases and excludes potential future sole-source production under the company's engineering development contract programs. Next, turning to cash [Audio Gap] compared to $10.3 million in the year ago comparable period, driven by our solid operating results and financial discipline. Capital expenditures during the first 9 months of 2026 were $3.2 million versus $5.5 million in the year ago period. Free cash flow was $12.3 million during the first 3 quarters of the year, up from $4.8 million in the previous year. Our strong free cash flow reflects the capital-light nature of our business model, translating into consistently strong conversion rates. At the end of third quarter of 2026, we had total debt of $54.5 million and cash and cash equivalents of $10.7 million, resulting in net debt of $43.8 million. Net debt increased $21 million from the year ago period despite more than $35 million deployed towards acquisitions and capital expenditures in support of growth initiatives. As of June 30, we had total cash and availability on our line of credit of approximately $53.7 million. Our net leverage at the end of the quarter was 1.4x despite the recent acquisitions. Our modest leverage, combined with our availability under our expanded credit facility gives us significant financial flexibility to continue executing on our strategic initiatives. Before we move into our Q&A session, I'd like to provide our current thoughts around the outlook for the remainder of the fiscal 2026. As we look ahead, we expect to close out our fiscal 2026 on a positive note. We expect to generate fourth quarter revenue around $28 million to $30 million, including continued expected organic growth and the contribution from recent acquisitions. That completes our prepared remarks. Operator, we are now ready for the question-and-answer portion of the call.

[Operator Instructions] Our first question comes from Bobby Brooks with Northland Capital Markets.

I wanted to unpack the eVTOL program win yesterday, very exciting news, but wanted to hear more about how this win came about. How long was the sales process attached to it? Then the last piece, you cite like $50 million total contract value. Is that assuming all 400-plus units are produced? Or just how should we be thinking about that $50 million?

For the -- we're having a little bit of a phone issue here. For the -- your first question of how long was the sales process, it's been about a year now that we've been working with this company to finalize agreements and put them in place. In terms of your question about what the value of the contract is, we really can't comment on that right now. It's early on. We know they have about 400 airplanes in the backlog, but that's not the extent of this program. We believe that there is a significant number of aircraft that are going to be produced by this manufacturer.

That contract value is assuming all 400-plus get shipped out.

Got it. That's helpful. And maybe just if you could touch on what led -- like the factors that you think led you guys to get this win. Obviously, Liberty Flight Deck, very customizable. I'm guessing that was a piece. Was there anything else important to note there on landing that win?

Again, when we look at the cockpit of some of these newer aircraft that are coming into the market, the customization of their graphics and the cockpit displays is very important and key to the operators. Our system is very flexible, and we can customize it at a very reasonable cost, and that's essentially what made it attractive to this particular company. But we're seeing similar interest from a number of aircraft manufacturers. Again, this is the first air mobility aircraft that we've signed the contract with, but it's not the only one that going forward, we see on the horizon.

Got it. That's helpful. And then just last week, Honeywell Aerospace called out some challenges within their own supply chain, specifically relating to electronic suppliers. My initial thought is this wouldn't be you or affecting you, but just wanted to confirm that and hear anything you might be seeing within your own supply chain?

So our supply chain is a little bit different than Honeywell's supply chain as we don't outsource our circuit cards. We build them in-house. We don't have those kind of issues that they have. And also, we -- the basic principles that we've had in our product development for years has always been that we make sure any component that we have multiple sources available. And sometimes we even qualify some of the key components like the LCD, for example, we qualify our system with LCDs from multiple suppliers, multiple manufacturers that make the same size. So we don't get into this trap of supply chain. The landscape of -- and we see that in the international scope, there's a lot of changes happening with the kind of the political environment that's out there. And it's created a lot of issues for the companies that a few years ago, they saw opportunities to make the quick cash by outsourcing all of their IP to countries abroad in Southeast Asia, and that's creating some of these supply chain issues for them now because they don't have the capabilities to do it in-house.

That's super helpful color, Shahram. I really appreciate it. And then just last one for me. Jeff, in your prepared remarks, I think you gave -- you made the comment of like excluding the F-16 year-over-year comps and the sales this quarter. And I believe acquisitions as well, you gave a growth rate. Could you just repeat that?

Yes. So what we do is we backed out the F-16 over comparable periods because keep in mind, this time last year, there was about $12 million of F-16 revenue that got sort of front-loaded because of the buildup of inventory before the change over to the Exton [ facility ] versus $5 million this quarter. So when you back those 2 out and the acquisitions revenue, we came in about 40% growth year-over-year.

On the organic side?

Correct.

Our next question comes from Josh Sullivan with JonesTrading & Company.

Just as you guys execute on your long-term strategy here and the recent acquisitions, how do we think of that 50% gross margin run rate you're doing over the last 4 quarters here looking ahead?

I think that's kind of where -- guidance we've given before was somewhere around 45% to 50%. Again, quarter-by-quarter, depending on the product mix that we sell, those margins are going to vary. But around 50% is -- seems to be where we're heading as we -- on some of these product lines that we acquired as well, the in-sourcing of the circuit cards is ongoing right now. And we believe that once all of that is completed, that -- those margins should become more uniform and as well as fall within that 50% gross margin, which is our ultimate goal is to try to keep it there.