Innovative Solutions and Support, Inc.

Good evening and welcome to the Innovative Solutions and Supports 4th 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 1, on your telephone keypad. To withdraw your question, please press star, then 2. Please note, this event is being recorded. I would now like to turn the conference over to Paul Bertolai. Please go ahead.

Thank you. Welcome to Innovative Solutions and Supports 4th Quarter and Full Year 2024 Results Conference Call. Leading the call today are our CEO, Sharam Asgharpur, and CFO, Jeff DiGiovanni. Earlier today, we issued a press release detailing our 4th Quarter and Full Year 2024 operational and financial results. This release is publicly available in the investor relations section of our corporate website at -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 of some of the factors 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 Sharam Asgharpur, who provide a review of our recent business performance and strategic outlook, followed by a financial update from Jeff DeGiovanni. 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 4th Quarter and Full Year financial performance. This was a transformative year for IS&S, one in which we delivered significant -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 4th Quarter, we delivered more than 18% -over-year growth in revenue, driven by momentum from new military programs and recently acquired platforms. In recent quarters, demand across our military end markets has increased, supported by orders from both the U.S. 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, and 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 disciplined 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 expansion of existing platforms, new original equipment manufacture 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 cocktail automation, we anticipate a 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 Auto Throttle System was selected by the U.S. 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 instrument and our auto throttle, and on the military side, Boeing on KC-46A, KC-767, and the T-7 platforms. 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 workloads. 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 PC-24 platform with Pilatus. In layman's terms, the UMS is to an aircraft where the 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. UMS-2 is an AI-capable system, one whose integrated neural network controls the flight of the aircraft's processing capabilities, significantly enhance crew efficiency by enabling additional cockpit automation. As our UMS-2 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 prepared 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 would 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, Sharam, 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 contributions 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 the 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 investment 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 a forward shift in our sales mix. Historically, military sales represent less than a third of sales, while 2025, due to the recent acquisition, it 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 -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 even a margin realization and profitability over time. Consequently, we believe adjusted even a margin and expansion will be a comparably 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 and 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 backlog, 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 30, 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 KC46A, 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 were $700,000 during 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 a 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 expansion. 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 1 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 2. We'll pause a moment as callers join the queue. Once

again, if you have a question,

please press star, then 1. 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 the revenue and EBITDA contribution, or just give us some sense of what that acquisition looks like and impact

on FY25? First of all, Andrew,

we did the acquisition in September. Are we going to be putting out backlog information?

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

In terms of EBITDA, the

margins we believe is going to be similar to our EBITDA margins.

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?

It's 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.

Okay.

On

the

backlog, does it necessarily burn off linearly or can it be more chunky? Yeah,

part of the backlog being what it is was that there was an obsolescence issue that Honeywell resolved a few months ago. Because of that obsolescence issue, the deliveries over the prior year or so were very limited. So there is a catch up that's going to be done in 2025. It's still a little bit too early for us to be able to accurately say how much of that is going to be done in 2025 because Honeywell is going to continue operating this product line for another 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. It's going to get a dip and 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 will fall in the customer service segment. And then on cafx,

I think you guys said $6 million. Is that all in FY25?

Some of it we already spent. Very little. So some is $24 million but all that is going to be fiscal 25. 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

million. So now you're moving forward with the construction in fiscal 25 so you see that in the cafx going in 2025. And would you expect to complete

all that work in fiscal 25? About June. Okay. If any construction is completed on time. Okay. Alright, 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.

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

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 our IFNS, when we have production contracts, we get, you know, releases, maybe 18 months releases or a year releases. This is our backlog is usually not of this magnitude. These are military contracts and some of them are with Lockheed, their own production contracts. And Lockheed has, for some of these, they've gone out and issued purchase orders over the next four years. But 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, well, I mean, if you remember, when we did the acquisition from, the first acquisition from Honeywell, the first quarter for it was RQ4 of 2023, we got like a $6 million revenue that came from Honeywell. Yeah, I remember that. Because, 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 to make sure the customer has enough equipment, you know, 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?

So, there is, yeah, I

mean, there is, I thought we outlined that in our speech, but we've got product development where we're looking at launching our latest generation, which 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 is we're going to finish the flight test with Pilatus for the PC 24 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 will be hit a low of, 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 maintain that -50% ranges is by increasing the insourcing of the sub-assemblies. So that's a big focus for us. And then the final is to continue 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 you're 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 the space, and how do you build momentum in that space?

So, I mean, essentially what

we've done is a shift in strategy. I'll go back to a few years ago 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 autothrottle for the U.S. Army autothrottle 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 the King Air, but the U.S. Army, the U.S. Air Force, maybe they have a number of these King Air C-12s, and they could use the autothrottle. But 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 C-12 platforms, and we continue marketing that into the military side. We won this other program for a mission computer on the 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 color. Given the increasing military presence, what are the potential challenges in a longer cell 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 development states?

I mean, the cell 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 where we can become a serious defense contract.

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?

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's formulas 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 fivefold because I'm going to grow the business fivefold, then that becomes significant enough that you need to put some controls in place.

Okay. And I think you mentioned this about your USM2, but with the COXIC phase, how do you see the interplay between military and commercial technologies evolving? I think you mentioned the USM2 is agnostic by fairly specific synergies or cross-border synergies 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, the variation of it that goes into the military, for example, we make the same display that we put in the 75767, we put them in the C-130s, but the one that goes in the C-130s 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 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 it in the military as well as in the business aviation side, utilize it for more capabilities. And that's the kind of information that

we're working on. My last question is, given the issues at Boeing, do you see any kind of potential lift in terms of retrofit opportunities? How do you see that playing out?

I think your question is the Boeing issues are having, how does that affect the ISNS? It's

very good for ISNS. 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 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 to answer.

Thank

you. This concludes the question and answer session. I would like to turn the conference back over to Shara Mashkapur 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.