Innovative Solutions and Support, Inc.

Good evening and welcome to the Innovative Solutions and Supports Fourth Quarter Fiscal 2024 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 your telephone keypad. 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 Paul Bertolini. Please go ahead.

Thank you. Welcome to Innovative Solutions and Supports fourth quarter and full year 2024 results conference call. Leading the call today are our CEO, Sheram Askapur, and CFO, Jeff DiGiovanni. Earlier today, we issued a press release detailing our fourth quarter and full year 2024 operational and financial results. This release is publicly available in the investor relations section of our corporate website at www.innovative-ss.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 that could cause actual results to differ, please refer to the risk factor section of the 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 earlier today. Today's call will begin with prepared remarks from Sharon Moskapor, who will provide a review of our recent business performance and strategic outlook, followed by a financial update from Jeff DiGiovanni. At the conclusion of these prepared remarks, we will open the line for your questions. With that, I'll turn the call over to Sharam.

Thank you, Paul, and good afternoon to everyone joining us on the call today. Let's begin with a high-level overview of our fourth quarter and full-year financial performance. This was a transformative year for IS&S. one in which we delivered significant year-over-year growth in revenue, net income, EBITDA, and free cash flow. We generated net income of 7 million, which was up 16% from the prior year. In addition, total EBITDA was approximately 12 million, which was up 36% from the prior year, and is up nearly three-folds from just three years ago. During the fourth quarter, we delivered more than 18% year-over-year growth in revenue, driven by momentum from new military programs and recently acquired platforms. In recent quarters, demand across our military and markets has increased, supported by orders from both the US Department of Defense and allied foreign militaries. As a higher volume of backlog converts to revenue, we've realized improved operating leverage, a dynamic we expect to continue into the coming year. At a strategic level, we continue to build a growth platform centered exclusively on advanced avionics solutions for both commercial and military markets. Over time, our systems integration expertise has positioned IS&S as a preferred partner in the fleet modernization and retrofit markets. One whose in-house design, manufacturing, Installation and support capabilities provide customers with safe, compliant, and cost-effective solutions that enhance aircraft safety, compliance, and mission readiness. We've built a strong reputation in the market that positions us to further scale our business moving forward. Today, we are introducing IS&S Next, a long-term value creation strategy. We consider this strategy the guiding framework for our next chapter of growth, as we'll outline over the coming quarters. At a high level, our strategy centers on a combination of targeted commercial growth within high value markets, improving operating leverage, and a discipline returns driven approach to capital allocation. While many of these elements are already at work in our existing business, we intend to provide more transparency around our progress under the strategy each quarter moving forward. The first pillar of our growth strategy centers on targeted commercial growth within our core advanced avionics market verticals. Looking ahead, we expect commercial growth will come from several key areas, including the expansion of existing platforms, new original equipment manufacturer, or OEM, and retrofit programs, new product development, and strategic product line acquisitions. In 2024, we delivered significant commercial growth through an expansion of our military business, continued growth in existing platforms, and realized synergies resulting from our recent Honeywell product line acquisitions. Our military end markets were very strong last year And given our leadership in cockpit automation, we anticipate the continuation of this trend into 2025. Earlier this year, we announced a new foreign military platform with a major aerospace OEM to supply multi-function displays with an integrated mission computer. We've already begun executing under this contract and realized revenues in 2024. We also recently announced that our ThrustSense autothrottle system was selected by the US Army to be installed on the C-12 aircraft. This advanced technology will provide full flight envelope protection from takeoff to landing, including go around, enabling pilots to automatically control engine power settings, for enhanced safety and efficiency. Entering 2025, we are seeing several other similar opportunities with commercial customers entering our pipeline and anticipated our work with both the U.S. DOD and allied foreign militaries will remain a significant growth engine for us in the year ahead. Within our commercial end markets, we continue to experience solid growth across existing platforms and OEM contracts. This includes Pilatus for our utility management system, Textron for our standby instruments and our auto throttle, and on the military side, Boeing on KC-46A, KC-767, and the T-7 platform. On the heels of our recent Honeywell product line acquisitions, cross-selling synergies have increased as expected. These acquisitions have brought us the opportunity to cross-sell our existing products into new customer relationships acquired in the transactions, while also selling new product lines to our legacy customers. New product development remains integral to our long-term growth. We continue to expand the sophistication of our cockpit automation technology through functionalities that enhance safety and reduce pilot workload. The integration of AI functionality to enhance cockpit automation remains a major area of focus for our industry over the coming years. In early 2025, we will begin flight testing our new generation utility management system, or UMS, on the PC24 platform with Pilatus. In layman's terms, the UMS is to an aircraft what a CPU is to a laptop computer. It guides, controls, and powers the most critical operating systems. Additionally, in 2025, we plan to launch our UMS-2, which is a cutting-edge, certifiable flight monitoring and control system. UMS2 is an AI-capable system, one whose integrated neural network processing capabilities significantly enhance crew efficiency by enabling additional cockpit automation. As our UMS2 is platform agnostic, we see significant growth potential for this product line over the next several years, particularly within the military and business aviation markets. The second key pillar of our value creation strategy focuses on driving increased operating leverage across the organization. As we layer on higher base of revenue within our business, we anticipate improved fixed cost absorption and ultimately a higher sustained run rate of EBITDA dollars. During 2025, we intend to increase the volume of maintenance, repair, and overhaul work we handle at our Exxon facility, while also increasing the volume of sub-assemblies that are being manufactured internally. More on this shortly. The final pillar of our value creation strategy focuses on a returns driven approach towards capital allocation. We demonstrated our ability to successfully allocate capital during 2024, including both investments in our organic growth initiatives, as well as the deployment of capital for product line acquisitions. Our organic growth investments included the addition of R&D staff and increased manufacturing headcount as we prepare to capitalize on higher sales volumes across our business. In 2025, we intend to increase our manufacturing capacity by more than 100% through a $6 million facility expansion. This investment we'd add a second sub-assemblies line as part of the 40,000 square foot addition. Subsequently, we anticipate this will provide us with the opportunity to acquire other strategic product lines in the future. Further to my point earlier on increased operational efficiency. The highlight of Our capital allocation strategy during 2024 was clearly the additional acquisitions from Honeywell. We invested nearly $20 million in the two additional acquisitions during the year, positioning us to expand our capabilities, add new customers, and open the door to significant cross-selling synergies entering 2025. In July, 2024, we acquired additional key assets for certain communication and navigation product lines from Honeywell for roughly 4 million in consideration. This was followed in September, 2024 with the acquisition of various generations of military display generators and flight control computers from Honeywell for 14 million in cash. As we have discussed, these acquisitions provide us with several unique opportunities to drive profit uplift through the insourcing of certain components, the potential to bring more maintenance and repair work in-house, as well as attractive revenue synergy opportunities. In conclusion, 2024 represented over 30% growth in revenue and adjusted EBITDA, and we expect similar growth in 2025, exclusive of any future acquisition opportunities. We intend to remain an opportunistic acquirer of complementary product lines that expand our capabilities in advanced avionics. We believe our collective focus on commercial growth operational efficiency, and disciplined capital allocation, position IS&S for sustained value creation in the year ahead. And we look forward to having you join us on that journey. With that, I'll turn the call over to Jeff for his prepared remarks.

Thank you, Sherm, and good afternoon to all those joining us. Today, I will provide a high-level overview of our fourth quarter performance. including a discussion of our working capital, balance sheet, and liquidity profile at quarter end. We generated net revenues of $15.4 million in the fourth quarter, up 18% when compared to the fourth quarter last year. The increase was driven by contribution from the recently acquired Honeywell product lines, growing momentum in new military programs, as well as revenue synergies from the Honeywell platforms acquired last year. It is worth noting that our fourth quarter 2024 revenues were impacted by a $1.7 million true-up payment for services performed by third parties. Additionally, we were pleased to see continued stabilization in the air transport market, and we saw sequential growth in this market when compared to the first half of the year. Product sales increased to $9.8 million during the fourth quarter, driven by contribution from our commercial air transport programs. Customer service revenue was $5.5 million, owing largely to customer service sales from the product lines acquired from Honeywell. Gross profit was $8.5 million during the fourth quarter, up $8.1 million in the same period last year. Driven by strong revenue growth, partially offset by the higher depreciation and amortization expense resulting from the Honeywell acquisitions and continued investments in growth initiatives. On that note, I think it's important to recalibrate expectations around our recent gross margin performance and our anticipated margin outlook entering 2025. There are two primary factors that have impacted gross margin capture in recent quarters. The first factor is related to the incremental depreciation and amortization that has resulted from recent product line acquisitions. As we continue to complete product line acquisitions in the future, we expect that this will be an ongoing margin headwind. The second factor involves the forward shift in our sales mix. Historically, military sales represent less than a third of sales, while 2025, due to the recent Acquisition will be a higher percent of sales. Generally, military sales carry a lower average gross margin versus commercial contracts. However, given the significant potential we see for absolute even-a-dollar growth in military, we believe this is good for us and work that we will continue to pursue as it advances our focus on approved operating leverage. Given these factors, we expect our consolidated gross margins will likely trend closer toward mid-50% on a normalized basis over the intermediate term, which is below historical levels. However, we anticipate that with our improved top-line growth profile, we'll be able to drive increased adjusted EBITDA margin realization and profitability over time. Consequently, we believe adjusted EBITDA margin and expansion will be a comparatively better measure of our relative performance over time than gross margins. Research and development expense during the fourth quarter of 2024 was 1.1 million, an increase from approximately 740,000 in the comparable period last year. This increase was driven by growth in our product development efforts in support of our long-term growth strategy. Fourth quarter of 2024, selling general and administrative expenses were 3.1 million, a decrease of $3.7 million from last year. The decrease in SG&A expense in the quarter was primarily the result of some one-time expenses included in the prior year results, partially offset by incremental amortization expense related to the acquired Honeywell product lines. Fourth quarter net income was $3.2 million or $0.18 per diluted share compared to net income of $2.6 million or 15% per diluted share a year ago. a year a quarter ago. Adjusted EBITDA was $5.6 million during the fourth quarter, up from $4.8 million last year due to our strong revenue growth and operating expense leverage. Moving on to backlogs, new orders in the fourth quarter of fiscal 2024 were $95.4 million, which includes $74.3 million of backlog acquired as part of the product line acquisition announced on September 27, 2024, and backlog as of September 30th, 2024 was $89.2 million. This backlog includes only purchase orders in hand and excludes orders from the company's OEM customers under long-term programs, including Pilatus, PC24, Textron, King Air, Boeing T7, the Boeing KC-46A, and Lockheed Martin. We expect these programs to remain in production for several years and anticipate that they will continue to generate future sales. Further due to the nature, the product lines from Honeywell do not typically enter backlog. Now turning to cash flow. During fiscal 2024, cash flow from operations was 5.8 million, up 2.1 million in the year-ago comparable period. The improvement was driven by higher cash earnings and improved working capital efficiency. Capital expenditures was $700,000 during the fiscal 2024 versus $300,000 in the same period last year. As a result of these factors, free cash flow for the full year 2024 was $5.1 million, up from $1.8 million last year. Total net debt as of September 30, 2024, was $27.5 million, up from $16.4 million at the end of 2023, reflecting the incremental debt to fund the recent Honeywell transactions. This was partially offset by our strong free cash flow generation during the year. Our net leverage at the end of the fourth quarter was two times. We recently amended our credit agreement with PNC Bank to expand the facility to $35 million. Our total cash and availability under our credit lines was $7.5 million at the end of the fourth quarter, which provides us financial flexibility to support our ongoing operations and facility expansions. That completes our prepared marks. Operator, we're now ready for question and answer portion of the call.

Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. We'll pause a moment as callers join the queue. Once again, if you have a question, please press star, then one. The first question comes from Andrew Rem with Audison Partners. Please go ahead.

Hi, gentlemen. Maybe if I could start, I'm going to call it the Honeywell acquisition number three, the one you announced in early October. Can you give us a perspective on like the revenue and EBITDA contribution, or just give us some sense of what that acquisition looks like and impact on FY25?

Well, first of all, Andrew, yeah, we did the acquisition in September. Okay. The, yeah, there is, are we going to be putting up backlog information?

Yeah, so Andrew, a couple of things on that one. Under that acquisition, the backlog came on around $74 million. So in our backlog, you include about $74 million of backlog acquired on that acquisition, which is production. So that's going to bleed off over, you know, probably a three to four year period. And military has lower margins than commercial.

In terms of EBITDA, the margins we believe is going to be similar to our EBITDA margins.

Okay, just to clarify, you're saying that, I think you said it in your prepared remarks as well, gross margin is lower, but were you saying EBITDA margins are closer to being similar, or those also are a little lower?

Comparable to what we have, because the way we look at it, is that it's an addition. It doesn't significantly increase our SG&A or engineering. So in a lot of ways, when you look at it, the gross margins fall into EBITDA.

OK. And on the backlog, does it necessarily burn off linearly? Or can it be more chunky?

Yeah, I mean, part of the backlog being what it is was that there was an obsolescence issue that Honeywell resolved a few months ago. And because of that obsolescence issue, the deliveries over the prior year or so were very limited. So there is a catch up that's gonna be done in 2025. And it's still a little bit too early for us to be able to accurately say how much of that is gonna be done in 2025, because Honeywell is gonna continue operating This product runs at least for another three, four months before it comes to us. And there's going to be a shutdown period, as we experienced before, while all the test equipment gets transferred here. So if I was to be a guessing man, I would say our Q2 is going to see a big bump in revenue from this. Q3 probably would be the transition quarter. You're going to get a dip and it will hopefully recover by Q4. But I think some of the backlog, its period of performance is over four years. And some of it is just behind the eight ball that we've got to ship as soon as we can.

Okay. And then, Jeff, you mentioned the $1.7 million true-off payment. Which segment does that fall in?

That would fall in the customer service segment.

Okay. And then on CapEx, I think you guys said $6 million. Okay. Is that all in FY25?

Some of it we already spent.

Very little.

So some in 24, but majority, all that's going to be fiscal.

All the architectural work and all the design work and preliminary to get timing permissions and all of that. I think we paid for all that in 24.

Right. So now you're moving forward with the construction in fiscal 25. So you see that in the capex going in 2025.

And when do you expect to complete all that work in fiscal 25? About June.

Okay.

If any construction is completed on time.

Okay. All right. Thank you. Great quarter, you guys. Appreciate it. Thanks, Andrew. Thank you.

The next question comes from Doug Root with Lenox Financial Services. Please go ahead.

I also want to congratulate you on the strong quarter. You know, you really gave us a lot of information. Is there any way that you can give us any kind of projection what Q1 might look like as far as revenue?

With the quarter that we're in right now?

Unfortunately, we don't provide the forward-looking statements.

Yeah, I think I'll wait until February for that.

Yeah, okay.

And is this the norm in your business to say that the backlog could take up to four years to earn out?

It depends on, I mean, some of these are military contracts and they're production contracts. I mean, typically for IS&S, when we have production contracts, We get releases, maybe 18-month releases or a year releases. Our backlog is usually not of this magnitude. These are military contracts, and some of them are with Lockheed. They're on production contracts, and Lockheed, for some of these, they've gone out and issued purchase orders over the next four years. For us, it's not typical, but this is new.

Okay. And then can you – you mentioned that you thought that the Q2 was – you called it a big bump. Could you explain that a little bit more, what you see happening in that quarter?

Yeah, so what – I mean, if you – Remember, when we did the first acquisition from Honeywell, the first quarter for it was our Q4 of 2023, where we got like a $6 million revenue that came from Honeywell. Yeah, I remember that. Yeah, because the next quarter, they were planning on packing all the test equipment and shipping it to us. So they typically... do as much pulling as they can in the prior quarter before shipping their equipment to make sure the customer has enough equipment to support them while we go through this transition phase. That quarter where that's going to happen looks like, it's going to be Q2 of our financial 2025. So between January to March, we anticipate Honeywell is going to ship a lot of this equipment to Lockheed before they tear down the equipment to send it to us.

Okay. And my final question, could you tell us what the three highest priorities are for fiscal 2025?

I thought we outlined that in our speech, but we've got product development where we're looking at launching our latest generation, which is has a lot of artificial intelligence capabilities. It's certifiable artificial intelligence, which is unique in our industry at this point. So that product, we're going to be launching it. We're going to finish the flight test with Pilatus for the PC24 version of that utility management system. Another priority for us is insourcing a lot of the sub-assemblies, and that would allow us to hopefully increase our gross margins. I think our gross margins gradually, we hit a low in low 50% middle of last year. and as we've kind of gained some efficiency and learning curve of our technicians, we've built it up to mid-50s. We like to be able to maintain that long-term, and one way to do that, because as long as we're doing acquisitions, there's always going to be inefficiencies, and you're going to be training new technicians while other technicians are doing the work. So the way we can increase, the way we can maintain that mid 50% ranges is by increasing the insourcing of the sub-assemblies. So that's a big focus for us. And then the final is continue with our with our capital allocation of opportunistically identifying products that fit our profile and acquiring them. And those are the three things that are priorities for us.

Okay, that helps me, and I appreciate you explaining that to me. I want to again congratulate you on a very strong quarter. Thank you.

The next question comes from Gashi Sri with Singular Research. Please go ahead.

Good afternoon, gentlemen. Can you hear me?

Yes.

Thank you. The first question is, with the recent wins on the military side, the U.S. Army, could you give us a color on what are you excited about in the military space? And what are you guys doing that is helping you win market share? And what's making you competitive in this space? And how do you build momentum in that space?

So, I mean, essentially what we've done was a shifting strategy. I'll go back to a few years ago where the... where they put a sequestration of dollars and the military budget got cut significantly. At the time, the strategy of our company became to shift our focus from military more towards the commercial side of things, which is what we did three years ago when I took over I started building our military business development team and to focus on getting more military business. It takes a while for these things to start paying off. So what we've seen so far, we've seen positive results. I think the auto-throw for the... For the U.S. Army, Orotar is a product that we developed many years ago, and we had not been successful in marketing it to the military. We've been selling it to Textron as a forward fit on their King Air. But the U.S. Army, the U.S. Air Force, they have a number of these King Air C-12s. and they could use the autostraw. About just over a year ago, we got selected by METS, which is the multi-engine training system for the U.S. Navy, and now the U.S. Army selected us for their C2O platforms, and we continue marketing that into the military side. We won this other program. for a mission computer and a display. And we've got, we actually got several other opportunities on the mission computer side of things that we're looking to explore. The acquisition we did from Honeywell for the F-16 flight control computer and the mission computer is going to open a lot of doors for us in terms of being at the table with the Lockheed and taking opportunity of other product lines that they are looking to acquire.

Okay, okay. Let's start with Carlos. Given the increasing military presence, what are the potential challenges in a longer sales cycle with a more complex procurement process? Can you give us some color on how you manage that or stay responsive in your R&D and product development space?

I mean, the sales cycles are longer. But like I said, we started down that line about three years ago, and we're beginning to see fruits of those efforts, and we're going to continue down that path. I mean, some of the things we're doing now in our organization in anticipation of some of the new contracts we're getting is making our facility more secure, We're putting a lot of controls in place so we can take on secret programs from our military, as well as putting in a system that can withstand government accounting audits and all of that. So we've changed our MRP system, which is going to go live early 2025 we've been working on it for about a year now and because our ERP system is kind of old and antiquated so that would allow us to be able to easily show kind of costs to the government and be able to categorize expenses differently the way the government wants to see. So we've put in a lot of efforts into the infrastructure that would get us to a point that we can become a serious defense contract.

And given your strategy that you mentioned, the next strategy, what percentage of revenue ideally would you think in one to three years would be military sector?

So I think on average, just about less than a third of our business used to be military. I guess last year that went down because of the acquisitions we did with Honeywell that were mainly focused towards the commercial side. I think this year military is going to be pretty large because of that new acquisition we did from Honeywell on the F-16. I think long-term we like the idea of having third military, third business aviation, and third air transport. That formula has worked for us for over 35 years, and we like to see it that way. But, you know, as you grow, you've got to grow every sector. And when you say I'm going to grow my – military five-fold because I'm going to grow the business five-fold, then that becomes significant enough that you need to put some controls in place.

Okay. And I think you mentioned this about your US M2, but with the cockpit space, how do you see the interplay between military and commercial technologies evolving? Are there any other specific... I think you mentioned the US M2 is agnostic, but is there any specific synergies or cross-pollination opportunities that you're targeting?

Well, I think again, our product development strategy from day one was that we made one product and we sold that product to the military, to the commercial aviation, as well as their transport. Now, There are variations of it that go into the military. For example, we make the same display that we put in the 75767. We put them in the C130s. But the one that goes in the C130 has night vision capabilities. So it's got two sets of lighting for night light sensing. But kind of the backbone of the technology is the same. And going forward, we continue developing our products. Like, for example, the UMS that we made for Pilatus, it was very much one platform product. We developed it specifically for Pilatus. When we came, they wanted to do a more capable UMS, which we've been developing with them, and that's the one that's going to go into flight test. I think it's scheduled for March or April. When we did that, we started taking account into, okay, how do we now – make this more universal that we can put it in military aircraft as well, as well as put it in other business aircraft. And one of the things that became apparent is that, you know, if you're putting a flight control computer in a military aircraft today, they want to see artificial intelligence capabilities in it. So we added the artificial intelligence core to this product line so we can cross in the military as well as in the business aviation side utilize it for more cockpit automation.

My last question is So given the issues at Boeing, do you see any kind of potential lift in terms of retrofit opportunities, or how do you see that playing out?

I think your question is saying that the Boeing issues are happening. How does that affect the IS&S?

Oh, it's very good for IS&S. Not that we want them to have issues, but as long as they can't make new airplanes, people are going to fix their old airplanes.

So you're going to see that aging airframe still, you know, a lot of repairs and maintenance, parts sales, spare sales in the market overall going up in aerospace because of that.

Awesome. Thank you, guys. Thanks for taking my question. I'm happy with all this. Thank you.

This concludes our question and answer session. I would like to turn the conference back over to Sheram Ashkapur for any closing remarks. Please go ahead.

Thank you, operator, and thank you all for your time and interest in ISNS. Have a good holidays and a good day. Thank you.

This conference is now concluded. Thank you for attending today's presentation. You may now disconnect.