UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 2004
OR
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the transition period from _____________ to_____________ .
Commission File No. 0-3115
INNOVATIVE SOLUTIONS AND SUPPORT, INC.
(Exact name of registrant as specified in its charter)
| Pennsylvania | 23-2507402 | ||||||
| (State or other jurisdiction of incorporation) | (IRS Employer Identification No.) | ||||||
| 720 Pennsylvania Drive, Exton, Pennsylvania | 19341 | ||||||
| (Address of principal executive offices) | (Zip Code) | ||||||
(610) 646-9800 |
|||||||
| (Registrant’s telephone number, including area code) | |||||||
Securities registered pursuant to Section 12 (b) of the Act: None
Indicate
by check mark whether registrant (1) has filed all reports required to be
filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing requirements
for the past 90 days. Yes No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s
knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this Form 10-K.
Indicate
by check mark whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Act). Yes No
The aggregate market value of the Registrant’s common stock held by non-affiliates of the Registrant as of December 6, 2004 was approximately $284,548,000. Shares of common stock held by each executive officer and director and by each person who owns 10% or more of our outstanding common stock have been excluded since such persons may be deemed affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.
As of December 6, 2004, there were 11,838,356 outstanding shares of the Registrant’s Common Stock.
Documents Incorporated by Reference
Portions of the Registrant’s Proxy Statement for the 2005 Annual Meeting of Shareholders to be filed prior to February 1, 2005 are incorporated by reference into Part III of this Report. Such Proxy Statement, except for the parts therein which have been specifically incorporated by reference, shall not be deemed “filed” for the purposes of this Report on Form 10-K.
INNOVATIVE SOLUTIONS AND SUPPORT, INC.
2004 Annual Report on Form 10-K
Table of Contents
PART I
Item 1. Business
Overview
Innovative Solutions and Support, Inc. (the “Company”, “IS&S” or “We”) was founded in 1988. The Company designs, manufactures and sells flight information computers, flat-panel displays and advanced monitoring systems to the Department of Defense (DoD), government agencies, defense contractors, commercial air transport carriers, original equipment manufacturers (OEMs), and corporate/general aviation markets. Our strategy is to leverage the latest technologies developed for the personal computer and telecommunications industries into advanced, cost-effective solutions for both the aviation industry and DoD requirements. We believe that this approach, combined with our industry experience, enables us to develop high-quality products, substantially reduce product time to market and achieve cost advantages over the products offered by our competitors.
Historically, we have focused our efforts on developing and marketing air data systems that measure, calculate and display critical flight information, such as airspeed and altitude, and instruments that measure engine and fuel data, primarily for use in the aircraft retrofit market but also for the Original Equipment Manufacturer (OEM) market. Since fiscal 1997, a substantial portion of our revenues has been from the sale of air data systems that are critical for safe flight. Additionally, our air data equipment will bring aircraft into compliance with government regulations; including Reduced Vertical Separation Minimum (RVSM) requirements that have been phased in by regulatory authorities on most heavily traveled global flight routes. We believe we are one of three primary suppliers of RVSM products to the U.S. retrofit market. As a result of our expertise, we were selected as a supplier of RVSM systems and components in connection with the United States Air Force’s KC-135 retrofit program, which we believe to be one of the largest U.S. military RVSM retrofit programs to date. The Company successfully completed this major multi-year procurement in fiscal 2002. We have been selected by a number of airframe OEM’s and modification centers as an RVSM system supplier for a variety of air transport and business aviation aircraft.
Advances in technology are providing pilots increasing amounts of information that enhance both the safety and efficiency of flying. However, the limited amount of space in the cockpit coupled with inefficiencies associated with currently used displays inhibits the display and integration of this information in a user-friendly manner.
During fiscal 2000, we introduced our large flat-panel display system, or Cockpit Information Portal (CIP), which is the first in a series of new products we intend to develop to enhance the management and integration of cockpit information. Our CIP is the centerpiece of our cockpit information management system that organizes and displays a multitude of flight information. This system provides enhanced growth capability for systems that will become available to pilots in the future. This information may be generated from a variety of sources, including our RVSM air data system, our engine and fuel instrumentation, or from third-party data and information products.
In fiscal 2003 our CIP product line was advanced by the capture of two strategic programs. The first was the U.S. Navy Landing Craft Air Cushion (LCAC) Service Life Extension Program on which the Company provided six large flat panel displays. The second award came from Boeing to provide Aerial Refuel Operator Control Display Units for Boeing’s Global Tanker Transport Aircraft.
In fiscal 2004 the CIP product line was further advanced when the Federal Aviation Administration (FAA) awarded the Company a Technical Standard Order (TSO) for the large flat panel display or CIP. The TSO establishes the product as meeting the requirements that have been implemented by the FAA to ensure safe flight on a variety of aircraft types. The TSO awarded to the Company addresses the most stringent Commercial Air Transport Market requirements as provided in Section 14 of the Code of Federal Regulation, subpart 25, Commercial Air Transport.
Our Industry
A wide range of information, including airspeed and altitude, is critical for the proper and safe operation of aircraft. With advances in technology, new types of information to assist pilots, such as weather depiction and ground terrain maps, are becoming available for display in cockpits. We believe that aircraft cockpits will increasingly become information centers, capable of delivering additional information that is either mandated by regulation or demanded by pilots to assist them in the safe and efficient operation of aircraft.
There are three general types of flight data: flight critical aircraft control information such as air data, which includes aircraft speed, altitude and rates of ascent and descent; aircraft heading and altitude as well as engine data such as fuel and oil quantity and other engine measurements; navigation data such as radio position, flight management and GPS and alternative source information, which is information not originating on the aircraft, including weather depiction maps, GPS navigation and surface terrain maps. Air data calculations are based primarily on air pressure measurements derived from sensors on the aircraft. Engine data are determined by measuring various indices such as temperature, volume, RPM and pressure within an aircraft’s engines and other mechanical equipment. Alternative source information is typically derived from satellites or equipment located on land and fed by satellite or radio signals to the aircraft. Pilots can then display this information in the cockpit for reference.
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Traditionally, flight data and other cockpit information were displayed on a series of separate analog dials. In the early 1980s, digital displays using cathode ray tubes began to replace some of the individual analog displays. The industry has now begun to develop color flat panel displays using liquid crystal displays (LCD) to replace traditional analog or digital displays. We expect that the ability to display more information in a space-efficient and customized platform will become increasingly important as additional information, such as weather depiction maps, traffic information and surface terrain maps, becomes mandated by regulation or demanded by pilots. Accordingly, we believe that flat panel displays, which can integrate and display a “suite” of information, will increasingly replace individual displays as the method for delivering and ordering the information displayed in the cockpit.
Air Data and Reduced Vertical Separation Minimum (RVSM)
Pilots use air data for a number of important purposes, including maintaining safe separation from other aircraft. Until recently, aircraft on a similar flight path at altitudes between 29,000 and 41,000 feet have been required to maintain a vertical separation of at least 2,000 feet. As air travel has increased over the past decade, U.S. and global aviation authorities sought ways to increase traffic flow on high traffic routes. These organizations have developed RVSM for adoption in the most congested air space to reduce vertical separation between aircraft from 2,000 feet to 1,000 feet. RVSM essentially doubles flight routes within a vertical airspace, thereby increasing aircraft capacity on high traffic routes throughout the world.
Safe travel on RVSM routes requires that an aircraft’s altimeter be extremely accurate, and aircraft flying RVSM routes must have RVSM-certified equipment. RVSM has been in effect, as part of the international mandate, between 29,000 and 41,000 feet for certain North Atlantic routes since March 1997. Western Atlantic air routes commenced in 2001 and, as of January 2002, RVSM was phased in on Trans-Pacific and European air routes. We believe the North American market comprises over half of the total RVSM marketplace. On October 24, 2003, the Federal Aviation Administration (FAA) affirmed the mandatory compliance date for Domestic Reduced Vertical Separation Minimum (DRVSM) as January 20, 2005.
The Company is well positioned to support the aviation industry’s needs in both a timely and cost effective manner. The recent investment in a new manufacturing facility was made to ensure we would have the production capacity to meet the market demands associated with this mandate. It is clear the number of planes that need to receive updated equipment in order to fly in RVSM space will not all make the compliance deadline. While there is equipment capacity to accommodate the demand, there are insufficient installation facilities, as planes need to be grounded for several days in order to change out equipment. Accordingly, the demand will continue well into 2005.
Flat Panel Displays
Air data and other flight information have traditionally been displayed on analog instrumentation and, more recently, individual small digital displays. Within the last several years, color flat panel displays began to be used in aircraft cockpits. Flat panel displays are LCD screens that can replicate the display of one or a suite of analog or digital displays on one screen. Like other instrumentation, flat panel displays can be installed in new aircraft or used to replace existing displays in aircraft already in use. LCDs are also being used for cabin entertainment, security monitoring on-board aircraft and as tactical workstations on military aircraft. The flat panel product line presents numerous advantages for the presentation of engine performance data as well.
Engine and Fuel Displays
Equipment data, such as engine and fuel related data, traditionally have been displayed on conventional solid-state displays. Equipment data displays fuel and oil levels and provides information on engine activity, including oil and hydraulic pressures and temperature. This instrumentation includes individual and multiple displays clustered throughout an aircraft’s cockpit. Engine and fuel displays tend to be replaced more frequently than other displays due to normal wear-and-tear. As the information displayed by this instrumentation is vital for safe and efficient flight, aircraft operators continue to purchase individual conventional engine and fuel displays to replace older or non-functioning displays.
Strategy
Our objective is to become a leading supplier and integrator of cockpit information. We believe that our industry experience and reputation, our technology and products and our business strategy provide a basis to achieve this objective. Key elements of our strategy include:
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| • | Maintaining our leadership in the air data markets. We believe that we are one of the largest suppliers of air data products to the U.S. retrofit market. |
| • | Establishing leadership in the flat panel display market. We expect that over the next several years, many aircraft will either be retrofitted or newly manufactured with flat panel displays. Given the versatility, visual appeal and lower cost of displaying a series of instruments and other flight-relevant information on a single flat panel, we believe that flat panel displays will increasingly replace individual analog and digital instruments. We also believe that our CIP has significant benefits over the flat panel displays currently offered by our competitors, including its lower cost, larger size and enhanced viewing angles. Accordingly, we believe that these advantages will allow us to generate significant revenues from our CIP and gain significant market share within this market. |
| • | Continuing our engineering and product development successes. We have developed innovative products by combining our avionics, engineering and design expertise with commercially available technologies, components and products from non-aviation applications, including the personal computer and telecommunications industries. We believe our processes allow us to bring products to market quickly and to control our development costs. Our CIP is an example of our ability to engineer a superior product through the selective application of non-avionic technology. |
| • | Increasing our sales to the DoD, government agencies, defense contractors, commercial air transport and corporate/general aviation markets. We have strengthened our efforts to diversify our sales to include all end user markets of the aviation industry, particularly legacy military aircraft programs and the commercial air transport market, including national and regional carriers and other fleet operators as well as the corporate/general aviation market, primarily through aircraft modification centers, as well as the OEM market. We have begun building a sales and marketing force dedicated to expanding our sales efforts to these markets while at the same time maintaining our position as a provider of avionics products for the DoD. |
| • | Expanding our international presence. We plan to increase our international sales through expanding sales and marketing personnel and adding foreign offices. As large flat panel displays become more prevalent throughout the world, we believe that European and other international aircraft operators and aircraft modification centers will accelerate their retrofitting activities, thereby increasing the demand for large flat panel displays. |
| • | Growth through acquisitions or joint ventures. We intend to pursue strategic acquisitions or joint ventures as a means of growing our business with respect to both information management products and content. We have identified profiles of the types of companies we would like to acquire and are evaluating various potential forms of joint ventures. We may seek to acquire developers or suppliers of complementary products, technology or information, or we may acquire suppliers of similar products as a means of increasing our product offerings and market share. |
Our Products
Our current line of products includes:
Air Data and RVSM Systems and Components
Our air data and RVSM products calculate and display various measures of air data, such as aircraft speed, altitude and rate of ascent and descent. The functionality of our traditional non-RVSM air data systems and our RVSM systems is similar. However, our RVSM systems use advanced sensors to gather air pressure data and customized algorithms to interpret the data, thus allowing the system to more accurately calculate altitude and to qualify for RVSM certification.
We sell individual components as well as partial and complete air data systems. Our components and systems include:
| • | digital air data computers, which calculate various air data parameters such as altitude, airspeed, vertical speed, angle of attack and other information derived from the measure of air pressure; |
| • | integrated air data computers and display units, which calculate and convey air data information; |
| • | altitude displays, which convey aircraft altitude measurements; |
| • | airspeed displays, which convey various types of airspeed measurements including vertical airspeed and rates of ascent and descent; and |
| • | altitude alerters, which allow the pilot to select a desired cruising altitude that the aircraft will reach and maintain. |
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Flat Panel Displays
We have developed a large flat panel color display that can replace the conventional analog and digital displays currently used in a cockpit and can also display additional information that is not now commonly displayed in the cockpit. Our Cockpit Information Portal (CIP) is capable of displaying nearly all types of air data, equipment data, altitude, heading and navigational data as well as alternative source information. As technology and information delivery systems further develop, additional information, such as surface terrain maps, will be displayed in the cockpit. We have designed our CIP to be capable of displaying information generated from a variety of sources, including our RVSM air data system, our engine and fuel instrumentation and third-party data and information products.
Our flat panel display system has demonstrated its broad capability by being selected by the U.S. Navy for application on a Service Life Extension Program for the Landing Craft Air Cushion (LCAC) vehicle. In this program six IS&S flat panel displays replace the previous outdated displays. This kit includes two sizes of displays–10-inch and 15-inch. This program is in current production. Over 75 LCACs exist in the U.S. Navy fleet.
The flat panel display system broad capability was further demonstrated when The Boeing Company selected our displays for use on its new B767 Global Tanker Transport Aircraft (GTTA). This new refueling and transport aircraft is intended to provide a significant upgrade in capability to air forces around the world. The aircraft has already been sold to Japan and Italy. The U.S. Air Force is expected to purchase this aircraft as a replacement for the KC-135 tanker. The Company’s equipment on the GTTA includes two displays and one Symbol Generator (SG). The SG is a computer capable of displaying graphics on our flat panel displays.
The Boeing GTTA program represents a series of opportunities for the Company. In addition to the United States Air Force, several foreign governments have picked the GTTA program to replace their aging refueling tankers. The initial GTTA business the Company received from Boeing is for end use with the Italian government and is expected to continue without interruption. The United States Air Force order of 100 planes, however, is currently on hold and under investigation.
On July 2, 2004 the Federal Aviation Administration (FAA) awarded the Company a Technical Standard Order (TSO) for the large flat panel display or CIP. The TSO establishes our flat panel display as meeting FAA requirements that have been put in place to ensure safe flight on a variety of aircraft types. The TSO awarded to the Company addresses the most stringent Commercial Air Transport Market requirements as provided in Section 14 of the Code of Federal Regulation, subpart 25, Commercial Air Transport.
Engine and Fuel Displays
We develop, manufacture and market engine and fuel displays. Our solid-state multifunction displays convey information with respect to fuel and oil levels as well as engine activity, such as oil and hydraulic pressures and temperature. This instrumentation includes individual and multiple displays clustered throughout an aircraft’s cockpit. Our displays can be used in conjunction with our own engine and fuel data equipment or that of other manufacturers.
Engine and fuel displays are found in all aircraft and are vital to the safe and proper flight of aircraft. In addition, the accurate conveyance of engine and fuel information is critical for the monitoring of engine stress and the maintenance of engine parts. Engine and fuel displays tend to be replaced more frequently than other displays and have remained largely unchanged since their introduction due to their low cost, standard design and universal use.
We believe that our engine and fuel displays are extremely reliable, and we have designed them to be programmable to adapt easily without major modification to most modern aircraft. Our products have been installed on C-130H, DC-9, DC-10, P3 and A-10 aircraft.
Customers
Our customers include, among others, the United States Government, Garrett, Bombardier Aerospace (the manufacturer of Learjet), Raytheon, Northwest Airlines, ASTAR Air Cargo (formerly DHL Airways, Inc.), Federal Express Corporation, The Boeing Company, Lockheed Martin Corporation, Rockwell Collins, Airborne Express, Gulfstream Aerospace Corporation, Plain Avionics and Star Aviation.
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Retrofit Market
Historically, the majority of our sales have come from the retrofit market. Among other reasons, we have pursued the retrofit market because of its continued rapid growth in response to the increasing need to support the world’s aging fleet of aircraft.
Updating an individual aircraft’s existing electronics equipment has become increasingly common as new technology makes existing instrumentation outdated while an aircraft is still structurally and mechanically sound. Retrofitting an aircraft is generally a substantially less expensive alternative to purchasing a new aircraft. We expect our main customers in the retrofit market to be:
• the DoD and defense contractors;
• aircraft operators; and
• aircraft modification centers.
Department of Defense and Defense Contractors. We sell our products directly to the DoD as well as to defense contractors for end use on military aircraft retrofit programs. DoD programs generally take one of two forms, a subcontract with a prime government contractor, such as Boeing or Rockwell Collins, or a direct contract with the appropriate government agency such as the United States Air Force’s requirement for replacing Central Air Data Computers on the fleet of A-10 aircraft. The government’s desire for cost-effective retrofitting of aircraft has led it to purchase commercial off-the-shelf equipment rather than requiring the development of specially designed products, which are usually more costly and take a longer time to develop. These contracts tend to be on commercial terms, although some of the termination and other provisions of government contracts described below are typically applicable to these contracts. Each government agency or general contractor retains the right to terminate the contract at any time at its convenience. Upon such alteration or termination, we would be entitled to an equitable adjustment to the contract price so that we may receive the purchase price for already delivered items and reimbursement for allowable costs incurred.
Aircraft Operators. We also sell our products to aircraft operators, including commercial airlines, cargo carriers and business and general aviation. Our products are used mostly in the retrofitting of aircraft owned or operated by these customers, which generally retrofit and maintain their aircraft themselves. Our commercial fleet customers include Northwest Airlines, Air Canada, Midcoast, MK Airlines, ASTAR Air Cargo, Emery, ABX Air, Federal Express, Kitty Hawk, ARC, Champion and Kelowna Flightcraft LTD. We sell these customers a range of products from fuel quantity indicators to air data systems.
Aircraft Modification Centers. Based on industry data, we believe there are approximately 12,800 private and corporate aircraft in service in North America. The primary retrofit market for private and corporate jets is through aircraft modification centers, which repair and retrofit private aircraft in a manner similar to the way auto mechanics service a person’s car. We have established relationships with a number of aircraft modification centers throughout the United States. These modification centers essentially act as distribution outlets for our products. We believe that our air data systems and related components are being promoted by aircraft modification centers to update older or outdated equipment. Our large modification center customers include Bombardier Learjet, Garrett Aviation, AVCON, Star Aviation, Plain Avionics and Raytheon Aircraft Services.
We anticipate that retrofitting of air data systems by aircraft modification centers, and thus the demand for our RVSM products, will increase significantly as RVSM is phased-in on many of the world’s most popular flight routes. Furthermore, we anticipate that as flat panel displays gain popularity, aircraft modification centers will become significant customers of our flat panel product as aircraft owners seek to upgrade their display systems.
OEM Market
We also market our products to original equipment manufacturers, particularly manufacturers of corporate and private jets as well as to DoD contractors manufacturing military jets. Customers of our products include Bombardier (the manufacturer of Learjet), Gulfstream, Boeing, Raytheon, Piaggio and Lockheed.
Most aircraft manufacturers equip their current production aircraft with RVSM-compliant air data systems. In addition, we expect that as flat panel displays become increasingly popular, OEMs will begin manufacturing an increasing percentage of their aircraft with flat panel displays, either as standard or optional equipment. Most new high-end business aviation aircraft have flat panel displays as standard equipment.
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Backlog
As of September 30, 2004, our released backlog was $35.4 million. This represented an increase of $11.3 million or 47% from the September 30, 2003 released backlog of $24.1 million. We anticipate that essentially all of the current released backlog will be delivered to customers in fiscal 2005.
Sales and Marketing
We have generally focused our sales efforts on the DoD, DoD contractors, aircraft operators and OEMs, and more recently on aircraft modification centers. We have recently increased our sales efforts with respect to the commercial and corporate aviation markets. To date, we have made substantial use of third-party sales representatives for our sales efforts. We compensate these third-party sales representatives through commissions.
We believe that our ability to provide prompt and effective repair and upgrade service is critical to our marketing efforts. As part of our customer service program, we have implemented a 24-hour hotline that customers can call with respect to product repair or upgrade concerns. We employ five field service engineers to service our equipment and, depending on the service required, we may either dispatch a service crew to make necessary repairs or request that the customer return the product to us for repairs or upgrades at our facility. In the event repairs or upgrades are required to be made at our facility, we provide spare products for use by our customers during the repair time. Our in-house turnaround repair times average 15 days and turnaround upgrade times average 30 days. Before returning our products to customers, all repaired or upgraded products are retested for airworthiness.
In connection with our customer service program, we typically provide our customers with a two-year warranty on new products. We also offer our customers extended warranties of varying terms for additional fees.
Government Regulation
The manufacture and installation of our products in aircraft owned and operated in the United States is governed by U.S. Federal Aviation Administration (FAA) regulations. We maintain an FAA certified production facility. The most significant of the product and installation regulations focus on Technical Standard Order (TSO) and Supplemental Type Certificate (STC) certifications. These certifications set forth the minimum general standards that a certain type of equipment should meet. As required, we deliver our product in accordance with FAA regulations.
Sales of our products to European or other non-U.S. owners of aircraft also typically require approval of the Joint Aviation Authorities (JAA), the European counterpart of the FAA, or another appropriate governmental agency. JAA certification requirements for the manufacturing and installation of our products in European-owned aircraft mirror the FAA regulations. Much like the FAA certification process, the JAA has established a process for granting European Certifications.
In addition to product-related regulations, we are also subject to the government’s procurement regulations with respect to sales of our products to government entities or government contractors. These regulations dictate the manner in which products may be sold to the government and set forth other requirements that must be met in order to do business with or on behalf of government entities. For example, pursuant to such regulations, the government agency or general contractor may alter the price, quantity or delivery schedule of our products. In addition, the government agency or general contractor retains the right to terminate the contract at any time at its convenience. Upon such alteration or termination, we would be entitled to an equitable adjustment to the contract price so that we may receive the purchase price for already delivered items and reimbursement for allowable costs incurred.
Manufacturing, Assembly and Materials Acquisition
Our manufacturing activities consist primarily of assembling and testing components and subassemblies and integrating them into a finished system. We believe that this method allows us to achieve relatively flexible manufacturing capacity while minimizing expenses. We generally purchase the components for our products from third-party vendors and assemble them in a clean room environment to reduce impurities and improve the performance of our products. Many of the components we purchase are standard products, although certain parts are made to our specifications.
When appropriate, we enter into long-term supply agreements and use our relationships with long-term suppliers to improve product quality and availability and to reduce delivery times and product costs. In addition, we are continually identifying alternative suppliers for important component parts. Using component parts from new suppliers in our products generally requires FAA certification of the entire finished product if the newly sourced component varies significantly from our original drawings and specifications. To date, we have not experienced any significant delays in the delivery of our products caused by the inability to obtain either component parts or FAA approval of products incorporating new component parts.
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Quality Assurance
Product quality is of vital importance to our customers, and we have taken steps to enhance the overall quality of our products. We are ISO 9001 and AS 9100 certified. ISO 9001 and AS 9100 standards are an international consensus on effective management practices with the goal of ensuring that a company can consistently deliver its products and related services in a manner that meets or exceeds customer quality requirements. These standards allow us to represent to our customers that we maintain high quality industry standards in the education of our employees and the design and manufacture of our products. In addition, our products undergo extensive quality control testing prior to being delivered to customers. As part of our quality assurance procedures, we maintain detailed records of test results and our quality control processes.
Our Competition
The market for our products is highly competitive and characterized by several industry niches in which a number of manufacturers specialize. Our competitors vary in size and resources, and substantially all of our competitors are much larger and have substantially greater resources. With respect to air data systems and related products, our principal competitors include Kollsman Inc., Honeywell International Inc., Rockwell Collins, Inc., Thales and Smiths PLC. With respect to flat panel displays, our principal competitors currently include Honeywell, Rockwell Collins, Inc., L-3 Communications and Smiths. However, because the flat panel display industry is a new and evolving market, as the demand for flat panel displays increases, we may face competition in this area from additional companies in the future.
We believe that the principal competitive factors in the markets we serve are cost, development cycle time, responsiveness to customer preferences, product quality, technology, reliability and breadth of product line. We believe that our significant and long-standing customer relationships reflect our ability to compete favorably with respect to these factors.
Intellectual Property and Proprietary Rights
We rely on patents to protect our proprietary technology. We currently hold twelve U.S. patents and have seven U.S. patent applications pending relating to our technology. In addition, we have eight international patents and twenty-four international patent applications pending. Our patents have durations of between 3 and 18 years. Certain of these patents and patent applications cover technology relating to air data measurement systems and RVSM calibration techniques while others cover technology relating to flat panel display systems and other aspects of our CIP solution. While we believe that these patents have significant value in protecting our technology, we also believe that the innovative skill, technical expertise and the know-how of our personnel in applying the technology reflected in our patents would be difficult, costly and time consuming to reproduce.
While there are no pending lawsuits against us regarding the infringement of any patents or other intellectual property rights, we cannot be certain that such infringement claims will not be asserted against us in the future.
Innovative Solutions and Support Website
Our primary website is at http://www.innovative-ss.com. We make available, free of charge, at our corporate website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
Our Employees
As of September 30, 2004, we had 129 employees, 61 were in our manufacturing and assembly operations, 33 in research and development, 11 in quality and 24 in selling & general administrative positions.
Our future success depends on our ability to attract, train and retain highly qualified personnel. We plan to hire additional personnel, including, in particular, sales and marketing personnel, during the next twelve months. Competition for such qualified personnel is intense and we may not be able to attract, train and retain highly qualified personnel in the future. Our employees are not represented by a labor union.
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Executive Officers of the Registrant
The following is a list of our executive officers, their ages and their positions:
| Name | Age | Position | |||||||||||
| Geoffrey S. M. Hedrick | 62 | Chairman of the Board and Chief Executive Officer | |||||||||||
| Roman G. Ptakowski | 56 | President | |||||||||||
| James J. Reilly | 64 | Chief Financial Officer | |||||||||||
| Roger E. Mitchell | 50 | Vice President of Operations |
Geoffrey S. M. Hedrick has been our Chief Executive Officer since he founded IS&S in February 1988 and our Chairman of the Board since 1997. Prior to founding IS&S, Mr. Hedrick served as President and Chief Executive Officer of Smiths Industries North American Aerospace Companies. He also founded Harowe Systems, Inc. in 1971, which was subsequently acquired by Smiths Industries. Mr. Hedrick has over 35 years of experience in the avionics industry, and he holds a number of patents in the electronics, optoelectric, electromagnetic, aerospace and contamination-control fields.
Roman G. Ptakowski has been our President since March 2003. Prior to that, Mr. Ptakowski served as a Group Vice President and General Manager and, before that, as a Vice President of Sales and Marketing at B/E Aerospace, Inc. Previously, Mr. Ptakowski held a number of positions with increasing responsibility within ASEA Brown Boveri Power T&D Company, Inc. There, he was General Manager of the Protective Relay Division before leaving to join B/E Aerospace, Inc. Mr. Ptakowski received a B.S. in Electrical Engineering from New York University and a MBA from Duke University.
James J. Reilly has been our Chief Financial Officer since February 2000. From 1996 to 1999, Mr. Reilly was employed by B/E Aerospace, Inc., Seating Products Group, where he served as Vice President and Chief Financial Officer. From 1989 to 1996, Mr. Reilly was employed by E-Systems, Inc. as Vice President and Principal Accounting Officer. Mr. Reilly received a Bachelor of Science degree and a MBA from The University of Hartford.
Roger E. Mitchell has been our Vice President of Operations since September 1999. From July 1998 until September 1999, Mr. Mitchell served as our Director of Operations. Prior to joining us, Mr. Mitchell was employed by AlliedSignal, where he held various positions, including Operations Manager from 1994 to 1998. Mr. Mitchell received a Bachelor of Arts degree from Lewis University.
In fiscal 2001 we purchased 7 and 1/2 acres of land in the Eagleview Corporate Park located in Exton, Pennsylvania, a suburban Philadelphia location. There we constructed a 44,800 square foot design, manufacturing and office facility. Land development approval allows for expansion of up to 20,400 additional square feet. This would provide for a 65,200 square foot facility. The construction was principally funded with a Chester County Industrial Revenue Bond. The building serves as security for the Industrial Revenue Bond.
In the ordinary course of our business, we are at times subject to various legal proceedings. We do not believe that any current legal proceedings will have a material adverse effect on our results of operations or financial position.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of our shareholders during the three months ended September 30, 2004.
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Part II
Item 5. Market for the Registrant’s Common Equity and Related Stockholder Matters.
Our common stock has been traded on the Nasdaq National Market under the symbol “ISSC” since our initial public offering on August 4, 2000. The following table lists the high and low per share sale prices for our common stock for the periods indicated:
| Fiscal 2004 | Fiscal 2003 | ||||||||||
| Period | High | Low | High | Low | |||||||
| First Quarter | $ | 18.25 | $ | 7.58 | $ | 8.00 | $ | 5.50 | |||
| Second Quarter | $ | 17.10 | $ | 11.90 | $ | 6.49 | $ | 5.50 | |||
| Third Quarter | $ | 21.60 | $ | 13.85 | $ | 9.06 | $ | 5.70 | |||
| Fourth Quarter | $ | 29.10 | $ | 19.06 | $ | 8.49 | $ | 6.62 | |||
On December 6, 2004, there were 43 holders of record of the shares of outstanding common stock.
We have not paid cash dividends on our common stock, and we do not expect to declare cash dividends on our common stock in the near future. We intend to retain any earnings to finance the growth of our business.
Equity Compensation Plan Information
The following table gives information about our common stock that may be issued upon the exercise of options, warrants and rights under all of our existing equity compensation plans and arrangements as of September 30, 2004, including the 1998 Stock Option Plan.
| Plan Category | Number of Securities to be issued upon exercise of outstanding options, warrants and rights | Weighted-average exercise price of outstanding options, warrants and rights |
Number of Securities remaining available for future issuance under equity compensation plans (excluding securities reflected in second column) |
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| Equity compensation plans approved by security holders | 560,458 | $ | 10.19 | 194,012 | |||
| Equity compensation plans not approved by security holders | 0 | $ | 0 | 0 | |||
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| Total | 560,458 | $ | 10.19 | 194,012 | |||
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The 2003 Restricted Stock Plan for non-employee directors was approved by shareholders at the Company’s February 26, 2004 Annual Meeting of Shareholders. Each individual who was an eligible Director on both October 1, 2003 and February 26, 2004, was automatically granted a one-time award of restricted stock for shares having a fair market value of $25,000 as of the close of business on October 1, 2003. The shares vest quarterly during the fiscal year, provided that the director was still serving on the board on the date the shares were scheduled to vest. Six of our seven non-employee directors received a grant of 3,125 shares of restricted stock as of October 1, 2003. The remaining Director received a pro rated grant of 2,500 shares as of
October 1, 2003.
Item 6. Selected Financial Data.
The following tables present portions of our consolidated financial statements. You should read the following selected consolidated financial data set forth below together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes to our financial statements appearing elsewhere herein. The selected statement of operations data for the years ended September 30, 2004, 2003 and 2002 and the balance sheet data as of September 30, 2004 and 2003 are derived from our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The selected statements of operations data for the years ended September 30, 2001 and 2000 and the balance sheet data as of September 30, 2002, 2001 and 2000 are derived from our audited consolidated financial statements that are not included in this Annual Report on Form 10-K.
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| Fiscal year ended September 30, | |||||||||||||||
| 2000 | 2001 | 2002 | 2003 | 2004 | |||||||||||
| Statement of Operations Data: | |||||||||||||||
| Net sales | $ | 33,273,890 | $ | 34,384,562 | $ | 28,345,620 | $ | 28,168,752 | $ | 46,099,777 | |||||
| Cost of sales | 14,819,043 | 14,477,868 | 11,290,085 | 11,346,057 | 15,663,108 | ||||||||||
| Gross profit | 18,454,847 | 19,906,694 | 17,055,535 | 16,822,695 | 30,436,669 | ||||||||||
| Research and development | 3,274,708 | 4,371,570 | 4,755,422 | 3,376,849 | 4,811,156 | ||||||||||
| Selling, general and administrative | 4,951,732 | 5,777,929 | 5,732,886 | 5,890,362 | 7,567,959 | ||||||||||
| Total operating expenses | 8,226,440 | 10,149,499 | 10,488,308 | 9,267,211 | 12,379,115 | ||||||||||
| Operating income | 10,228,407 | 9,757,195 | 6,567,227 | 7,555,484 | 18,057,554 | ||||||||||
| Interest (income) expense, net | (564,555 | ) | (2,196,401 | ) | (722,850 | ) | (450,421 | ) | (404,727 | ) | |||||
| Income before income taxes | 10,792,962 | 11,953,596 | 7,290,077 | 8,005,905 | 18,462,281 | ||||||||||
| Income tax (expense) benefit, net | (4,043,405 | ) | (4,422,831 | ) | (1,879,799 | ) | (2,464,715 | ) | (6,530,084 | ) | |||||
| Net income | $6,749,557 | $ | 7,530,765 | $ | 5,410,278 | $ | 5,541,190 | $ | 11,932,197 | ||||||
| Net income per common share: | |||||||||||||||
| Basic | $ | 0.86 | $ | 0.59 | $ | 0.42 | $ | 0.45 | $ | 1.03 | |||||
| Diluted | $ | 0.66 | $ | 0.57 | $ | 0.41 | $ | 0.44 | $ | 1.00 | |||||
| Weighted average shares outstanding | |||||||||||||||
| Basic | 7,893,630 | 12,731,395 | 12,830,894 | 12,261,084 | 11,600,253 | ||||||||||
| Diluted | 10,231,931 | 13,284,484 | 13,069,387 | 12,495,774 | 11,952,120 | ||||||||||
| September 30, | |||||||||||||||
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| 2000 | 2001 | 2002 | 2003 | 2004 | |||||||||||
| Balance Sheet Data: | |||||||||||||||
| Cash and cash equivalents | $ | 38,657,433 | $ | 42,769,837 | $ | 52,245,754 | $ | 48,789,744 | $ | 65,867,167 | |||||
| Working capital | 50,944,599 | 56,254,288 | 59,158,307 | 55,996,411 | 70,627,114 | ||||||||||
| Total Assets | 60,746,527 | 68,051,426 | 72,616,685 | 69,876,625 | 87,468,627 | ||||||||||
| Debt and capital lease obligations, | |||||||||||||||
| less current portion | 4,265,447 | 4,252,635 | 4,235,000 | 4,235,000 | 4,255,681 | ||||||||||
| Total shareholders’ equity | 50,822,496 | 60,378,704 | 64,726,210 | 61,058,290 | 75,454,987 | ||||||||||
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
All statements made in this Annual Report on Form 10-K, other than statements of historical fact, are forward-looking statements. The words “anticipate”, “believe”, “estimate”, “expect”, “intend”, “may”, “plan”, “will”, “would”, “should”, “guidance”, “potential”, “continue”, “project”, “forecast”, and similar expressions, beliefs, assumptions, estimates and forecasts about our business and the industry and markets in which we operate are not guarantees of future performance and involve risks, uncertainties and assumptions, which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or implied by these forward-looking statements. Factors which may affect our business, financial condition and operating results are discussed under “Risk Factors”. We expressly disclaim any intent or obligation to update these forward-looking statements.
Overview
Innovative Solutions and Support was founded in 1988. The Company designs, develops, manufactures and markets flight information computers, large flat-panel displays and advanced monitoring systems that measure and display critical flight information, including data relative to aircraft separation (RVSM), airspeed and altitude as well as engine and fuel data measurements.
Our sales are derived from the sale of our products to the retrofit market and, to a lesser extent, original equipment manufacturers (OEMs). Our customers include the DoD and their commercial contractors, aircraft operators, aircraft modification centers and various OEMs. Although we occasionally sell our products directly to the DoD, we primarily have sold our products to commercial customers for end use in DoD programs. Sales to defense contractors are on commercial terms, although some of the termination and other provisions of government contracts are applicable to these contracts.
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Our cost-of-sales are comprised of material components purchased through our supplier base and direct in-house assembly labor and overhead costs. Many of the components we use in assembling our products are standard, although certain parts are manufactured to meet our specifications. The overhead portion of cost of sales is primarily comprised of salaries and benefits, building occupancy, supplies, and outside service costs related to our production, purchasing, material control and quality departments as well as warranty costs.
We intend to continue investing in the development of new products that complement our current product offerings and will expense associated research and development costs as they are incurred.
Our selling, general and administrative expenses consist of sales, marketing, business development, professional services and salaries and benefits for executive and administrative personnel as well as facility costs, recruiting, legal, accounting and other general corporate expenses.
Results of Operations
Fiscal Year Ended September 30, 2004 Compared to Fiscal Year Ended September 30, 2003
Net sales. Net sales increased $17.9 million or 64% to $46.1 million for the fiscal year ended September 30, 2004 from $28.2 million in the fiscal year ended September 30, 2003. The rise in net sales was primarily due to increased demand for our Air Data Display Units, Digital Air Data Computers and other related air data products. The increased demand is in response to commercial aviation and air transport customers continuing to upgrade their respective aircraft with up-to-date air data systems that fully meet the Federal Aviation Administration’s (FAA) Reduced Vertical Separation Minimum (RVSM) mandate. Several customers, including Garrett, Northwest Airlines, Bombardier, Plain Avionics, Raytheon, Star Aviation and AVCON contributed to the year over year growth.
Cost of sales. Cost of sales increased $4.3 million or 38% to $15.7 million, or 34% of net sales, for fiscal 2004 from $11.3 million, or 40% of net sales, for fiscal 2003. The increase in the dollar amount was essentially due to higher sales in the period. The decline as a percent of net sales was primarily the result of cost containment efforts coupled with fixed operating costs being absorbed over higher net sales in the current period.
Research and development. Research and development expenses increased $1.4 million, or 42%, to $4.8 million, or 10% of net sales in fiscal 2004 from $3.4 million or 12% of net sales in fiscal 2003. The dollar increase was principally due to increased spending on the flat panel program as the Company was in final stages of submitting its Technical Standard Order (TSO) application to the FAA. As a result of that effort the Company was awarded a TSO certification for their Flat Panel Display on July 2, 2004 by the FAA. On a percent to sales basis, fiscal 2004 was less than fiscal 2003 by two percentage points because of higher net sales in the current period.
Selling, general and administrative. Selling, general and administrative expenses increased $1.7 million or 28% to $7.6 million, or 16% of net sales, for fiscal 2004 from $5.9 million, or 21% of net sales, for fiscal 2003. The increase in the dollar amount was the result of higher wages, corporate governance initiatives and commissions due to higher net sales. The decrease as a percent of net sales was the result of higher net sales in the current peri