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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 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 23-2507402
-------------------------------------------------
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation)
720 Pennsylvania Drive, Exton, Pennsylvania 19341
----------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(610) 646-9800
--------------
(Registrant's telephone number, including area code)
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 [_]
As of August 9, 2002, there were 12,796,825 shares of the Registrant's Common
Stock, with par value of $.001, outstanding.
INNOVATIVE SOLUTIONS AND SUPPORT, INC.
FORM 10-Q JUNE 30, 2002
INDEX
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS (unaudited)
Condensed Consolidated Balance Sheets - September 30, 2001 and June 30, 2002 ............................ 3
Condensed Consolidated Statements of Operations - Three and Nine Months Ended June 30, 2001 and 2002 .... 4
Condensed Consolidated Statements of Cash Flows - Nine Months Ended June 30, 2001 and 2002 .............. 5
Notes to Condensed Consolidated Financial Statements .................................................... 6-7
Item 2. MANAGAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS ................................................................................. 7-12
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK .............................................. 13
PART II OTHER INFORMATION ....................................................................................... 13
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS ............................................................... 13
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ..................................................... 13
Item 6. EXHIBITS AND REPORTS ON FORM 8-K ........................................................................ 13
Signatures ......................................................................................................... 14
2
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
INNOVATIVE SOLUTIONS AND SUPPORT, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
September 30, June 30,
2001 2002
---- ----
ASSETS
Current Assets:
Cash and cash equivalents ..................................................... $ 42,769,837 $ 50,859,231
Cash restricted for capital expenditures ...................................... 317,465 -
Accounts receivable, less allowance for doubtful accounts of $100,000 at
September 30, 2001 and June 30, 2002, respectively ........................... 8,330,126 3,432,624
Inventories ................................................................... 5,701,673 4,188,446
Deferred income taxes ......................................................... 652,535 652,535
Prepaid expenses .............................................................. 1,386,270 630,535
------------ ------------
Total current assets ..................................................... 59,157,906 59,763,371
------------ ------------
Property and Equipment:
Computers and test equipment .................................................. 2,899,744 3,275,122
Corporate airplane ............................................................ 2,998,161 2,998,161
Furniture and office equipment ................................................ 422,288 517,128
Leasehold improvements ........................................................ 54,299 -
Manufacturing facility ........................................................ - 6,489,935
Construction in progress ...................................................... 3,949,298 -
------------ ------------
Total property and equipment ................................................ 10,323,790 13,280,346
Less-Accumulated depreciation and amortization ................................ (2,238,916) (2,818,380)
------------- ------------
Net property and equipment .................................................... 8,084,874 10,461,966
------------ ------------
Deposits and Other Assets ......................................................... 808,646 269,716
------------ ------------
Total Assets ............................................................... $ 68,051,426 $ 70,495,053
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Current portion of note payable ............................................... $ 100,000 $ 100,000
Current portion of capitalized lease obligations .............................. 15,696 16,220
Accounts payable .............................................................. 473,785 377,170
Accrued expenses .............................................................. 2,168,066 1,457,653
Accrued income taxes .......................................................... - 588,631
Deferred revenue .............................................................. 146,071 78,446
------------ ------------
Total current liabilities .............................................. 2,903,618 2,618,120
------------ ------------
Note Payable .................................................................... 4,235,000 4,235,000
------------ ------------
Capitalized Lease Obligations ................................................... 17,635 4,417
------------ ------------
Deferred Revenue ................................................................ 473,349 420,495
------------ ------------
Deferred Income Taxes ........................................................... 43,120 43,120
------------ ------------
Commitments and Contingencies
Shareholders' Equity:
Preferred stock, 10,000,000 shares authorized--Class A Convertible stock,
$.001 par value; 200,000 shares authorized, no shares issued and
outstanding at September 30, 2001 and June 30, 2002 .......................... - -
Common stock, $.001 par value; 75,000,000 shares authorized, 13,023,629
and 13,046,825 shares issued at September 30, 2001 and June 30, 2002,
respectively .................................................................. 13,024 13,047
Additional paid-in capital .................................................... 45,906,405 46,054,281
Retained earnings ............................................................. 14,459,275 18,356,573
Treasury stock, 250,000 shares at cost ........................................ - (1,250,000)
------------ ------------
Total shareholders' equity ............................................... 60,378,704 63,173,901
------------ ------------
Total Liabilities and Shareholders' Equity ................................. $ 68,051,426 $ 70,495,053
============ ============
The accompanying notes are an integral part of these statements.
3
INNOVATIVE SOLUTIONS AND SUPPORT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
June 30, 2001 June 30, 2002 June 30, 2001 June 30, 2002
------------- ------------- -------------- -------------
Revenues ......................................... $ 7,497,395 7,212,210 $ 26,714,375 $ 21,118,243
Cost of Sales .................................... 3,205,778 2,936,254 11,277,457 8,455,920
------------ ------------ ------------ ------------
Gross Profit ..................................... 4,291,617 4,275,956 15,436,918 12,662,323
------------ ------------ ------------ ------------
Research and Development ......................... 1,103,419 1,609,678 3,539,760 3,803,888
Selling, General and Administrative .............. 1,264,943 1,391,128 4,421,936 4,332,678
------------ ------------ ------------ ------------
Operating Income ................................. 1,923,255 1,275,150 7,475,222 4,525,757
Interest Income .................................. 592,206 215,268 1,802,288 646,609
Interest Expense ................................. -- 37,157 -- 97,292
------------ ------------ ------------ ------------
Income Before Income Taxes ....................... 2,515,461 1,453,261 9,277,510 5,075,074
Income Tax Expense (Benefit) ..................... 930,721 (162,293) 3,432,678 1,177,776
Net Income ....................................... $ 1,584,740 $ 1,615,554 $ 5,844,832 $ 3,897,298
============ ============ ============ ============
Net Income Per Common Share
Basic ........................................ $ 0.12 $ 0.13 $ 0.46 $ 0.30
Diluted ...................................... $ 0.12 $ 0.12 $ 0.44 $ 0.30
Weighted Average Shares Outstanding
Basic ........................................ 12,808,077 12,789,780 12,654,589 12,840,828
Diluted ...................................... 13,361,471 13,040,546 13,258,359 13,081,431
The accompanying notes are an integral part of these statements.
4
INNOVATIVE SOLUTIONS AND SUPPORT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
For the Nine Months For the Nine Months
Ended June 30, Ended June 30,
2001 2002
---- ----
Cash Flows From Operating Activities:
Net income ................................................................. $ 5,844,832 $ 3,897,298
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization .............................................. 469,514 648,885
Tax benefit of stock options exercised ..................................... (421,615) -
Loss on disposal of assets ................................................. - 35,720
Write off of capitalized certification costs ............................... - 711,195
Stock issued to directors .................................................. - 117,000
(Increase)/decrease in -
Accounts receivable ........................................................ (205,467) 4,897,502
Inventories ................................................................ (2,227,211) 1,513,227
Prepaid expenses and other ................................................. 124,137 560,471
Increase/(decrease) in -
Accounts payable ........................................................... (817,254) (96,615)
Accrued expenses ........................................................... (52,437) (114,883)
Deferred revenue ........................................................... 28,942 (120,482)
------------ ------------
Net cash provided by operating activities .................................. 2,743,441 12,049,318
------------ ------------
Cash Flows From Investing Activities:
Purchases of property and equipment ........................................ (3,668,739) (3,038,696)
Restricted cash ............................................................ (568,573) 317,465
------------ ------------
Net cash (used in) provided by investing activities ........................ (4,237,312) (2,721,231)
------------ ------------
Cash Flows From Financing Activities:
Repayments of capitalized lease obligations ................................ (14,024) (12,694)
Proceeds from the issuance of stock ........................................ 1,326,424 24,001
Purchase of treasury stock ................................................. - (1,250,000)
------------ ------------
Net cash (used in) provided by financing activities ........................ 1,312,400 (1,238,693)
------------ ------------
Net Increase (Decrease) In Cash and Cash Equivalents ........................... (181,471) 8,089,394
Cash and Cash Equivalents, Beginning of Year ................................... 42,799,122 42,769,837
------------ ------------
Cash and Cash Equivalents, End of Period ....................................... $ 42,617,651 $ 50,859,231
============ ============
The accompanying notes are an integral part of these statements.
5
1. Basis of Presentation:
Innovative Solutions and Support, Inc., (the "Company"), was incorporated in
Pennsylvania on February 12, 1988. The Company's primary business is the design,
manufacture and sale of flight information computers, electronic displays and
advanced monitoring systems to the military, government, commercial air
transport and corporate aviation markets.
The balance sheet as of June 30, 2002, the statements of operations for the
three months and nine months ended June 30, 2001 and 2002 and the statements of
cash flows for nine months ended June 30, 2001 and 2002 have been prepared by
the Company without audit. In the opinion of management, all adjustments,
consisting of normal and recurring adjustments, necessary to present fairly the
financial position, results of operations and cash flows at June 30, 2002 and
for all periods presented have been made.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
in the United States have been condensed or omitted. It is suggested that these
financial statements be read in conjunction with the financial statements and
notes thereto included in the Company's Form 10K for the year ended September
30, 2001 as filed with the Securities and Exchange Commission. The results of
operations for the three months and nine months ended June 30, 2002 are not
necessarily indicative of the operating results for the full year.
2. Initial Public Offering and Treasury Stock
In August 2000, the Company completed its initial public offering of 3,450,000
shares of Common Stock at a price of $11.00 per share. The Company received net
proceeds of approximately $34 million from the offering. Upon the closing of the
offering, the outstanding shares of Preferred stock were converted into
1,941,353 shares of Common stock. In December, 2001, the Company purchased
250,000 shares at a cost of $1,250,000.
3. Net income per Share
Net income per share ("EPS") is calculated using the principles of SFAS No. 128.
On July 7, 2000, the Company's Board of Directors approved a split of the
Company's common shares on a 1.09624-to-1 basis. All references in the financial
statements to the number of common shares and to per share amounts have been
retroactively stated to reflect the common share split.
A reconciliation of weighted average shares outstanding appears below:
Three months ended Nine months ended
June 30, June 30,
-------- --------
2001 2002 2001 2002
---- ---- ---- ----
Weighted average shares outstanding:
Basic ................................................. 12,808,077 12,789,780 12,654,589 12,840,828
Potentially dilutive securities:
Employee Stock Options ................................ 309,499 43,382 359,875 42,023
Warrants .............................................. 243,895 207,384 243,895 198,580
---------- ---------- ---------- ----------
Weighted average shares outstanding:
Diluted ............................................... 13,361,471 13,040,546 13,258,359 13,081,431
========== ========== ========== ==========
The weighted average number of shares for potentially antidilutive employee
stock options was 381,030 as of June 30, 2002.
6
4. Concentrations
During the three months and nine months ended June 30, 2002 and 2001, the
Company derived 10% and 71%, respectively and 48% and 63%, respectively of its
revenues from one customer. Accounts receivable related to this customer totaled
$0 at June 30, 2002. The Company's supply arrangement with this customer was
completed in the third quarter of fiscal 2002. During the three months and nine
months ended June 30, 2002 the company delivered 33% and 11%, respectively, of
its revenue to one new customer. If new supply arrangements with other customers
are not realized the company may experience a significant reduction in sales.
This result may have a material adverse effect on the company's operating
results and financial condition.
5. Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market and
consist of the following:
September 30, June 30,
2001 2002
-----------------------------
Raw materials .............................. $3,380,431 $2,978,213
Work-in-process ............................ 1,661,000 679,202
Finished goods ............................. 660,242 531,031
---------- ----------
$5,701,673 $4,188,446
========== ==========
6. Open - Market Stock Repurchase Program
On June 6, 2002, the board of directors authorized an open-market stock
repurchase program of up to 2,000,000 shares of its common stock. There have
been no shares purchased under this plan.
7. Certification Costs
The Company wrote off $711,000 of capitalized certification costs that was
incurred in prior periods and carried as an intangible asset supporting Flat
Panel certification on the Pilatus airplane. The decision to change our initial
launch aircraft from a Pilatus PC-12 to a Boeing 737 necessitated recognizing
this charge at this time.
8. Research and Development Tax Credits
The company recognized $700,000 in research and development tax credits.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
We design, manufacture and sell flight information computers, electronic
displays and advanced monitoring systems to the military, government, commercial
air transport and corporate aviation markets.
Our revenues are derived from the sale of our products to the retrofit market
and, to a lesser extent, original equipment manufacturers (OEMs). Our customers
include government and military entities and their commercial contractors,
aircraft operators, aircraft modification centers and various OEMs. Although we
occasionally sell our products directly to government entities, we primarily
have sold our products to commercial customers for end use in government and
military programs. These sales to commercial contractors are on commercial
terms, although some of the termination and other provisions of government
contracts are applicable to these contracts.
We record revenues when our products are shipped. Since fiscal year 1998, the
majority of our revenues have come from the sale of Reduced Vertical Separation
Minimum (RVSM) compliant air data systems, including sales to commercial
contractors in connection with the United States Air Force KC-135 retrofit
program. We are the sole supplier of these systems and components under
subcontracts with various commercial contractors for the retrofit program, which
covers the approximately 600 KC-135 aircraft currently in use. With the
exception of spare part and on-going repair effort, the Company's existing
supply arrangement with this customer was completed in the quarter ended June
30, 2002. As a result, the Company may experience a significant reduction in net
sales should supply arrangements with other potential customers not be realized.
This result may have a material adverse effect on the Company's operating
results and financial condition.
7
We have recently begun marketing our flat panel display system, or Cockpit
Information Portal (CIP), and are in the process of obtaining the required
certifications. We expect to begin recording revenues from our flat panel
display in the first half of fiscal year 2003.
Our cost of sales are comprised of material components purchased through our
supplier base and direct in-house assembly labor and overhead costs. Because our
manufacturing activities consist primarily of assembling and testing components
and subassemblies and integrating them into a finished system, we believe that
we can achieve flexible manufacturing capacity while controlling overhead
expenses. In addition, 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 services costs
related to our production, purchasing, material control and quality departments
as well as warranty costs.
We intend to continue to invest in the development of new products and the
enhancement of our existing product line. We expense research and development
costs related to future product development as they are incurred.
Our selling, general and administrative expenses consist of marketing and
business development expenses, professional expenses, salaries and benefits for
executive and administrative personnel, facility costs, and recruiting, legal,
accounting and other general corporate expenses.
Nine Months Ended June 30, 2002 Compared to the Nine Months Ended June 30, 2001
Revenues. Revenues decreased $5.6 million, or 21%, to $21.1 million for the nine
months ended June 30, 2002 from $26.7 million in the nine months ended June 30,
2001. The decrease was primarily attributable to the economic slowdown that
curtailed commercial air transport orders coupled with a decline in deliveries
for the KC-135 program. We recognized $10.2 million in revenues related to the
KC-135 program in the first nine months of fiscal 2002 and $16.9 million in the
first nine months of fiscal 2001. The KC-135 program was completed, with the
exception of on going-spare part and repair support, in the third quarter of
fiscal 2002.
Cost of sales. Cost of sales decreased $2.8 million, or 25%, to $8.5 million, or
40.0% of revenues, in the nine months ended June 30, 2002 from $11.3 million, or
42.2% of revenues, in the nine months ended June 30, 2001. The decrease in
dollar amount of cost of sales was related to our decrease in revenues, and the
decrease as a percentage of revenues was primarily related to a higher
concentration of mature program deliveries.
Research and development. Research and development expense increased $264,000 or
8%, to $3.8 million or 18.0% of revenues, in the nine months ended June 30, 2002
from $3.5 million or 13.3% of revenues, in the nine months ended June 30, 2001.
The increase in research and development spending was a result of expensing
$711,000 of certification cost that was incurred in prior periods and carried as
an intangible asset supporting Flat Panel certification on the Pilatus airplane.
The decision to change our initial launch aircraft from a Pilatus PC-12 to a
Boeing 737 necessitated recognizing this charge at this time. Research and
development spending in the nine months ended June 30, 2002, excluding the
$711,000, amounted to $3.1 million or 14.6% of revenue and was a decrease from
the prior nine month period ended June 30, 2001 of $447,000 or 12.6%. At this
level, the reduced spending was a result of lower recruiting cost and reduced
contract labor cost on selected development programs. As a percentage of
revenue, research and development expense decreased for the same reasons.
Selling, general and administrative. Selling, general and administrative
expenses decreased $89,000, or 2%, to $4.3 million, or 20.5% of revenues, in the
nine months ended June 30, 2002 from $4.4 million or 16.6% of revenues, in the
nine months ended June 30, 2001. The decrease in dollar amount was a result of
reduced outside services and the increase as a percentage of revenue was due to
lower revenues in the period.
Interest income. Interest income was $647,000 in the nine months ended June 30,
2002 as compared to interest income of $1.8 million in the nine months ended
June 30, 2001. The decreased interest income in the nine months ended June 30,
2002 was primarily the result of lower interest rates in the period.
Interest expense. Interest expense was $97,000 in the nine months ended June 30,
2002 as compared to $0 in the nine months ended June 30, 2001. The increase was
due to the fact that interest is no longer being capitalized as part of the cost
of the company's new manufacturing facility. The facility was placed into
service in November 2001.
Income tax expense. We recognized an income tax expense of $1.2 million for an
effective rate of 23.2% for the nine months ended June 30, 2002. In the nine
months ended June 30, 2001 we recorded a tax expense $3.4 million for an
effective rate of 37%. The decreased effective tax rate is due to the company
recognizing a research and development tax credit of $700,000 in the
8
three-month period ended June 30, 2002. Without the benefit of this tax credit
the effective tax rate would have remained unchanged period over period.
Net income. As a result of the factors described above, our net income decreased
$1.9 million or 33%, to $3.9 million, or 18% of revenues.
Three Months Ended June 30, 2002 Compared to the Three Months Ended June 30,
2001
Revenues. Revenues decreased $285,000, or 4%, to $7.2 million for the three
months ended June 30, 2002 from $7.5 million in the three months ended June 30,
2001. The decrease in revenue was primarily the result of a $4.6 million decline
in deliveries for the KC-135 program that was mostly offset with additional new
business deliveries. We recognized $0.7 million in revenues related to the
KC-135 program in the third quarter of fiscal 2002 and $5.3 million in the third
quarter of fiscal 2001.
Cost of Sales. Cost of sales decreased $270,000, or 8%, to $2.9 million, or
40.7% of revenues, in the three months ended June 30, 2002 from $3.2 million, or
42.8% of revenues, in the three months ended June 30, 2001 The decrease in
dollar amount of cost of sales was related to our decrease in revenues as well
as improved margins. As a percentage of revenue, cost of sales improved from
42.8% in the three months ended June 30, 2001 to 40.7% in the three months ended
June 30, 2002. The improvement reflected lower direct labor and material costs.
Research and development. Research and development expense increased $507,000 or
46%, to $1.6 million or 22.3% of revenues, in the three months ended June 30,
2002 from $1.1 million or 14.7% of revenues, in the three months ended June 30,
2001. The increase in research and development spending was a result of
expensing $711,000 of certification cost that was incurred in prior periods and
carried as an intangible asset supporting Flat Panel certification on the
Pilatus airplane. The decision to change our initial launch aircraft from a
Pilatus PC-12 to a Boeing 737 necessitated recognizing this charge at this time.
Research and development spending in the three months ended June 30, 2002,
excluding the $711,000, amounted to $0.9 million or 12.5% of revenue and was a
decrease from the prior three month period ended June 30, 2001of $204,000 or
18.5%. At this level the reduced spending was the result of both lower
recruiting cost and contract labor spending on selected development programs. As
a percentage of revenue, research and development expense decreased for the same
reasons.
Selling, general and administrative. Selling, general and administrative
expenses increased $126,000, or 10%, to $1.4 million, or 19.3% of revenues, in
the three months ended June 30, 2002 from $1.3 million or 16.9% of revenues, in
the three months ended June 30, 2001. Both the increase in dollar amount and
increase in percent of revenue were the result of increases in insurance, travel
and commission expenses.
Interest income. Interest income was $215,000 in the three months ended June 30,
2002 as compared to interest income of $592,000 in the three months ended June
30, 2001. The decreased interest income in the three months ended June 30, 2002
was primarily the result of lower interest rates in the period.
Interest expense. Interest expense was $37,000 in the three months ended June
30, 2002 as compared to $0 in the three months ended June 30, 2001. The increase
was due to the fact that interest is no longer being capitalized as part of the
cost of the company's new manufacturing facility. The facility was placed into
service in November 2001.
Income tax expense. We recognized an income tax benefit of $162,000 in the three
months ended June 30, 2002. In the three months ended June 30, 2001 we recorded
a tax expense $931,000 for an effective rate of 37%. The income tax benefit in
the quarter was due to recording a research and development tax credit of
$700,000 in the three months ended June 30, 2002. Without the benefit of this
tax credit the effective tax rate would have remained unchanged at 37% period
over period.
Net income. As a result of the factors described above, our net income increased
$31,000 or 2%, to $1.6 million, or 22.4% of revenues.
Liquidity and Capital Resources
Our main sources of liquidity have been cash flows from operations, borrowings
and the proceeds of our initial public offering in August 2000. We require cash
principally to finance inventory, accounts receivable and payroll.
Our cash flow provided from operating activities was $12.0 million for the nine
months ended June 30, 2002 as compared to $2.7 million for the nine months ended
June 30, 2001. The increase was mainly the result of a $5.1 million improvement
in accounts receivable and a $3.7 million improvement in inventory that more
than offset $2.0 million in lower net income.
9
Our cash used in investing activities was $2.7 million for the nine months ended
June 30, 2002 as compared to $4.2 million for the nine months ended June 30,
2001. The increase in the nine months ended June 30, 2002 was primarily due to
the Company's completion of its new manufacturing facility.
Net cash flow used in financing activities was $1.2 million for the nine months
ended June 30, 2002 as compared to $1.3 million of cash flow received from
financing activities for the nine months ended June 30, 2001. This use of cash
in the period ended June 30, 2002 was primarily due to the acquisition of
250,000 shares of treasury stock at a cost of $5 per share.
Our future capital requirements depend on numerous factors, including market
acceptance of our products, the timing and rate of expansion of our business and
other factors. We have experienced increases in our expenditures since our
inception consistent with growth in our operations, personnel and product line,
and we anticipate that our expenditures will continue to increase in the
foreseeable future. We believe that our cash and cash equivalents, together with
the net proceeds from our initial public offering will provide sufficient
capital to fund our operations for at least the next twelve months. However, we
may need to raise additional funds through public or private financings or other
arrangements in order to support more rapid expansion of our business than we
anticipate, develop and introduce new or enhanced products, respond to
competitive pressures, invest in or acquire businesses or technologies or
respond to unanticipated requirements or developments. If additional funds are
raised through the issuance of equity securities, dilution to existing
shareholders may result. If insufficient funds are available, we may not be able
to introduce new products or compete effectively in any of our markets, which
could hurt our business.
Significant Accounting Policies
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amount of revenues and expenses during the reporting period. The most
significant estimates and assumptions relate to our allowance for doubtful
accounts, inventory reserves and warranty reserves.
We maintain an allowance for doubtful accounts for customer returns and for
estimated losses resulting from the inability of our customers to make required
payments. These allowances are determined by analyzing historical data and
trends. If actual losses are greater than estimated amounts or if the financial
condition of our customers were to deteriorate, resulting in an impairment of
their ability to make payments, future results from operations could be
adversely affected.
Inventories are written down for estimated obsolescence equal to the difference
between the cost of inventory and the estimated net realizable value based upon
assumptions about future market conditions. If actual future demand or market
conditions are less favorable than those projected by management, additional
inventory write-downs may be required.
We offer warranties on some products of various lengths. At the time of
shipment, we establish a reserve for the estimated cost of warranties based on
our best estimate of the amounts necessary to settle future and existing claims
using historical data on products sold as of the balance sheet date. The cost of
warranties is affected by the length of the warranty, the product's failure
rates and the customer's usage. If the actual cost of warranties differs from
our estimated amounts, future results of operations could be adversely affected.
RISK FACTORS
This report includes a number of forward-looking statements that reflect our
current views with respect to future events and financial performance. We use
words such as anticipates, believes, expects, future, and intends, and similar
expressions to identify forward-looking statements. There are important factors
that could cause actual results to differ materially from those expressed or
implied by such forward-looking statements, including:
- most of our sales are air data systems products, and we cannot be
certain that the market will continue to accept these or our other
products.
- we currently have a limited number of customers that use our products,
primarily for government-related contracts, making us reliant on these
customers and government needs.
10
- our business derived a large portion of its revenues from one military
retrofit program, which was substantially completed in the third quarter
of fiscal 2002.
- the growth of our customer base could be limited by delays or
difficulties in completing the development and introduction of our
cockpit information portal (CIP) or other planned products or product
enhancements.
- we rely on third party suppliers for the components of our air data
systems products, and any interruption in the supply of these components
could hinder our ability to deliver our products.
- our market in general and our customers have been adversely affected
by the events of September 11th.
- our government retrofit projects allow the government agency or
government contractor to terminate or modify their contracts with us.
- we depend on our key personnel to manage our business effectively, and
if we are unable to retain our key employees, our ability to compete
could be harmed.
- our revenue and operating results may vary significantly from quarter
to quarter, which may cause our stock price to decline.
- our revenues and operating results may vary significantly from quarter
to quarter due to a number of factors, including:
- variations in demand for our products;
- the timing of the introduction of RVSM requirements on various
flight routes;
- the capital expenditure budgets of aircraft owners and operators and
the appropriation cycles of the U.S. government;
- changes in the use of our products, including non-RVSM air data
systems, RVSM systems and flat panel displays;
- delays in introducing or obtaining government approval for new
products;
- new product introductions by competitors;
- changes in our pricing policies or the pricing policies of our
competitors; and
- costs related to possible acquisitions of technologies or
businesses.
- our inability to replace the KC-135 RVSM contract.
- our competition includes other manufacturers of air data systems and
flight information displays against whom we may not be able to compete
successfully.
- we may not be able to identify or complete acquisitions or we may
consummate an acquisition that adversely affects our operating results.
- our success depends on our ability to protect our proprietary rights,
and there is a risk of infringement. If we are unable to protect and
enforce our intellectual property rights, we may be unable to compete
effectively.
Risks Related to Our Industry
If we are unable to respond to rapid technological change, our products
could become obsolete and our reputation could suffer.
Future generations of air data systems, engine and fuel displays and
flat panel displays embodying new technologies or new industry standards
could render our products obsolete. The market for aviation products is
subject to rapid technological change, new product introductions,
changes in customer preferences and evolving industry standards. Our
future success will depend on our ability to:
- adapt to rapidly changing technologies;
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. adapt our products to evolving industry standards; and
. develop and introduce a variety of new products and product
enhancements to address the increasingly sophisticated needs of our
customers.
Our future success will also depend on our developing high quality,
cost-effective products and enhancements to our products that satisfy
the needs of our customers and on our introducing these new technologies
to the marketplace in a timely manner. If we fail to modify or improve
our products in response to evolving industry standards, our products
could rapidly become obsolete.
Our products must obtain government approval
Our products are currently subject to direct regulation by the U.S.
Federal Aviation Authority (FAA), its European counterpart, the Joint
Aviation Authorities (JAA), and other comparable organizations. Our
products and many of their components must be approved by the FAA, the
JAA or other comparable organizations before they can be used in an
aircraft. To be certified, we must demonstrate that our products are
accurate and able to maintain certain levels of repeatability over time.
Although the certification requirements of the FAA and the JAA are
substantially similar, there is no formal reciprocity between the two
systems. Accordingly, even though some of our products are FAA-approved,
we may need to obtain approval from the JAA or other appropriate
organizations to have them certified for installation outside the United
States.
Significant delay in receiving certification for newly developed products or
enhancements to our products or losing certification for our existing products
could result in lost sales or delays in sales. Furthermore, the adoption of
additional regulations or product standards, as well as changes to the existing
product standards, could require us to change our products and underlying
technology. Some products, from which we expect to generate significant future
revenues, including our CIP, have not received regulatory approval. We cannot
assure you that we will receive regulatory approval on a timely basis or at all.
Because our products utilize sophisticated technology and are deployed in
complex aircraft cockpit environments, problems with these products may arise
that could seriously harm our reputation for quality assurance and our business.
Our products use complex system designs and components that may contain errors,
omissions or defects, particularly when we incorporate new technologies into our
products or we release new versions or enhancements of our products. Despite our
quality assurance process, errors, omissions or defects could occur in our
current products, in new products or in new versions or enhancements of existing
products after commercial shipment has begun. We may be required to redesign or
recall those products or pay damages. Such an event could result in the
following:
. the delay or loss of revenues;
. the cancellation of customer contracts;
. the diversion of development resources;
. damage to our reputation;
. increased service and warranty costs; or
. litigation costs.
Although we currently carry product liability insurance, this insurance may not
be adequate to cover our losses in the event of a product liability claim.
Moreover, we may not be able to maintain such insurance in the future.
We face risks associated with international operations that could cause our
financial results to suffer or make it difficult to market our products outside
of the United States.
We expect to derive an increasing amount of our revenues from sales outside the
United States, particularly in Europe. We have limited experience in marketing
and distributing our products internationally. In addition, there are certain
risks inherent in doing business on an international basis, such as:
. differing regulatory requirements for products being installed in
aircraft;
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. legal uncertainty regarding liability;
. tariffs, trade barriers and other regulatory barriers;
. political and economic instability;
. changes in diplomatic and trade relationships;
. potentially adverse tax consequences;
. the impact of recessions in economies outside the United States; and
. variance and unexpected changes in local laws and regulations.
Currently, all of our international sales are denominated in U.S. dollars.
An increase in the value of the dollar compared to other currencies could make
our products less competitive in foreign markets. In the future, we may conduct
sales in local currencies, exposing us to changes in exchange rates that could
adversely affect our results of operations.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's operations are exposed to market risks primarily as a result of
changes in interest rates. The Company does not use derivative financial
instruments for speculative or trading purposes. The Company's exposure to
market risk for changes in interest rates relates to its cash equivalents and an
industrial revenue bond. The Company's cash equivalents consist of funds
invested in money market accounts, which bear interest at a variable rate, while
the industrial revenue bond carries an interest rate that is consistent with 30-
day tax-exempt commercial paper. As the interest rates are variable, and we do
not engage in hedging activities, a change in interest rates earned on the cash
equivalents or paid on the industrial revenue bond would impact interest income
and expense along with cash flows, but would not impact the fair market value of
the related underlying instruments.
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds.
None.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K.
The Company filed a Form 8-K on April 10, 2002 disclosing that the Company had
dismissed its independent accountants Arthur Andersen LLP.
The Company filed a Form 8-K on April 16, 2002 announcing that Deloitte and
Touche LLP had been retained as the Company's independent accountants pursuant
to authorization of the Company's board of directors and audit committee.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INNOVATIVE SOLUTIONS & SUPPORT, INC.
Date: August 13, 2002 By: /s/ James J. Reilly
-------------------
James J. Reilly
Chief Financial Officer
(Principal Financial Officer)
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