A Primer on Innovative Solutions and Support

Introduction

• Innovative Solutions & Support (ISSC), incorporated in Pennsylvania in 1988, operates as a vertically integrated provider of flight solutions and equipment for commercial air transport, general aviation, the United States Department of Defense (DoD), and allied foreign militaries.

• The company operates in a single business segment that designs, develops, manufactures, sells, and services avionics products and systems for retrofit applications and Original Equipment Manufacturers (OEMs).

• ISSC holds more than 120 U.S. and international patents as of September 30, 2024. Approximately 27% of full-time employees were in engineering-related roles at that date.

• The company operates a 45K square foot design, manufacturing, and office facility in Exton, Pennsylvania, and is ISO 9001 and AS9100D certified. These certifications indicate adherence to quality standards.

• The Exton facility is currently being expanded by 40K square feet at an expected cost of approximately $6M to support commercial growth, including opportunities from recent Honeywell transactions. Products undergo extensive and documented quality control testing.

Products

• ISSC specializes in providing systems integration capabilities. This involves the design, manufacture, sale, and servicing of high-performance avionics products and systems for both commercial and military aircraft platforms.

• As a systems integrator, ISSC leverages expertise to develop end-to-end systems combining mechanical, electrical, software, and avionics components. Integration activities include system design and analysis, integration and testing, regulatory compliance and documentation, and lifecycle support.

• This leverages owned intellectual property, products, and service capabilities, along with third-party technologies. This approach is believed to provide customers with a unique value proposition, helping to reduce cost and optimize fleet utilization.

• It sells several different product lines:

  • Integrated Flight Deck Systems COCKPIT/IP®: Includes primary flight/navigation displays, crew alerting and engine displays, integrated standby instruments, and mission displays.

  • Navigation Systems: Includes flight management systems, mission computers, navigation radios, and transponders.

  • Communication Systems: Includes communication radios, audio panels, and radio management units.

  • Sensors and Control Systems: Includes air data computers, attitude and heading reference systems, magnetometers, inertial reference units, GPS receivers, utility management systems, and flight control computers.

  • Advanced Flight Actuators: An array of linear and rotary smart-actuators for movement of aircraft levers and surfaces.

Business Model

• The multi-channel sales strategy targets passenger and cargo carrying aircraft operators, general aviation owner/operators, MRO dealer networks, distributors, avionics integrators, aircraft modification centers, the DoD, DoD contractors, and OEMs. Third-party sales representatives are used where appropriate.

• ISSC purchases various raw materials and component parts from suppliers. While most are available from multiple suppliers, some are sole source. Key suppliers in fiscal year 2024 included Honeywell, FilConn, APCT Inc, and Brandywine Precision Inc., accounting for most inventory-related purchases. Supply chain disruptions have caused delays and increased costs, though conditions somewhat improved in fiscal 2024. Identifying alternative suppliers is possible, but lengthy and expensive aviation authority and OEM certification processes could hinder efficient replacement.

• The company's customers include the U.S. government (DoD, Department of Interior, Department of Homeland Security), ATSG, Amazon.com, American Airlines, Boeing, Deutsche Post DHL Group, FedEx, Icelandair, L3Harris Technologies, Lockheed Martin, Pilatus, Sierra Nevada Corporation, Textron, and the Department of National Defense (Canada). Revenue is concentrated with a limited number of customers. In fiscal year 2024, the three largest customers were Pilatus (23%), Textron (7%), and Honeywell (7%).

• The retrofit market involves modifying, refurbishing, or upgrading existing aircraft. This market is growing as operators seek to extend fleet life, reduce costs, and meet regulations.

• Historically, most of ISSC's sales have come from the retrofit market, driven by the need to upgrade aging aircraft fleets with modern avionics. Products enable cost-competitive upgrades with capabilities equivalent to newer aircraft. Main customers in this market are expected to continue to be the DoD and defense contractors, aircraft operators, and aircraft modification centers. The DoD often purchases commercial off-the-shelf equipment for retrofit programs.

• ISSC also markets products to OEMs. Current OEM programs include supplying ThrustSense Autothrottles for Textron King Air 360 and 260, and the utilities management system for Pilatus' PC-24.

Competitive advantage

• ISSC's competitive strengths include its vertically integrated model, allowing reduced time-to-market. Its systems integration expertise is considered a key differentiator, enhancing ease of installation, reducing downtime and complexity.

• Expertise in the retrofit market is a strength, particularly given the aging global commercial airline fleet. The company's strong product and IP portfolio is noted, including patents on air data measurement systems, flat panel display systems, and COCKPIT/IP technology. Depth of experience serving global customer brands across commercial and military sectors is also a strength.

• The company operates in highly competitive markets. Principal points of competition include product quality, reliability, price, design/engineering capabilities, development, conformity to specifications, delivery timeliness, distribution effectiveness, and post-sale support.

• Competitors include Honeywell Aerospace, Collins Aerospace, GE Aerospace, Thales Defense & Security, Inc., Elbit Systems, and Garmin Ltd.. The industry outlook suggests continued market growth and a trend towards aircraft cockpits becoming more complete information centers, incorporating new technologies like satellite-based weather, ground terrain maps, and ADS-B.

• There is also a belief that the market will migrate toward autonomous flight, with the flight deck incorporating stepping-stone technologies. The company sees an opportunity in replacing analog instruments with integrated display systems.

Business Strategy

ISSC's strategy includes three key elements:

Targeted Commercial Growth

• Expand the product line portfolio. This is achieved through internal research and development and licensing, and the acquisition of mature product lines that complement their existing business. ISSC combines its expertise with commercially available technologies from non-aviation applications. An example is their ThrustSense Autothrottle, developed to address the unmet need for such a system on turboprop aircraft. Acquisitions are also seen as an opportunity to leverage cost synergies and expand the customer base, potentially introducing them to internally developed products.

• Focus on the retrofit opportunity. The Company pursues the retrofit market due to the growing need to support the world's aging fleet of aircraft. They believe retrofitting existing aircraft with their products, such as the COCKPIT/IP FPDS, FMS, and integrated standby unit system components, is a cost-effective alternative to acquiring new aircraft, providing similar functionality. The average age of the global commercial airline fleet has increased, which extends lifespan but increases maintenance demands, making retrofit expertise valuable. ISSC specializes in upgrading older aircraft with state-of-the-art avionics.

• Expand presence in the flat panel display market. Due to demand, particularly from cargo operators, ISSC believes many aircraft will be retrofitted with flat panel displays, replacing older analog and digital instruments. They believe their COCKPIT/IP flat panel displays offer advantages over competitors, including lower cost, larger size, reduced weight, enhanced viewing angles, and a broader array of functions. Patented features like the Integrity Checking Processor and Zooming enhance situational awareness, reliability, performance, and utility. Factors like demand for new aircraft, FAA mandates, and obsolescence contribute to this growth area.

• Evaluate potential acquisitions and strategic partnerships. As part of their growth strategy, ISSC continuously evaluates acquisition opportunities and investments in complementary businesses, technologies, services, or products. They may also enter into strategic partnerships to gain access to assets, additional offerings, distribution/marketing synergies, or industry expertise. Recently, they have completed four acquisitions since 2020 to complement organic growth. This includes acquiring product lines from Honeywell, which has significantly contributed to sales growth and expanded its customer base. They also evaluate acquiring small avionics manufacturers to realize synergies by insourcing outsourced production into their facility.

Improve Operational Efficiency

• Build on a legacy of strong operational execution to generate attractive margins.

• Increase operating leverage from higher revenues.

• Implement internal margin initiatives.

• Realize efficiencies in manufacturing and repair of acquired products (such as from Honeywell) by insourcing production.

• Benefit from higher fixed cost leverage by better utilizing the manufacturing capacity at their Exton facility. The Company is expanding this facility to support commercial growth and capitalize on recent Honeywell transactions, effectively doubling its footprint and increasing production capabilities by more than threefold.

• Realize additional efficiencies through sourcing and procurement initiatives to drive cost savings.

• Investments in infrastructure and systems capabilities (ERP, IT, security, accounting) support growth, particularly in the military business.

Return-Focused Capital Allocation Strategy

• Employ a disciplined, return-focused approach.

• The primary focus is on capital deployment in support of growth initiatives.

• Maintain strong financial flexibility.

ISSC believes its vertical integration, systems integration expertise, and retrofit application expertise are key competitive strengths supporting its strategy. A vertically-integrated U.S.-based production, like their Exton facility, is seen as providing a competitive advantage. The successful execution of this strategy, including the accelerated integration of acquired products and growth in the military business, has been highlighted as driving recent strong financial results.

Stay tuned for our Quick Take, discussing the progress, financials, and prospects from an investment perspective.