Release Date: February 13, 2025

For the complete transcript of the earnings call, please refer to the full earnings call transcript.

Positive Points

• Innovative Solutions and Support Inc (NASDAQ:ISSC) reported over 70% year-over-year growth in revenue, driven by new military programs and legacy platforms.
• The company's backlog increased significantly to $81 million as of December 31, 2024, compared to $14.6 million in the prior year.
• ISSC is making strategic investments in infrastructure and systems to support high-performance requirements for defense customers, including a modern ERP system.
• The company is expanding its Exton, Pennsylvania facility, which will double its footprint and increase production capabilities threefold by mid-2025.
• ISSC is focusing on new product development, particularly in cockpit automation and autonomous flight, with the next generation of its utility management system on track for a test flight by mid-2025.

Negative Points

• Gross margin decreased to 41.4% from 59.3% in the same period last year, impacted by higher depreciation expenses and a shift in sales mix towards lower-margin military sales.
• The company is experiencing duplicative costs due to the transition of manufacturing from a recent acquisition, which is affecting margins.
• Operating expenses increased to $5.3 million from $3.9 million in the comparable period last year, driven by product development efforts and acquisition-related costs.
• Free cash flow decreased to $1.6 million from $4 million in the previous year, primarily due to inventory buildup and timing of payables.
• The transition of manufacturing from the recent acquisition is delayed, with expectations to complete in the third quarter, impacting current operational efficiency.

Q & A Highlights

• Warning! GuruFocus has detected 6 Warning Signs with ISSC.

Q: What strategies or investments are being made to remain relevant and gain market share in military revenue growth? A: CEO Shaam Akhapour explained that the company is transitioning from being a second-tier supplier to a prime contractor for the Department of Defense (DOD). This involves becoming compliant with defense acquisition requirements, including certified government accounting and IT systems that meet DOD standards. The company has implemented a modern ERP system and is applying for security clearance to bid on larger military programs.

Q: How do the margin profiles of foreign military engagements compare to the domestic market? A: CEO Shaam Akhapour noted that foreign military sales not going through the U.S. DOD are treated as commercial deals, allowing for premium pricing. Contracts funded by the U.S. government for allied nations are subject to the same regulations as domestic sales. Having systems on U.S. Air Force aircraft strengthens the company's position to sell to other air forces.

Q: With the shift towards a 40% military business mix, what is the anticipated new margin profile? A: CEO Shaam Akhapour stated that military programs have lower gross margins than commercial business due to the nature of defense contracts. However, military contracts have minimal engineering and SG&A expenses, leading to strong EBITDA margins. The company expects gross margins to be around 50%, focusing on EBITDA and profit margins.

Q: How will the company balance infrastructure spending with strategic acquisitions? A: CFO Jeff D Giovanni mentioned that current strategic initiatives and building expansions are funded through operations and existing credit facilities. The company aims to maintain a leverage ratio around 3 times and is diligent in evaluating acquisitions to ensure they fit within financial constraints.

Q: What are the expectations for the transition of the H1ywell military product line manufacturing? A: CEO Shaam Akhapour indicated that the transition is expected to occur in the third quarter. The delay is due to H1ywell needing to build sufficient backlog before shutting down their line. The company is prepared to manufacture parts in-house to expedite the process.

For the complete transcript of the earnings call, please refer to the full earnings call transcript.