Greetings. Welcome to Innovative Aerosystems second quarter fiscal year 2026 results conference call. At this time, all participants are in listen-only mode. Question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star 0 on your telephone keypad. Please note this conference is being recorded. At this time, I'll turn the conference over to Paul Bartley, partner at Valen Advisors. Thank you, Paul. You may now begin.
Thank you. Good morning, everyone, and welcome to Innovative Aerosystems second quarter fiscal 2026 results conference call. Leading the call today are our CEO, Shahram Askarpour, and CFO, Jeffrey DiGiovanni. This morning, we issued a press release detailing our fiscal 2026 second 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. 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.
Additionally, please note that you can find reconciliations of all historical non-GAAP financial measures mentioned on this call in the press release issued this morning. 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. With that, I'll turn the call over to Shahram.
Thank you, Paul, good morning to everyone joining us on the call today. Our positive business momentum carried into the second quarter as we reported another strong result highlighted by significant organic growth in our commercial aerospace and business aviation markets, continued strength in bookings, strong margin realization, and efficient free cash flow conversion. We were able to deliver second quarter modest organic growth, driven by growth of approximately 50% in our commercial and business aviation markets despite an unfavorable comparison to the second quarter of 2025. As a reminder, we faced an unfavorable comparison to last year due to the transition of the F-16 manufacturing to our facility in Exton. Our F-16 revenues in the second quarter of 2025 were elevated as deliveries to Lockheed were accelerated to buffer them during the transition-related manufacturing hiatus, resulting in a $7 million year-over-year decline in F-16 revenues.
We anticipated lower F-16 revenues due to the IPDG required approvals and therefore shifted the mix of our operation to be more commercial-centric in our commercial aftermarket sales together with increasing volumes in business aviation. We continued to make important progress under our IA Next long-term value creation strategy during the second quarter, highlighted by three new acquisitions during the quarter that further expand our base of recurring high-value aftermarket and OEM revenue across legacy and next-generation aviation platforms. Together, these transactions are projected to contribute $10 million in annual revenue with a blended gross margin profile of approximately 50%, putting us another step closer to delivering on our $250 million annual revenue target. In February, we acquired the S-TEC autopilot product line from Moog. This was an important transaction as it brought us an established autopilot solution to integrate into our avionics cockpit solution.
This was one of the key products missing in our integrated cockpit avionics platform. We could have built this on our own, but the solution from Moog gives us a recognized and trusted product. This was followed in March with the acquisition of several product lines from Honeywell. In addition to navigation radios, multifunction displays, transponder technologies, and power generation, this transaction importantly included additional autopilot solutions. Coupled with the Moog autopilot, together, these autopilot platforms significantly enhance our integrated cockpit solution and accelerate our ability to deliver autonomous solutions to our customers for both the military and commercial markets. In aggregate, the autopilot product line acquisitions recently made established us as a major supplier of aircraft autopilots with certified and fielded solutions that range from small general aviation aircraft all the way to large Part 25 platforms, including helicopters for both military and commercial markets.
These solutions will also be integrated into our UMS platform and Liberty Flight Deck. Our full suite of avionics solutions now include advanced flight deck and mission systems, precise flight and navigation computers, auto throttles, flight control computers, mission computers, navigation and communication radios, transponders, audio systems, electrical power generation systems, and proprietary software technologies targeting autonomous flight. This is an important milestone fulfilling the company's ongoing strategy to build a comprehensive avionics ecosystem that bridges legacy platform sustainment with next-generation capability development, ensuring operators can maximize aircraft availability, safety, and long-term value. As with the past transactions, these acquisitions expand our reach into new customers and platforms, as well as provide an opportunity to re-engineer these products and integrate them into our existing solutions to offer to new potential customers in military, business aviation, and commercial air transport sectors.
Our acquisition funnel remains robust, and we see additional opportunities as we continue to execute on our strategic growth initiatives. This quarter provided clear evidence that our strategy is working as we saw the benefits of both acquisitions and strong organic growth driven by internal investments in new product development. We will remain disciplined in our approach, continuing to focus on transactions and investments that advance our strategic objectives. I also wanted to provide a quick update on integration of our products in support of the F-16 program. As we discussed last quarter, we completed all required recertifications and resumed full-scale production of the Digital Flight Control Computer at our Exton facility. The recertification and resumption of production of the Improved Programmable Display Generator is also now complete.
We are excited to be fully up and running on these products. We continue to be optimistic regarding the long-term growth potential of this platform. The F-16 remains a critical asset for our military, as well as many of our allies around the world. Additionally, we remain encouraged by the growth potential for our broader defense business as we experience significant level of inquiries for cockpit upgrades and new aircraft platforms. As such, in the current political climate, we are even more encouraged by the long runway of growth we see ahead. We have made significant investments to position our business as a mission-critical partner with the defense supply chain and believe that we stand to benefit given the strong backdrop for defense spending. At a product level, we continue to move closer to delivering the new version of our UMS platform.
We expect deliveries to ramp up through the year and remain excited for the potential of our new UMS platform and our Liberty Flight Deck. We continue to make significant investments in internal research and development as we continue to advance our progress towards autonomous flight through our next-generation Flight Deck, Liberty, which employs our UMS system. Our next-generation UMS system is an advanced aircraft systems management platform designed to monitor and control multiple aircraft subsystems, from flight controls to environmental and power systems, in a unified, intelligent architecture. In summary, we were pleased with our strong second quarter results that further built on our recent strong performance. We remain encouraged by the growth outlook for our business, supported by strength across our key end markets, momentum for our new products, and an active acquisition pipeline.
We remain committed to our strategic priorities with an ongoing focus on maximizing long-term value for our shareholders. With that, I'll turn the call over to Jeff for his prepared remarks.
Thank you, Sham. Good morning to all those joining us. Today, I will provide a high-level overview of our second quarter performance, including a discussion of working capital, 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 $22.4 million in the second quarter, up 2% from the second quarter last year, despite the unfavorable comparison given the elevated F-16 revenues during the second quarter last year, as Sham discussed. We anticipated lower F-16 revenues and were able to offset this $7 million headwind by shifting our operations to be more commercial and business aviation centric, which increased roughly 50% on an organic basis.
We've now completed all certifications and testing related to the Digital Flight Control Computer. The Display Generator in support of the F-16 program at our Exton facility. We expect manufacturing levels to normalize to support ongoing shipment levels in the third quarter of 2026. Product sales were $14.3 million during the second quarter, up from $13.2 million during the same period last year, as stronger volumes of aftermarket products upgrades to the commercial market and sales to the business aviation market more than offset the decline in the F-16 revenues. Service revenues was $8.1 million, down modestly from $8.8 million in the same period last year due to a decline of nearly $3 million in F-16 service revenues. This was partially offset by growth in the service volumes related to the IRUs and radio product lines.
Gross profit was $11.4 million during the second quarter, up 1.5% from the same period last year. The improvement was driven by revenue growth and a favorable mix within the commercial aftermarket business, partially offset by an unfavorable comparison to last year's second quarter, given the timing of expense recognition related to the F-16 transaction. 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. As a result, our second quarter gross margin was 51.1%, down modestly compared to 51.4% last year, given the difficult comparison. We continue to expect our gross margins to be in the mid-40% range over the long term with some quarterly fluctuations based on mix.
As our military business ramps back up, which has lower gross margins, we would expect our gross margins to normalize. However, as we have discussed, our military business has similar EBITDA margins to our other businesses, given a lower SG&A burden. Operating expense during the second quarter of 2026 was $6.5 million, an increase from $4.3 million during the same period last year. The increase in operating expenses reflects investments in R&D in support of growth initiatives, as well as one-time acquisition-related costs associated with the 3 recent acquisitions. Net income was $3.4 million or $0.19 per diluted share during the second quarter compared to net income of $5.3 million or $0.30 per share in the second quarter of last year.
The effective tax rate was 22.6% during the second quarter, up from 19.2% during the same period last year due to our overall growth in the business. Adjusted net income, which includes the same adjustments made to adjusted EBITDA, in addition to an adjustment for the amortization acquired intangibles, was $4.8 million for the quarter as compared to $5.7 million last year. Adjusted earnings per diluted share was $0.27 versus $0.32 last year. Adjusted EBITDA was $6.8 million during the second quarter, down from $7.7 million in the second quarter of last year due to growth investments and timing of expense recognition related to the F-16 transition in the prior year period. Our R&D investments during the second quarter were up roughly $1 million versus the second quarter last year.
For the remainder of the fiscal year, we continue to expect to increase R&D spending to support our growth initiatives. Moving on to backlog. New orders in the second quarter of fiscal 2026 were $24.7 million, and backlog as of March 31st was approximately $87 million and an increase of approximately $7 million over the comparable period. Backlog represents the value of contracts and purchase orders, less the revenue recognized to date on those contracts and purchase orders. The backlog includes committed purchases and excludes potential sole source production orders from products developed under the company's engineering development contracts programs. Now turning to cash flow. During the first half of 2026, cash flow from operations was $10.5 million, compared to $3.1 million in the year ago comparable period, driven by our solid operating results and financial discipline.
Capital expenditures during the first six months of 2026 were $2.7 million versus $1.8 million for the year-ago period. Free cash flow was $7.7 million during the first half, up from $1.3 million in the previous year. Our strong free cash flow reflects the limited capital needed to grow our business, which results in strong free cash flow conversion. At the end of the second quarter of 2026, we had total debt of $55.1 million and cash and cash equivalents of $6.8 million, resulting in net debt of $48.3 million. Net debt increased to $22.2 million from the year-ago period, despite over $35 million used for acquisitions and capital expenditures in support of the company's growth initiatives, reflecting strong operating results and strong free cash flow conversion.
As of March 31, 2026, we had total cash and availability under our credit line of approximately $49.8 million. Our net leverage at the end of the quarter was 1.7 times despite the recent acquisitions. Our modest leverage, combined with 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, I'd like to provide our current thoughts around the outlook for the remainder of the fiscal 2026. As previously disclosed, we continue to expect organic revenue growth to be essentially flat year over year, given the pull forward of revenue from 2026 into 2025 related to the F-16 production and service revenue. As we look ahead, we expect third quarter revenues to be in the range of $24 million-$26 million. That completes our prepared remarks.
Operator, we are now ready for the question and answer portion of our call.
Thank you. At this time, we'll be conducting a question and answer session. If you'd like to ask a question, please press star one on your telephone keypad and a confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Thank you. Our first question comes from the line of Bobby Brooks with Northland Capital. Please proceed with your questions.
Hey, good morning, guys, thank you for taking my question. I thought it was interesting, the commentary that you shifted operational mix away from F-16 to more commercial aftermarket and business aviation. Just wanted to hear more discussion on that. The verbiage makes it seem like it was one or the other, you have the limiting capacity of being able to execute on F-16 orders and commercial and aftermarket, but I don't think that's the case. I just wanted to unpack that a little bit more by what you, what you meant.
Thank you, Bobby. Effectively we, the approval of Lockheed for the IPDG, was getting us to the last couple of weeks of the quarter. There's over 80 hours of testing that goes for these boxes each before we ship them. There wasn't much we could ship when you only had a few weeks left to the end of the quarter. In anticipation for that, we focused the production more towards the commercial deliveries that we were doing. If we would have shipped more F-16 if the thing would have happened a little bit earlier, like early in the quarter. It wasn't either/or situation.
We have capacity here, well over the numbers that we're delivering right now, with the infrastructure that we have. It was just the way the F-16 product lines, the amount of time it takes at the end before you can test them and ship them that would have made it difficult to ship a lot of F-16. In previous quarter we shipped last year, we did about roughly $10 million of F-16 product lines due to all the pull-ins. On average, we think every quarter the F-16 is going to be somewhere between $3 million-$5 million a quarter going forward. I think this quarter we just did over $3 million.
That was kind of a little bit of a shift in the going from $10 million to $3 million, and we had to kind of fill in for it.
Got it. That's helpful. That's especially the clarity on, yeah, you have the capacity to execute on both opportunities. Shifting gears to the acquisition that you've done in the quarter, you've kind of started, as you mentioned in the prepared remarks, really starting to build a pretty unique portfolio. I was just curious to hear what has the customer reception been? Have you guys been inbound after announcing these deals? Like, just wanted to hear how customer conversations have evolved. Have new customers came into the fold because of the, you know, the platform that you're accumulating? Just more color on that.
Sure. I'll start with the acquisition we did from Moog. To the best of our understanding, their strategic objectives had shifted over time. The S-TEC product lines that they had acquired a while ago, they were kind of moving away from those product lines. Their autopilot solutions that they offer in the market are more integrated into their cockpit. They wanted to divest these product lines because they weren't really supporting the customer base with it. After we did the acquisition, we've had significant inquiries from all over the world for people that wanna buy these autopilots. This has been going on. These product lines are well established. S-TEC autopilot is well established in the general aviation and business aviation markets.
It was very positive. We got a lot of inquiries and we're in the process of building a backlog so we can we can deliver on these product lines to the market. The Honeywell product lines that we got, there is OEM contents in that. I think we still supply some of these to Pilatus as well as Boeing. That was very positive because their experience hadn't been that great with the parts of Honeywell that produced these equipment. We've gained a fair amount of momentum here, especially acquiring this many lines of autopilot product lines.
We have acquired from Honeywell, we got the AeroCruise product line that goes in all the lower-end general aviation airplanes, and that's a good revenue generator that continues to do that. Also, the next generation that we got, which was the KFC 230, which is the new digital autopilot, as well as KFC 325, which was the older generation of autopilots, those are installed in over tens of thousands of aircraft, the KFC 325. There is revenue associated with maintaining and upgrading those things. The KFC 230 is going to be the workhorse for our own autopilot. It's a very capable digital autopilot that Honeywell developed, like, 3, 4 years ago.
In aggregate, it's put us in a position where I would say we're probably the largest autopilot suppliers right now in the market, covering the spectrum of aircraft.
That's very exciting to hear. Just last one for me is could you compare your acquisition pipeline today comparatively to when you reported 1Q results? Then could you just speak towards your appetite for more? Obviously, $33 million acquisitions over the past 2 months is a healthy chunk. Do you wanna get those integrated first before looking for more? Just thoughts there.
We've obviously, we've expanded our engineering group as well as contracts and program management group to be able to more easily transfer these technologies into our organizations and do a build. We're at the position now where we're still looking at acquisitions. We've got the dry powder to go do that. Obviously, product line acquisitions are good, we would only do that if they're strategic to us. We're also looking at acquiring businesses that complement us. We've got a pretty active pipeline, we will continue to evaluate.
If we find things that are of interest to us and they're profitable and they're good businesses, we will acquire them.
That's great to hear. I'll return it to you. Congrats on a good quarter.
Thank you.
Our next questions are from the line of Greg Palm with Craig-Hallum. Please just use your questions.
Yeah. Thanks. Good morning, everybody. I'm curious, Shahram, you talked a little bit about the defense market and some of the opportunities that, you know, may or may not be emerging, you know, in light of the positive backdrop. Maybe you can expand a little bit on kinda what you're seeing, you know, pipeline and kinda what you're excited about, you know, over the next couple of years?
Yeah. I mean, in terms of the I mean, I mean, you see what the news is out there and, you know, the investment that our government is planning to make in the defense area. There's a lot of aging aircrafts that resides in our within the DOD. The funding they're making available to do upgrades to all of these airplanes. There is very large programs out there, things like the KC-135. There is, which is, you know, there's hundreds of those, about 600 of them out there. So there is a lot of inquiries going on right now.
You know, we talked about this over a year ago, when we did the acquisition on the F-16, it put us at the table with the decision makers at Lockheed Martin. They're very impressed with the way we've integrated and delivering these equipment to them. That has opened a lot of new doors for us, so we're discussing a lot of other unrelated to our F-16 programs, as well as, you know, upgrades for the F-16 looking into the future. We see a lot of positive feedback that we've had on how we executed on integration of the defense contracting organization into our organization. We're upbeat about the future revenues we're gonna get from it.
Yeah. Okay. That sounds good. As it relates to F-16, and maybe you can tie this out to what's baked into the guide for the current quarter, but does it assume, you know, I assume it probably some sequential improvement in F-16, but does it imply kind of a normalization of revenues, or are we still in a ramp-up phase? If that's not the case, when does, you know, F-16, you know, get to more of a normalized run rate?
Yeah. I think we're there now. Moving forward, like I said, we're looking at about nominally $3 million-$5 million F-16 business a quarter. It's, again, there's so much you can produce on that product line in a quarter because of the amount of time it takes to put these boxes through the required testing. Once that, you know, we are up and running now, that's kind of gonna be the run rate for it.
Okay. I guess last one, in light of kind of a pickup in some recent acquisition activity, you know, what's your appetite going forward and, you know, how does the pipeline specifically look versus maybe previous quarters?
Actually, pipeline looks pretty good. It's, you know, Honeywell is obviously they're splitting the company up end of this quarter. For this quarter, we haven't seen any product divestitures that was at least related to us. I'm pretty sure once that's over with, they will divest additional product lines that they've indicated planning to do so. Some of those are of interest to us. We've now obviously opened up our aperture quite a lot and we're looking at a lot of other companies' divestitures. You know, some of them are just product lines, some of them are divisions, which we find interesting, and we're looking at those.
Okay, perfect. Best of luck. Thanks.
Our next questions are from the line of Sergey Gilyov with Freedom Brokers. Please proceed with your questions.
Yeah. Good day, gentlemen. Many talks about the F-16 program, and now we're aware of redesign issues. Just wondering, could it impact on your revenue next couple of quarters? Or maybe it doesn't matter what's happening with the program overall?
Sorry, can you repeat that?
Yeah, sure. We are aware of F-16 redesign issues. Could it impact on your revenue next couple of quarters or it's it doesn't matter what's happening with program overall, and you can deliver any way your products?
This is Jeff. What I think you're asking is, did that impact the fluctuation in the F-16 is gonna go forward. The answer to that is, right now is it's up and running. The IPDG line is up and running, and that's where we're expecting a roughly $3 million-$5 million on a quarterly basis. Again, the amount of time to test the equipment in the chambers, it's 80 hours, that takes just amount of time, how much we could deliver. The backlog's still there for the, keep that in mind, for the F-16s. There's still a plenty amount of backlog to be built over the next few years.
Okay, got it. Maybe I missed some point about your recent acquisitions, so maybe you can put some colors on what portion of revenue will bring this new acquisitions?
Yeah, as we said, it's about $10 million a year in revenue for the acquisitions that we just did.
Okay. Okay, thank you. The last one is, you know, in terms of your, you know, acquisition pipeline or recent acquisitions. On your commercial side, do you expect your revenue mix will shift toward products rather than services in the long term?
Yes. That's an ongoing thing. I think the original acquisitions that we did three years ago, it kind of increased our services significantly from what it was before. We were doing like roughly about $4 million or $5 million dollars in services, and then it became $25 million dollars in services. As we've done additional acquisitions and as we are developing our next generation cockpits and platforms, that mix is changing. As a percentage, our production is getting larger than our than the way the services are growing.
Yeah, got it. Thank you. That's all from me. Thank you for taking my question.
Thank you.
Thank you. At this time, this concludes our question and answer session, and I'll turn the floor back to management for closing comments.
Thank you, operator, thank you all for your time and interest in Innovative Aerosystems. Have a great day. Thanks.
Thank you. Ladies and gentlemen, thank you for your participation. This does conclude today's conference. You may now disconnect your lines at this time, and have a wonderful day.