Innovative Solutions and Support, Inc.

Good day and welcome to the Innovative Solutions and Support Second Quarter 2025 Results Conference Call and Webcast. All participants will be in the 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 Bartoli, Head of Investor Relations. Please go ahead.

Thank you. Good morning everyone and welcome to Innovative Solutions and Support Second Quarter 2025 Results Conference Call. Leading the call today are CEO, Sharam Asgopour and CFO, Jeff D. Giovanni. Yesterday, we issued a press release detailing our Second Quarter 2025 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 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 yesterday. Today's call will begin with prepared remarks from Sharam. We'll provide a review of our recent business performance and strategic outlook, 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 Sharam.

Thank you, Paul, and good morning everyone joining us on the call today. Let's begin with a high-level overview of our second quarter financial performance. During the second quarter, we delivered growth in revenue of just over 100% driven by momentum from our new military programs, including significant growth from our F-16 program and contributions from our legacy platform. As we discussed last quarter, we have been seeing improved trends in our commercial business. As expected, this translated to improved results this quarter with notable strength in our air transport business. Our EBITDA increased by over 200% and profit by over 300% from last year, highlighting the significant operating leverage in our business as we continue to grow. We are building a platform of scale with meaningful opportunity for EBITDA margin expansion as we grow the business. Our business momentum remains strong with a backlog of approximately 80 million as of March 31, 2025. We were pleased with our strong second quarter results. The trends in our core business remain strong. We are successfully executing our strategy to build a significant growth business. To that end, I would like to discuss an update on our progress under ISNS NICS, a long-term value creation strategy. As a quick refresher, 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. We continue to execute against our initiatives during the quarter, and I would like to take a moment to highlight just a few of the key achievements. As we have discussed, we have placed a priority on expanding our military business. In support of this objective, we have continued to make investments in both infrastructure and systems capabilities to support the high-performance requirements of our defense customers. During the second quarter, we completed the integration of our ERP system. We further expanded our more robust IT infrastructure and strengthened our security and accounting services to make us compliant with defense federal acquisition regulation supplements or DFARs requirements. These are necessary investments as we continue to bid on larger DOD programs. We continue to expect at least 40% of our revenue to come from military customers during fiscal 2025, and we are excited by our progress and the opportunities that lie ahead of our military business. We also have made further progress on the expansion of our infrastructure by mid-2025. When complete, we will have doubled our footprint and increased our production capabilities by more than threefold. The building construction is near completion, and the preparation for clean room production environment will commence by the end of May. As a reminder, we manufacture 100% of our products in our external facility. With the ongoing trade uncertainty and priorities of the current administration, we should be in an enviable position given the likely significant push for reshoring of manufacturing and an America First strategy. During the second quarter, we continued with the integration of our most recent acquisition from Honeywell. As we discussed last quarter, much of the spending and the integration activities are being done ahead of the expected growth from these platforms. The integration is also resulting in some duplicative costs as we transition the manufacturing of products into our external facility. Importantly, the integration is progressing, and we are excited by the opportunities from this acquisition. While we have spent a lot of effort on our military opportunities, we remain encouraged by the growth opportunities across our commercial air transport and business aviation markets. Our goal to achieve a larger percentage of our new production aircraft or OEM business is also being satisfied through organic product growth as well as our strategic acquisitions such as the

F-16 product lines. Even though it has been a couple of quarters,

since we have announced the transaction, deploying capital for strategic acquisitions remain a key priority. Although our most recent acquisitions have been focused on complementary product lines from larger avionics suppliers, we continue to evaluate opportunities to acquire small avionics manufacturers where we anticipate synergies will be realized by incorporating their outsourced production in our facility. We have demonstrated a track record of successfully scaling our business through a combination of organic growth and capital deployed for acquisitions. Since 2020, we have completed four acquisitions to complement our organic growth strategy. Over this period, we have grown our revenue and net income from $22 million and $3.3 million respectively during fiscal 2020 to well over $60 million in revenue and $9 million in net income during fiscal 2025 based on our stated forecast of greater than 30% growth. Given our capital light model and strong free cash flow generation, we have been able to generate this growth while maintaining modest leverage. We are proud of what we have accomplished and are positioning the company for continued growth going forward. Despite recent margin pressure due to acquisition related costs and inventory adjustments as well as inherent lower gross margins in defense products, we expect EBITDA and profit margins to grow steadily. We are further establishing our company as a premier systems integrator in flight navigation and precision instrumentation with cutting edge technology. A vertically integrated U.S. based production provides a competitive advantage fostering relationships with key aircraft manufacturers, operators, and defense organizations. In summary, we are encouraged by the progress we have made on our strategic priorities and remain committed to continuing to execute on our plan. During the quarter, we doubled our revenue, tripled our EBITDA, and quadrupled our profit from a year ago. As a result of our success, we will remain on track to deliver on our goal to generate both revenue and EBITDA growth of greater than 30% when compared to fiscal year 2024. We are excited by everything we have accomplished and are confident we are strategically positioned to continue generating profitable growth. With that, I'll turn the call over to Jeff for his prepared remarks.

Jeff Sheram Thank you, Sheriff, and good morning to all those joining us. Today, I will provide a high-level overview of our second quarter performance, including a discussion of our working capital balance sheet and liquidity profile at quarter end. We generated net revenues of $21.9 million in the second quarter, more than double our revenues during the second quarter last year. The increase was driven primarily by contribution from the recently acquired Honeywell Military Product Line, which contributed $10.8 million in growth in our air transport market. Our results during the quarter benefited from some pull forward of revenues under our F-16 program. We expect this dynamic could repeat again during our third fiscal quarter in anticipation of Honeywell, piecing production at its own facilities and transitioning that production to the company's facility. Product sales were $13.2 million during the second quarter, up significantly from product sales of $4.9 million from last year, driven primarily by the recently acquired Military Product Line. Service revenue was $8.8 million, owing largely to customer service sales from the product from Honeywell, including $3 million associated with the F-16 program and an increase of $700,000 in NRE programs, partially offset by lower legacy customer service revenue. Gross profit was $11.3 million during the second quarter, up from $5.6 million in the same period last year, driven by strong revenue growth and product mix, partially offset by higher depreciation expense resulting from the Honeywell acquisitions and continuing investment. Our second quarter gross margin was 51.4%, down modestly from 52% in the same period last year, but up meaningfully on a sequential basis from the .4% gross margin reported in the first quarter. We generated more normalized gross margins under our Honeywell contracts, which was the main driver of the improved gross margin relative to the prior quarter. We expect our gross margins to continue to be lumpy in the near term as we continue to integrate the Honeywell product lines into our facilities. As we have discussed in prior quarters, there can be some duplicate costs as we prepare to integrate these products and the hiring and training of engineers and other staff to support these products. Additionally, as we have discussed previously as it relates to the product mix, generally military sales carry a lower average gross margin versus commercial contracts. However, importantly, there is a minimal operating expense associated with these contracts. So the incremental EBITDA margins are strong. We saw an example of this during the second quarter as the incremental military revenues came through with little to no incremental SG&A expenses, resulting in meaningful operating leverage. Operating expense during the second quarter of 2025 was $4.3 million, a modest increase from $3.9 million last year despite the significant growth in revenue. The increase in operating expense was driven by approximately $300,000 from growth in our product development efforts in support of our long-term growth initiatives and $200,000 employee costs primarily to increased headcount, partially offset by a $100,000 decrease in third-party and professional fees. Operating expenses represented .6% of revenue during the second quarter, a significant decline from .7% in the second quarter of last year. Highlighting the opportunity for improved operating leverage as the business scales. Net income for the quarter was $5.3 million as compared to $1.2 million. Gap earnings per share of $0.30 increased by over 300% from $0.07 with benefits from higher volume and increased operating leverage. EBITDA was $7.6 million during the second quarter, up from $2.1 million last year or an increase of 260%, largely due to our revenue growth and operating expense leverage. Moving on to backlog, new orders in the second quarter of fiscal 2025 were $20.8 million and backlog as of March 31st was $80 million. The backlog includes only purchase orders in hand and excludes additional orders from the company's OEM customers under long-term programs including Pilatus PC24, Textron Kingair, Boeing T7 Red Hawk, the Boeing KC46A, and the F-16 with Lockheed Martin. We expect these programs to remain in production for several years and anticipate they will continue to generate future sales. Further, due to their nature, the customer service lines do not typically enter backlog. Now turning to cash flow. During the second quarter of 2025, cash flow from operations was $1.3 million compared to $200,000 in the year-ago comparable period. This increase was due to higher net income and changes in working capital accounts. Capital expenditures were $1.6 million during the second quarter of fiscal 2025 versus $100,000 in the same period last year. The increase in capital expenditures are primarily related to the facility expansion. As a result of the building expansion, free cash flow during the second quarter was negative $300,000 versus essentially flat free cash flow last year. Total net debt as of March 31st was $26.2 million. Our net leverage at the end of the quarter was 1.4 times. Our cash and availability under our credit line was $8.8 million at the end of the second quarter which provides us financial flexibility to support our ongoing operations and facility expansion. That completes our prepared marks. Operator, we are now ready for the question and answer portion of the call.

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 are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then 2. At this time, we will pause momentarily to

assemble our roster. The first question comes from

Gowshi Sri with Singular Research. Please go ahead.

Good morning. Can you

hear me?

Yes.

Congratulations on a strong quarter. My question is, you mentioned that the Honeywell product lines were pulled forward and you are expecting that to carry on into Q3. Any color on the magnitude of these pull forwards and the FY25 guidance of over 30% growth guidance that you guys alluded to in the last call is that are you seeing any signs of audit delays post transition?

We don't anticipate

further

delays

post transition. There's a lot of moving parts with the transition of the Honeywell. They have supply chain issues obviously with delivering sufficient quantities to Lockheed before they can close the line and transfer it to us. We are working very closely with them. Our supply chain is engaged daily with their supply chain as well as Lockheed to make this a successful transition for Lockheed because that's our customer and we will support them. In terms of our guidance that we gave for this year, I think we've went into over 30% as we see it. That's where we are.

The air transport revenue seems to have improved in Q2. Is this driven by new orders or deferred demand? What is the pipeline for commercial retrofights looking even at this high interest rate?

To be quite honest, I really don't think the interest rates bear much on what we do. Obviously, delays in production of new airplanes both from Airbus and following due to their supply chain issues is creating high demand for aftermarket upgrades of these airplanes. We are seeing benefits of that. For the future, we hope that trend is going to continue.

On the gross margin level, sequentially the rebound, so as the Honeywell production transitions fully to Extern, should we expect the margins to stabilize near these levels or the mix shift towards the military that's shading you with the 40% of sales? Does that act as a headwind as we move towards still poses a headwind towards the rest of FY25?

I think we've talked about this a number of times before with regards to gross margins. Gross margins are very volatile and kind of lumpy, as Jeff put it. The reason for that is that prior to acquisitions, the things that we build in here, we would sell them to target a certain gross margin. When we do acquisitions, the products that come in, the mix of the products, have a large variability in gross margins. Some of them are very good, some of them are low. Then what we get is that in a quarter, depending on the mix, we would end up with some blended gross margin. It really is difficult to predict because we don't know, where we have backlog of orders, we know that, but with the new orders coming in, it's difficult to predict what kind of margin we're going to get from that product mix. This is why we've been trying to steer everybody away from gross margins and put a focus on even the margins and profit margins. Quite frankly, I care about

profit more than anything else. Our

next question comes from Doug Ruth with Lennox Financial Services. Please go ahead.

Good morning, Sharma and Jeff. Thank you very much for the comments. Congratulations on the fabulous report. I specifically think that you clarified some of the questions that were out there, and I appreciate you taking the time to offer some clarity. Did you specifically say what percentage of sales in the quarter were to the Department of Defense, or can you give us that?

Right now, $21.9 million in sales, 10.3 was associated with the F-16 piece, so that would be with the military side. But then we had our own. We had our own. I don't have that breakdown in front of me, but Legacy was a little bit north of $11 million for the quarter, which includes air transport and business aviation, along with military. There's some military in the services as well because of our NRE projects and customer service repairs.

It sounds like it's approximately at least half, which is-

Yeah, I would say at least 40%. At least 40% is military, as we're experiencing.

You had thought that as a run rate, that it would be around 40%. Do you think that that is going to hold true for the year?

Yes.

Okay. Then what about hiring? Were additional people hired during the quarter?

Very,

very little.

Okay.

We just hired another military salesperson as well.

Okay.

Post quarter. Post quarter,

yes. Okay. Are you thinking that you're done hiring for the year, or will there be additional people hired still this year? Or has that not been decided?

I think that we continue to look for talented engineers. We continue to look for talented individuals that contribute to our organization. We are a growing business. You can't hire people after you've got the contracts, because then it will be too late. We continue looking for talent in terms of the hiring we were doing to support the F-16 platform. We are completed doing that. But there are other acquisitions that we're looking at. Also, we're looking at some significant growth from our base business. So we're constantly in hiring mode.

Okay. Are you working through search firms? Are you advertising open positions on your own website or LinkedIn?

Everywhere, yes. I think every job posting is on our website as well as depending on the position, we do work with some recruiters. We have an inside recruiter as well that works for our HR department. So we do all.

Okay. Now, I know that clean rooms can be very complicated. Is there any concern about you completing your clean room? You specifically mentioned that during your comments, Sharon.

No, it's just, obviously, our production floor here is a clean room facility. We're just expanding it. It's not part of the original building. The contractors that are building the building for us, they build the structure and paint it and all of that. We're almost done. Then we go in there and we've got to put anti-static flooring down and put some partition walls, some soundproofing walls for some areas. Those kind of things, which we do routinely.

Okay. So you feel like you've got it under control?

Yes.

What about the, did you mention the status of the next generation utility management system? That was something that you had generally been talking about?

Yeah, and I guess I didn't put anything in there. It is going on track. They're still planning on doing some flight testing on it over the next month. The project is finishing some qualification testing and getting it ready for flight tests.

Okay. I really like your strategy, the acquisition strategy of using reverse engineering, because over and over when we hear about one company buying another company, part of it is instead of having the products made in America, let's see if we can get them made somewhere else at a lower cost. The fact that you are, let's bring the stuff here to Pennsylvania and let's cost out of it, I think that that really plays to the company's competitive advantages. Are you close to any additional acquisitions at this point? We're

always evaluating. Specifically with that strategy?

Yes,

we're always evaluating some. We're also looking at some potentially foreign companies that we may buy and bring their production into the United States. The theory of outsourcing somewhere cheap is like you shift your problem somewhere else where it is outside your control. It is your customers that end up suffering. The philosophy of the company has always been to steer away from that.

Jeff, as far as financial covenants, do you feel that you have those set up properly, you're comfortable, that you're maintaining the covenants?

Yes, the covenants, we have a lot of headway in the covenants, so feel very confident where we are with our covenants.

You folks deserve a lot of credit. You really performed exceptionally well. I'm grateful for what you're doing for the shareholders and congratulations to both of you and to your teams. Thank you for answering. Thank you very

much. Thank you very much.

Our next question comes from Andrew Rem with Odinson Partners. Please go ahead. Hey, gentlemen,

I just want to, since you guys won't say it, I'll say it, which is in regards to Doug's comment, manufacturing in the US, you're smarter than Trump. So there we got that on the table. My question on revenue, Jeff, you had said in the quarter, 10.8 million came from acquisitions and then later you said about 3 million on the F-16 for customer service. So if I parse those two between product and customer service, am I right that from the acquisition, 7.8 million for product and then 3 million for customer services, is that, am I getting that right?

So it's 10.8 in total, three of which 3 million was customer service at a Delta 7.8 product.

Okay, got it. And then 6 million capex, that's still a good number for the full year?

Yes. And then

sequentially, DNA was down because I think it went from like 1.3 down to, I want to say about 700,000. What's

kind of a normalized level? For GNA? DNA, sorry, depreciation and amortization.

Oh, I would say when you add those two together, looking at that, and then that would be our normalized level for six months, look at the six-month period. So depreciation went down a little bit because we had amortization changes on our last acquisition during that period where you have to reassess and look at the items to make sure it was correct with the valuations. So we'll be closing that valuation period next quarter and that should settle.

And then for the third quarter kind of pull forward in revenue, would you expect that to be kind of similar magnitude or

much smaller? Well, I think given that

a good chunk of this is tied into Honeywell's supply chain, it's really difficult for us to predict

that. But I

don't anticipate

a huge swing. Right, we don't expect a huge swing between Q2 right now and Q3. So it's roughly similar in terms of... It's really hard to predict.

Okay. So then we should at least sequentially in the fourth quarter expect a fairly meaningful

decline. I don't expect a meaningful

decline. Barring something goes completely wrong with the supply chain. I don't see... We have $80 million in backlog as of end of March. So as long as we can execute and even for the transition, if it goes per plan that Honeywell has put in place and they get the material from the supply chain on time, there really shouldn't be much variations. But there

was a lot of ifs there. Okay. And then can

you just comment on in terms of making the transition? I think previously you guys had said kind of in the summer. So about the time that the facility expansion is completed. So it sounds like construction is nearly complete and then you've got some move-in and that kind of stuff. Should we be thinking that the integration of Honeywell will be largely complete sometime later in the summer? Is that the rough timeline?

That is our plan. Okay. All right.

Well, great quarter, you guys. You're doing a fantastic job with the team. So appreciate it.

Thank you. Thank you.

We have a follow-up question from Gaushi Sri with Singular Research. Please go ahead.

Okay. Thank you. My follow-up is on these ERP system. Does that, as that goes on live, will that improve productivity gains on inventory management labor costs? Is that SG&A looking to go below 50% in FY26?

So any ERP implementation, you still have to do it on a go-forward basis. Our goal is to utilize data to create actual data to make business decisions. Previously the data was, you know, we had to really work to get the data and the answers. So I think you'll see improvements from a production, when I would say production, in terms of getting the data and making the right business decisions on a go-forward basis. Now, how does that translate into the P&L? It's too soon to know what those impacts will be.

So on a quarterly basis, that SG&A level is going to look still look around $3 to $4 million?

That's correct. I mean, keep in mind, we're still, you know, the company's growing, the organization's growing, so you're always going to have some additional costs.

Gotcha. And on the ex-doms capacity, which is going to hit triple by mid 2025, what kind of utilization rate is needed to kind of achieve that mid 30% growth on the top line and is at the EBITDA level, given that, how does the current backlog support this?

So right now the 30% growth is based on everything that we have here today, and it really excludes a lot that the new building could produce. Okay.

With the new

building and the facility, we could do about $250 million we project.

No, for that.

In revenue of this building.

Gotcha. Thanks for that, and congratulations.

Thank

you. This

concludes our question and answer session. I would like to turn the conference back over to Sherim Askapour for any closing remarks.

Thank you, Operator, and thank you all for your time and interest in

ISNS. Have a good day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.