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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 2002
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. 0-31157
INNOVATIVE SOLUTIONS AND
SUPPORT, INC.
(Exact name of registrant as specified in its charter)
| Pennsylvania |
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23-2507402 |
| (State or other jurisdiction of incorporation) |
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(IRS Employer Identification No.) |
| 720 Pennsylvania Drive, Exton, Pennsylvania |
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19341 |
| (Address of principal executive offices) |
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(Zip Code) |
(610) 646-9800
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act: None. Securities registered pursuant to Section 12 (g) of the Act:
Common stock, par value $.001
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 x 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. x
The aggregate market value of the Registrant’s common stock held by non-affiliates of the Registrant as of December 9, 2002 was
approximately $67,848,993. 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 9, 2002,
there were 13,057,313 outstanding shares of the Registrant’s Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s Proxy Statement for the 2003 Annual Meeting of Shareholders to be filed
prior to January 28, 2003 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.
2002 Annual Report on Form 10-K
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Part I |
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Part III |
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Part IV |
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45-46 |
2
PART I
Overview
Innovative Solutions and Support, Inc. (the “Company”, “IS&S” or “We”) was founded in 1988. We design, manufacture and sell flight
information computers, electronic displays and advanced monitoring systems to the Department of Defense (“DOD”), government agencies, commercial air transport carriers 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 the aviation industry. We believe this approach, combined with our industry experience, enables us to develop
high-quality avionics products, substantially reduce product time to market and achieve cost advantages over 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 and also for the Original Equipment Manufacturer (“OEM”) market. Since fiscal 1997, a substantial portion of our revenues have been from the sale of air
data systems that bring aircraft into compliance with government regulations, including the reduced vertical separation minimum, or RVSM, requirements that are being phased in by regulatory authorities on certain heavily traveled flight routes. We
believe we are currently one of three primary suppliers of RVSM products to the U.S. retrofit market. As a result of our expertise, we were selected as the sole 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. During fiscal year 2002, we successfully completed all deliveries, both on time and within budget, on this multi-year
procurement.
Advances in technology are making available to pilots increasing amounts of information that enhance
both safety and efficiency of flying. However, limited amount of space in the cockpit coupled with inefficiencies associated with currently used displays inhibits 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 management and integration of cockpit information. Our CIP has a large, 15-inch diagonal high-resolution screen, which can integrate and replace virtually all of the
space-consuming conventional displays currently used in cockpits. Our CIP is the centerpiece of our cockpit information management system that organizes and displays a multitude of flight information mandated by regulation or that is or 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, our cabin surveillance and security system or from third-party data and
information products, such as a predictive weather information system and airport location awareness programs. In addition, we are in the process of developing technologies relating to other products to be incorporated with our CIP, such as a heads
up display system designed to project critical flight data onto cockpit windshields for easy reference by pilots.
Our Industry
A wide range of information, including airspeed, altitude and fuel levels, is critical for proper and safe
operation of aircraft. With advances in technology, new types of information to assist pilots, such as weather radar and ground terrain maps, are becoming available for display in cockpits. We believe aircraft cockpits will increasingly become
information centers, capable of delivering additional information that is either mandated by regulation or demanded by pilots to assist in safe and efficient operation of aircraft.
There are three general types of flight data: air data, which includes aircraft speed, altitude and rates of ascent and descent; equipment data, such as fuel and oil
quantity and other engine measurements; and alternative source information, which is information not originating on aircraft, including weather radar and surface terrain maps. Air data calculations are based primarily on air pressure measurements
derived from sensors on the aircraft. Equipment data are determined by measuring various indices such as temperature, volume 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 aircraft. All types of information are then displayed in the cockpit for reference by pilots.
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. Recently, the industry has begun to develop color flat panel displays using liquid crystal displays (“LCD”) to replace some of the traditional analog or digital displays. We expect
the ability to display more information in a space-efficient and customized platform will become increasingly important as additional information, such as weather radar and surface terrain maps, becomes mandated by regulation or demanded by pilots.
Accordingly, we believe flat panel displays, which can integrate and display a “suite” of information, will increasingly replace individual displays as the method of delivering and ordering cockpit information.
3
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 exceeding 29,000 feet were required to maintain a vertical separation of at least 2,000 feet. As air travel increased over the past decade, U.S. and international aviation organizations sought ways to
increase traffic flow on high traffic routes. These organizations developed reduced vertical separation minimums, or RVSM, for adoption on certain highly traveled routes to reduce vertical separation between aircraft from 2,000 feet to 1,000 feet.
RVSM increases available flight routes within a vertical airspace, thereby increasing the number of aircraft flying on high traffic routes.
Safe travel on RVSM routes requires an extremely accurate aircraft altimeter, and aircraft flying RVSM routes must have RVSM-certified equipment. RVSM-certified altimeters must be able to measure
altitude to within 25 feet at an altitude of 30,000 feet. In contrast, non-RVSM systems need only be accurate within 180 feet at 30,000 feet.
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 certain Trans-Pacific and European air routes. Implementation in the United States and Canada is expected to be complete by December 31, 2004. We believe the U.S. market comprises over half of the total RVSM
marketplace.
Flat Panel Displays
Air data and other flight information have traditionally been displayed on analog instrumentation and, more recently, individual digital displays. Within the last five years, color flat panel displays
to be used in aircraft cockpits. Flat panel displays are liquid crystal display (“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. LCD’s are also being used for aircraft cabin entertainment and security monitoring.
Engine and Fuel Displays
Equipment data, such
as engine and fuel related data, were traditionally displayed on conventional solid-state displays. Equipment data displays fuel and oil levels and provides information on engine activity, including oil and hydraulic pressures, temperature and
liquid oxygen levels. 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.
4
Strategy
Our objective is to become a leading supplier and integrator of cockpit information. We believe 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 air data and RVSM markets. We believe we are one of the largest suppliers of air data and RVSM-compliant products to the
U.S. retrofit market. As RVSM routes continue to be phased in over the next two years, we anticipate many aircraft will be retrofitted with RVSM-compliant air data systems. The RVSM retrofit market has a limited number of competitors, and we intend
to capitalize on our position as a leading provider of reliable, cost competitive RVSM air data products. |
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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 our CIP has significant benefits over flat panel displays currently offered by our competitors, including lower cost, larger size and enhanced viewing area. Accordingly, we believe
these advantages will allow us to generate significant revenues from our CIP and gain significant market share. |
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Continuing our engineering and product development successes. We 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 development costs. Our CIP, which we expect will be larger, display more information and cost less than flat panel displays offered by our competitors, is an example of our ability to engineer a superior product through the selective
application of non-avionic technology. We currently are developing technologies relating to other products intended to be incorporated with our CIP, such as a heads up display system designed to project critical flight data onto cockpit windshields
for easy reference by pilots. |
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Increasing our sales to the commercial air transport and corporate/general aviation markets. While we currently sell our products to commercial and
corporate aircraft operators and other retrofitters, our products have been predominantly used in government and military end user markets. We intend to strengthen and diversify our marketing efforts to include all end user markets of the aviation
industry, particularly the commercial air transport market, including national and regional carriers and other fleet operators, the corporate/general aviation market, primarily through aircraft modification centers, as well as the OEM market. We
began 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 United States military establishment. The results of
these efforts will also be influenced by economic factors and other trends affecting the aerospace industry. As a result of disruption of the commercial air travel market caused by recent general economic slowdown and terrorist attacks of September
11, 2001, demand for commercial aerospace products has been reduced. |
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Expanding our international presence. We plan to increase our international sales through expanding sales and marketing personnel and adding foreign
offices. As RVSM and flat panel displays become more prevalent throughout the world, we believe European and other international aircraft operators and aircraft modification centers will accelerate retrofitting activities, thereby increasing demand
for RVSM products and flat panel displays. We intend to expand our international sales presence in conjunction with the anticipated introduction of RVSM on other air routes throughout the world. |
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Growth through acquisitions. We intend to pursue acquisitions as a means of growing our business with respect to both information management products and
content, and have identified profiles of types of companies we would like to acquire. 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. |
5
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. These systems consist of a number of components, including internally mounted precision pressure sensors, a computer system and cockpit displays.
The sensors collect air pressure data from calibrated openings in the aircraft skin. Computers process raw data and convert it, using advanced proprietary algorithms developed by us, into useful information. Cockpit displays convey information to
pilots.
Our air data systems are highly accurate with respect to collection and interpretation of raw air
pressure data from specifically selected locations on the aircraft. We utilize state-of-the-art, highly sensitive digital sensors capable of gathering the requisite air pressure data. Software in our computer systems incorporates proprietary
mathematical algorithms that interpret air data to measure altitude, air speed and vertical speed. Our algorithms account for time, speed and temperature variations as well as the variations inherent in diverse profiles of different types of
aircraft so our products continuously provide accurate data over the requisite range of altitudes and atmospheric conditions for the type of aircraft in which the product is installed.
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 interpret the data, 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:
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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; |
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integrated air data computers and display units, which calculate and convey air data information; |
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altitude displays, which convey aircraft altitude measurements; |
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airspeed displays, which convey various types of airspeed measurements including vertical airspeed and rates of ascent and descent; and
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altitude alerters, which allow the pilot to select a desired cruising altitude that the aircraft will reach and maintain. |
Flat Panel Display
We have developed a large, high-resolution flat panel display that can replace virtually all of the conventional analog and digital cockpit displays currently used and can also display additional
information 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, we expect additional information, such as surface terrain maps, to be commonly 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 CIP can interpret, configure and display data from our own products and other manufacturers’ products. The “open architecture” characteristics of the cockpit instrumentation market
enables our CIP products to be adapted to work in most cockpit instrumentation systems. In addition, we designed our CIP to host and integrate a heads up display we are developing to project important flight information onto an aircraft’s
cockpit windshield for easy pilot reference.
Our CIP has been demonstrated to pilots and test pilots from major
airframe manufacturers, airlines and the United States Government. The reception has been outstanding. The large size allows all flight critical information to be displayed crisply in a non-obstructed presentation not currently available in either
Air Transport, Regional or Business Jet aircraft.
Flat panel displays, like other cockpit instrumentation,
require Federal Aviation Administration (“FAA”) approval before installation in non-military aircraft. We are in the process of seeking approval of our CIP pursuant to which we will be permitted to install our CIP on certain aircraft.
6
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, temperature and liquid oxygen levels. 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 safe and proper flight of aircraft. In addition, accurate conveyance of engine and fuel information is critical for monitoring engine stress and 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 our engine and fuel displays are extremely reliable, and designed them to be programmable to adapt easily without major modification to most modern aircraft. Our
products are installed on the Lockheed Martin C-130H, Boeing DC-9 and DC-10 and U.S. Air Force A-10 aircraft.
Customers
Our customers include, among others, the United States government, DME Inc., Northwest Airlines Corporation,
Air Canada, Inc., DHL Airways, Inc., Emery Worldwide Airlines, Federal Express Corporation, The Boeing Company, Lockheed Martin Corporation, Rockwell International Corporation, Raytheon, Bombardier Aerospace (the manufacturer of Learjet), Pilatus
Aircraft Ltd., Airborne Express and Gulfstream Aerospace Corporation.
Retrofit Market
Historically, the majority of our sales come from the retrofit market. Among other reasons, we 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:
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government and military contractors; |
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aircraft operators; and |
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aircraft modification centers. |
Government and Military Contractors. We sell our products directly to the Department of Defense (“DOD”) as well as first tier government contractors for end use on military aircraft retrofit programs. To
date, a majority of our sales have been realized in connection with this type of program procurement. 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. The majority of our government program sales are to government contractors pursuant to commercial off-the-shelf equipment contracts. As defense spending decreased over the past decade, the
government’s desire for cost-effective retrofitting of aircraft led it to increasingly purchase commercial off-the-shelf equipment rather than requiring 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-related contract includes
various federal regulations imposing certain requirements on us, including the ability of the government agency or general contractor to 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 normally 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.
7
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 retrofitting of aircraft owned or operated by these customers, which generally retrofit and maintain the aircraft themselves. Our
commercial fleet customers include Northwest Airlines, Air Canada, European Air, Midcoast, MK Airlines, DHL, Emery, Airborne Express and Federal Express. We sell these customers a range of products from fuel quantity indicators to RVSM air data
systems.
Aircraft Modification Centers. Based on industry data, we believe there are approximately 12,800
private and corporate turbine 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 RVSM products. We
believe that our RVSM and non-RVSM air data systems and related components are being promoted by aircraft modification centers to update older or outdated air data systems.
We anticipate air data systems retrofitting by aircraft modification centers, and thus the demand for our RVSM products, will increase significantly as RVSM is increasingly
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.
8
OEM Market
We also market our products to original equipment manufacturers, particularly manufacturers of corporate and private jets as well as military jets. Our customers include
Bombardier (the manufacturer of Learjet), Pilatus, Gulfstream, Boeing, Raytheon and Lockheed.
Certain jet
manufacturers currently equip their aircraft with traditional non-RVSM air data systems. However, we believe most aircraft manufacturers will begin equipping their aircraft with RVSM-compliant air data systems in anticipation of expected increasing
use of RVSM throughout the world. 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. The OEM market could be impacted as a result of disruption of the commercial air travel market caused by the recent general economic slowdown.
Backlog
As of September 30, 2002, our backlog was $12.7 million, $9.1 million of
which we expect will be sold in fiscal year 2003. This backlog and associated fiscal 2003 sales, however, will likely be reduced by $3.7 million in the first quarter of fiscal 2003. A company that was under contract to do this business with us is
expected to default and cancel the remaining rvsm systems scheduled for delivery in fiscal 2003. There are no outstanding accounts receivable with this customer. Our backlog as of September 30, 2001 was $12.8 million. Our backlog consists solely of
orders believed to be firm. In the case of contracts with government entities, orders are only included in backlog to the extent funding has been obtained for such orders.
Sales and Marketing
We have generally focused our sales
efforts on government and military entities and contractors, aircraft operators and OEMs, and more recently on aircraft modification centers. We recently increased our sales efforts with respect to commercial and corporate aviation markets in the
future. To date, we have made substantial use of third-party sales representatives. We compensate these third-party sales representatives through commissions.
We believe 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 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.
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Government Regulation
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. The most significant of these regulations focus on Technical Standard Order (“TSO”) and Type Certificate (“TC”) or Supplemental Type Certificate (“STC”) certifications. The FAA recommends that avionics
products be TSO-certified. A TSO sets forth minimum general standards that a certain type of equipment should meet. TSO certification is a declaration by the FAA that a product meets such consensus standards and guidelines and that it is certified
for use in an aircraft. For example, all altimeters, including RVSM and non-RVSM versions, have the same TSO, which sets forth the various general requirements that an altimeter must meet to be TSO-certified, such as life cycle, software,
environmental and other standards. Retrofitters and OEMs prefer avionic products that carry a TSO certification because they act as an industry-wide stamp of approval and facilitate the TC/STC approval process, described below. The TSO certification
process typically takes two to three months and consists of product and software testing and environmental simulation.
The FAA requires that all avionics products receive TC or STC certification upon their installation in aircraft. Without such certification, avionics products may not be installed in an aircraft. TC certification is required for
installation by an OEM, and STC certification is required for retrofitting installation. When an avionics product is installed in a certain type of aircraft, the FAA conducts an inspection and systems tests on a test aircraft containing such newly
installed product. The TC and STC process includes ground analyses and test flights to determine whether the product is functioning properly in the aircraft. Upon satisfactory completion of these tests, a product is TC- or STC-certified, meaning the
type of aircraft tested can be flown with the installed instrumentation. The TC and STC approval procedures typically last one to four months, depending on the complexity of the equipment being certified.
With respect to our RVSM air data products, the FAA also requires that these products be RVSM-certified before they are used in flight.
This certification process may be undertaken in conjunction with the TC/STC certification process. RVSM certification requires ground and flight tests and an analysis of flight data to ensure the accuracy, reliability, system safety and mean time
between failure rates of the product. The RVSM certification process typically lasts one to three months.
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. Currently, 18
European countries are members of the JAA. JAA certification requirements for manufacturing and installation of our products in European-owned aircraft mirror FAA regulations. Much like the FAA certification process, the JAA established a process
for granting TSOs, TCs and STCs. Certification by the JAA or other appropriate governmental agencies is generally granted upon demonstration that the equipment is accurate and able to maintain certain levels of repeatability over time.
In addition to product-related regulations, we are also subject to government 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 normally 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 this method allows us to achieve relatively flexible manufacturing capacity while lowering overhead expenses. We generally purchase 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 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 delivery of our products caused by the inability to obtain either component parts
or FAA approval of products incorporating new component parts.
10
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 utilize the Six Sigma program, which is
a process evaluation program based on the premise that efficient companies can reduce to a very low level the number of defects and inefficient processes. Under this program, we are continuously seeking to improve our operational efficiencies,
including our design and manufacturing processes and, thus, the general quality of our products. In particular, our Six Sigma program allows us to analyze our development processes and reduce the risks inherent in shortening our development cycle
times. In effect, Six Sigma has allowed us to improve our product quality and cycle times. Our employees are required to attend an in-house training session that teaches them the principles and application of our Six Sigma program.
In addition, we are ISO 9001 certified. ISO 9001 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. ISO 9001 standards set forth the requirements a company’s quality systems must
meet to achieve a high standard of quality. As an ISO 9001-certified manufacturer, we can 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 than we do. With respect to air data systems and related products, our principal competitors include Kollsman Inc., Honeywell International Inc., Rockwell-Collins, Inc., Meggitt Avionics Inc. and
Smiths PLC. Of these competitors, only Honeywell, Rockwell Collins and Smiths currently manufacture products that compete with our RVSM products. With respect to flat panel displays, our principal competitors currently include Honeywell,
Rockwell-Collins Inc., Meggitt and Smiths. However, because the flat panel display industry is a new and evolving market, as demand for flat panel displays increases, we may face competition from additional companies.
We believe that the principal competitive factors in markets we serve are cost, development cycle time, responsiveness to customer
preferences, product quality, technology, reliability and breadth of product line. We believe 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 seven U.S. patents and have thirteen U.S. patent applications pending relating to our technology. In addition, we have six
international patents and thirteen international patent applications pending. 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 these patents have significant value in protecting our technology, we also believe the innovative skill, technical expertise and the know-how of our
personnel in applying technology reflected in our patents would be difficult, costly and time consuming to reproduce.
While there are no pending lawsuits against us regarding 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.
11
Our Employees
On September 30, 2002, we had 110 employees, 48 of whom were in our manufacturing and assembly operations, 28 in research and development, 11 in quality, customer service
and field support, 11 in sales and 12 in general administrative and corporate positions.
Our future success
depends on our ability to attract, train and retain highly qualified personnel. We plan to hire additional personnel, including, 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.
None of our employees are
represented by a labor union.
Executive Officers of the Registrant
Following is a list of our executive officers, their ages and their positions:
| Name
|
|
Age
|
|
Position
|
| Geoffrey S. M. Hedrick |
|
60 |
|
Chairman of the Board and Chief Executive Officer |
| James J. Reilly |
|
62 |
|
Chief Financial Officer |
| Roger E. Mitchell |
|
48 |
|
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 holds a number of patents in the electronics, optoelectric, electromagnetic, aerospace and
contamination-control fields.
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 holds a Bachelor of Science degree and a Masters of Business Administration degree 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.
12
In fiscal 2001 we purchased 7 and 1/2 acres of land in the Eagleview Corporate Park
located in Exton, Pennsylvania, a suburb of Philadelphia. 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. Construction was funded with a Chester County Industrial Revenue Bond. The building serves as security for the Industrial Revenue Bond.
Item 3.
Legal Proceedings.
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.
13
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. Following are the high and low per share sale prices for our common stock for the periods indicated:
| |
|
Fiscal 2002
|
|
Fiscal 2001
|
| Period
|
|
High
|
|
Low
|
|
High
|
|
Low
|
| First Quarter |
|
$ |
9.00 |
|
$ |
4.26 |
|
$ |
20.00 |
|
$ |
12.50 |
| Second Quarter |
|
$ |
10.93 |
|
$ |
5.12 |
|
$ |
17.88 |
|
$ |
10.50 |
| Third Quarter |
|
$ |
10.70 |
|
$ |
7.05 |
|
$ |
14.95 |
|
$ |
11.45 |
| Fourth Quarter |
|
$ |
8.31 |
|
$ |
6.04 |
|
$ |
15.29 |
|
$ |
6.83 |
On December 2, 2002, there were 49 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.
Recent
Sales of Unregistered Securities
The Company issued 340,380 and 10,963 shares of common stock in fiscal year
2001 and 2002 upon exercise of employee stock options pursuant to Rule 701 under the Securities Act of 1933.
Equity Compensation Plan
Information
Following table is information about our common stock that may be issued upon exercise of
options, warrants and rights under all of our existing equity compensation plans and arrangements as of December 2, 2002, including the 1998 Stock Option Plan and the 1988 Stock Incentive 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)
|
| Equity compensation plans approved by security holders |
|
747,558 |
|
$ |
7.41 |
|
602,779 |
| Equity compensation plans not approved by security holders |
|
— |
|
$ |
— |
|
— |
| |
|
|
|
|
|
|
|
| Total |
|
747,558 |
|
$ |
7.41 |
|
602,779 |
| |
|
|
|
|
|
|
|
Each non-employee director who serves on the Board at the beginning of each fiscal year is
entitled to receive shares of common stock with a fair market value of $25,000, determined as of the first day of such fiscal year. The shares vest quarterly during the fiscal year, provided that the director is still serving on the board on the
date the shares are scheduled to vest. Each of our 6 non-employee directors received a grant of 3,496 shares of restricted stock on October 1, 2002. The restricted stock grants to the non-employee directors are not pursuant to the stock option plan
and have not been submitted to, and are not required to be submitted to stockholders for approval.
14
Item 6. Selected Financial Data.
You should read the data set forth below
together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and related notes appearing elsewhere herein.
| |
|
Fiscal Year Ended September 30,
|
|
| |
|
1998
|
|
1999
|
|
|
2000
|
|
|
2001
|
|
|
2002
|
|
| Statement of Operations Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Net Sales |
|
$ |
14,682,313 |
|
$ |
22,487,882 |
|
|
$ |
33,273,890 |
|
|
$ |
34,384,562 |
|
|
$ |
28,345,620 |
|
| Cost of sales |
|
|
8,480,549 |
|
|
10,570,009 |
|
|
|
14,819,043 |
|
|
|
14,477,868 |
|
|
|
11,290,085 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Gross profit |
|
|
6,201,764 |
|
|
11,917,873 |
|
|
|
18,454,847 |
|
|
|
19,906,694 |
|
|
|
17,055,535 |
|
| Research and development |
|
|
1,554,564 |
|
|
1,915,634 |
|
|
|
3,274,708 |
|
|
|
4,371,570 |
|
|
|
4,755,422 |
|
| Selling, general and administrative |
|
|
2,492,509 |
|
|
3,333,977 |
|
|
|
4,951,732 |
|
|
|
5,777,929 |
|
|
|
5,732,886 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Total operating expenses |
|
|
4,047,073 |
|
|
5,249,611 |
|
|
|
8,226,440 |
|
|
|
10,149,499 |
|
|
|
10,488,308 |
|
| Operating income |
|
|
2,154,691 |
|
|
6,668,262 |
|
|
|
10,228,407 |
|
|
|
9,757,195 |
|
|
|
6,567,227 |
|
| |