Innovative Solutions and Support Inc (ISSC) 2005 Q3 法說會逐字稿

Good morning and welcome to the Innovative Solutions and Support third quarter YTD sales and earnings call.

(OPERATOR INSTRUCTIONS.)

It is now my pleasure to turn the floor over to your host, Geoffrey Hedrick. Sir, you may begin.

Good morning. This is Geoff Hedrick and I'm Chairman and Chief Executive of Innovative Solutions and Support, and welcome you to the conference call this morning where, in a few minutes, I’ll discuss the third quarter and YTD results for the period ending June 30, 2005.

Joining me for the call in our corporate offices in Exton is Roman Ptakowski, our President, and Jim Reilly, our CFO.

Before we get started, I want Jim to read the conference call Safe Harbor message. And after that, I'll make a brief statement regarding the financial results for the quarter and YTD periods, and discuss the outlook for the fourth quarter.

Jim, would you please read our Safe Harbor message?

Thanks, Geoff, and thank you all for being on the call this morning.

Certain matters discussed in this conference call, including operating and financial results for future periods, are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially, either better or worse than those discussed, including other risks and uncertainties reflected in the Company's form 10-K annual report on file with the SEC.

Geoff, back to you.

Thanks, Jim. First, I’d like to remind everyone that all the numbers we discuss reflect our recent 3 for 2 common stock split, and that became effective July 8th.

As anticipated, we had another fine quarter. It was in line with the analysts’ revenue expectations and exceeded the EPS by a penny. The YTD period was great as well. In the third quarter we had sales of $17.1 million, ahead of last year by $4.8 million, 39%. Gross margins about 66% versus 67% last year. Net income of $4.9 million, ahead of last year by $1.6, or 49% over last year. And fully diluted EPS of $0.27, ahead of last year by $0.09 or 50%.

And the results for the nine months ending June 30th are as follows. A record YTD sales of $55.1 million, ahead of last year by $23.4, or 74% increase. Gross margins of 68% versus 65% last year. Record net income of $17.4 million, ahead of last year by almost $10 million, or 132%. And record fully diluted EPS of $0.95, ahead of last year by $0.53, or 126% over last year. And a record cash flow of $17.4 million with a backlog of $13.7 million.

The company continues to have a solid balance sheet. Cash on hand is now $83.2 million or $4.53 per share. This is the 3 for 2 split shares. Assets are over $106 million, and stockholder equity is now $96 million, or 91% of the total assets.

Looking into the future, we show double-digit revenue and earnings growth. And this concludes my remarks for the quarter and the YTD. And now, I’d like to address the fourth quarter, how it’s shaping up, and what the total of the year will look like.

In the past three quarters, we’ve experienced a strong demand for Air Data equipment as mandatory compliance date of January 20th, 2005 for reduced vertical separation passed. As we expected, demand for Air Data equipment continues well beyond the compliance date because of the over 3,500 domestic RVSM installations yet to do. According to the January 10th article in AvWeek, only about 6,000 or 62% of the eligible fleet has been outfitted.

As a result of the RVSM opportunities described above, third quarter results were supported by continued demand of RVSM products, well after the mandatory implementation date. This contributed a record sales and record EPS of $55 million and $0.95 per share, respectively, for the YTD results.

Also as expected, the third quarter reflected diverse orders for Flat Panel products that provide optimism for a strong transition into FY’06. While the Company backlog is lower than it has been, it does not reflect a change in our outlook or our prospects. We have said before that the backlog would fall for an interim period as we accommodated, one, peak demand for RVSM, our short cycle delivery -- that is our lead times are down to under three months now -- and our conversion to predominantly Flat Panel business. We expect the Flat Panel business to represent more than 50% of our ongoing business and it will continue to expand.

We see the market for just the equipment that we are now presently bidding and aggressively attacking as being more than double the size of the RVSM market we just finished addressing; and therefore, are very optimistic about the future. The Company was able to satisfy the peak demand for RVSM retrofit and we stepped up -- remarkably stepped up our production rates to accommodate that demand.

Although our current backlog now reflects a modest $13 million, we expect the backlog to recover as we gain new orders for Flat Panel systems, and as our distribution and our supply chain uses up their inventory that they ordered in expectation of the demand and we start to replenish that supply chain, so that we see a forward look of increased RVSM, or Air Data business, not only for RVSM, but for a broad range of retrofit products. In addition, South America has not made RVSM mandatory yet. They will in 2006, and we continue to see a growing demand there as well.

Our Flat Panel business, however, is paramount to understanding our confidence in the continued growth of the Company. The recent activity in Flat Panel orders and FAA TSO approval to the latest safety guidance strengthens our position for a robust product demand in the military, commercial, corporate and general aviation marketplace.

On June 13th, we announced our Flat Panel selection with the Royal Netherlands Air Force KC-10 cockpit update. In addition, on June 13th, we announced the Company had teamed with ABX Air to certify and upgrade their 767s and provide a 767 upgrade solution for the fleet of 767s and 57s, which is almost 2,000 aircraft. ABX Air will be an installer, a trainer, and a distributor for our 767 flight deck.

This past December we announced a C-130 retrofit award with Lockheed Martin. We also received an engine instrument Flat Panel Display order with Bar Aerospace for installation of our Flat Panels on the New Zealand Air Force C-130s.

Recently, we -- we’ll announce the selection by Marshall’s of Cambridge, a well-known installer, especially on C-130s, for a broad range of European retrofits, our selection as a standard configuration cockpit upgrade for Flat Panels. They will offer us on a variety of aircraft and they have selected us as the preferred solution. This recent selection provides yet another distribution channel for our equipment in a very large market.

We refer to these momentum orders because they position IS&S as a systems integrator, whose capability provides the Company with the potential to generate more substantive orders over a diverse product base. While the initial orders are limited in their breadth of installation, they provide a basis for retrofitted fleets on the KC-10, 767s, 757s, KC-135s and C-130s.

There’s great potential in both the KC-135s and 767s. We have a number of international customers in late stage evaluation that will yield new orders before the end of this year. We see Flat Panel demand building as we expand our customer base. Our Flat Panel IP information portal flight deck system is compact, lightweight and TSOs most importantly to the latest FAA air-worthiness circular guidance. This allows the system to be easily installed, retrofitted and certified in a broad range of aircraft types. Weight savings of more than 200 pounds provides significant fuel savings and dramatically increases dispatcher reliability.

Our cockpit IP is offered at a price point that makes it attractive, not only to air transport and military applications, but in general aviation applications, as well as light twins and high performance singles. We are aggressively pursuing the general aviation market, too, and have targeted King Air’s Gulfstreams, Lear jets, Falcons and Citation. For all of these, we have solutions in hand for Flat Panel retrofits, and we are now in discussions with retrofit service providers who can buy and install our products. We anticipate this will be a significant source of orders and revenue in FY 2006.

We believe that the total market for the Flat Panels systems that we presently have configured is approximately $1 billion. This represents more than double the size of the market we faced in RVSM, and we see in every case that market expanding. Keep in mind, however, that our business fluctuates through the nature of our customer base and the fact that this is a very aggressive and very steep growth curve. On balance, we expect to make steady improvement across the board in all of our markets.

Guidance. Year-to-date revenue of $55.1 million and EPS of $0.95. The fourth quarter revenue is expected to be within a range of $13 to $15 million. There are a couple of swing programs that leaves us with some uncertainty, not in the opportunity itself, but rather the timing. In each case, these are timing issues, not total business potential issues.

Fourth quarter EPS will be in a range of $0.17 to $0.23 and, as a result, the revenue for the year will be $68 to $70 million, which is in excess of what we initially expected for the year. And at the low end, represents a 54% growth year-over-year, or $27 million over Fiscal 2004. EPS for the year on a fully diluted basis will be between $1.12 and $1.18. At the low end of this range, the growth over last year, 2004, is also significant, up 67% or $0.45 a share. We continue to see the opportunity for double-digit growth.

And I will turn it over to questions now.

+++ q-and-a.

(OPERATOR INSTRUCTIONS.) Ali Motened of BP.

Hi. I was wondering, when you look at the decline in the backlog and the revenue you recognized, it looks like you booked only about $1 million in new business over the course of the quarter. I mean, backlog went from high 29s -- or 29-ish to 13, which is a 16 decrease, and you booked a little over 17 in revenues. How much confidence, I guess, do you have in these fourth quarter projections you have based on that? And how fast do you see that order book increasing?

Well, we have strong confidence in our fourth quarter. As you know, we booked a massive amount of business in the front end on RVSM. And what -- we have seen the reflection of that large [bowel wave] is supply chain being restabilized, that is using up the backlog, the inventory -- the installers have had for RVSM and, therefore, a slacking in orders for the RVSM. And in one case, actually a reduction of almost $1 million in orders.

A second point is that we announced the KC-10 selection by Boeing, but we did not book any revenue for that in our backlog because we don’t have a firm order defined yet. And that’s true in a couple other programs where we have been notified we have been selected. In some cases we’ve announced it, in some cases we have not. But we have not booked it into the backlog because we don’t have the firm purchase order. The purchase order is in negotiation.

We have letters of intent, but we don’t have a firm purchase order, and we only put numbers in backlog that are subject to firm purchase orders.

And how do you see the revenue breakdown coming? Because I guess the Street analysts are expecting the RVSM to continue at a relatively strong rate, sort of in the $13 million rate just for the fourth quarter. The backlog maybe doesn’t suggest that. What are you seeing with Flat Panel and sort of what are you seeing as that breakdown?

We see an opportunity for the Flat Panel to grow almost faster than we had expected. And it’ll take some time for the supply chain to stabilize out. As I reflected before that there were significant orders in anticipation of their orders. And they want to get orders in to make sure that they would be capable of delivering any possible demand. Got concerned about not being able to get product.

That will stabilize out. We’ve talked to our distribution people. They see -- their inventory’s adequate to support the demand, certainly for the next several months. But we believe that that will stabilize out and we’ll see a resurgence again.

On the fourth quarter itself, we expect right now about close to 45% of that backlog’s in Flat Panel right now. So, we see a good strong Flat Panel business. We’re driving that and we expect to see some resurgence in -- continued new orders in the Flat Panel -- I’m sorry, in the RVSM.

So, we would say that probably two-thirds of the business will still be Air Data business, maybe Flat Panel and -- I’m sorry, maybe RVSM, but definitely Air Data. And roughly a third of the remaining shipments in that quarter we expect to be Flat Panel, which is consistent with what our plans and hopes were.

David Campbell of Thompson Davis & Company.

Yes, Geoff, can you explain in a little bit more detail the recent decision you announced. You talked about the FAA, which improves the cockpit IP installation or something, making it more attractive for more customers. Could you explain all that, please?

Yes, I will. As I mentioned, we received actually a TSO on the Flat Panel itself. But importantly, there is new guidance from the FAA, an advisory circular, concerning complex integrated circuits and commercial graphics chips and microprocessors. For years, there’s been an ongoing interest in trying to understand what standards you must maintain to assure integrity and, therefore, FAA approval.

The FAA has recently provided guidance and clarification. And one of the things they’ve addressed is the use of commercial graphics processors in display systems. We use that. The advisory circular has suggested or says that commercial graphics chips require some integrity processing to assure the integrity that had previously been demanded of the custom made chips that suppliers like Collins have routinely done on their own. Collins has, as an example, produced their own custom integrated circuit and provided the very rigorous DO-254 standards. And the FAA is saying microprocessors have the ability to self check themselves. Commercial graphics chips do not appear to have it and they require special checking.

IS&S has developed and certified with the FAA an independent integrity processor that, to our knowledge, is the only people that have that. And the FAA has just issued us a TSO, noting that we contain -- our system has that compliant integrity processing that allows us to use the very highly flexible and highly advanced commercial graphics chip. So, it gives us a huge advantage in both cost and performance and maintains the quality of integrity that’s essential that the FAA requires for this kind of equipment.

OK. And also, could you go into a little bit more detail about the Marshall’s business that you say you will be announcing. That’s I assume part of your optimism for 2006 rather than the fourth quarter.

Right. Marshall’s of Cambridge is a very well known mod center that does a lot of C-130 work and a lot of European work, including the Netherlands Air Force and the Royal Air Force, British Royal Air Force, and worldwide, especially C-130 retrofits.

They had a competition to select a standard offering, a configuration, Flat Panel configuration for a variety of aircraft, including C-130s, 737s and KC-10s and large transport aircraft. They have a couple of -- several customers that have inquired about Flat Panel upgrades.

Flat Panel upgrades have seen a huge amount of interest lately because the price point has changed profoundly. Traditionally, it had been up and around $1.5 million, $1 to $1.5 million. It’s now a third or a quarter of that. And it provides an incredibly attractive alternative to the maintenance of the steam gauges, maintenance of the -- much of the equipment in flying commercial aircraft is basically unsupportable. Integrated circuits and components are no longer available that you can support them.

So, people are moving strongly into Flat Panels. And the thing that kept them out was the cost. The cost of our system is now very, very competitive and provides a significant improvement.

Marshall’s has seen an upsurgence in demand for a Flat Panel solutions and they needed to come up with a standard configuration they could readily offer to a broad range of their customers and selected us to provide that--.

--Common core architecture.

Common core architecture, which is I guess six Flat Panel Displays and a series of interfaced computers. This gives us the tremendous optimism for the future, because we see not only a significant demand at Marshall’s and a wonderful opportunity to work for a world renowned installer, but it verifies our own estimates of a snowballing demand for retrofit applications, that our system is uniquely capable of being installed in a very short period of time, providing remarkable performance.

So, that’s a major -- it’s a major and significant, not only a specific opportunity to work with Marshall’s of Cambridge, but also a vindication of our own estimates of a very large and expanding demand for Flat Panel Displays.

OK. But it sounds like this is really good because it’s your first big introduction into Europe, isn’t that correct?

Yes, it is, actually. I mean, a Boeing selection on the Royal Netherlands Air Force KC-10 was outstanding. This is really a -- you’re right, the big penetration into the European marketplace. And essentially, more than European. It’s actually world wide. They do a fair amount of business in the Middle East and Far East as well.

So, they’re very excited about it and we’re delighted to have an opportunity to work for them -- work with them. In fact, we’re in meetings right now on configurations of C-130s right now. So, we’re very excited about this. We see a very rapidly expanding demand and that’s why we’re optimistic about FY 2006.

Kevin Richardson of Prides Capital.

Two quick questions. One was I think I heard the -- I got the revenue guidance. I understand why that’s down because of the orders being week. But, the EPS is 17 to 20 or 17 to 23?

17 to 23. And the guidance -- it’s only the low end of the guidance. I mean, I don’t know that our guidance is down, but we are providing a broadened out of the range because of the timing uncertainty of some of the business. That’s all.

And the new orders, were those RVSM or were they more Flat Panel related?

More Flat Panels. We’ve had a significant number of Flat Panel orders.

Got it. And then--.

And there’s a lot of orders, again, that we’re received letters of intent on because we’re in final negotiation of configuration and ops, cost ops and things like that that are not part of the backlog, but have delivery schedules in the very near future.

So, have you shipped any? I mean, is this something that we have not seen revenue from yet?

This is stuff that you have not seen revenue from, but we expect to see revenue in the fourth quarter.

Got it. And the final question was just on the cash levels and thoughts on either buying back stock or acquisition opportunities. I know in past conference calls you’ve mentioned you’ve looked at a lot, but you have nothing to kind of report on. Just wondering on an update there.

We continue to have meetings. In fact, I had meetings yesterday with some bankers to discuss three opportunities for acquisition. Had a significant number of meetings at the Paris Air Show as well. We are moving along well on the acquisition front. We continue to have a significant war chest to buy back stock or, if we think it makes good sense to use our cash that way. We’re not going to let it sit and grow moldy. But, our primary purpose is to do an acquisition, and the kind of acquisition we’re talking about would be -- the ones we’ve been looking at are in the $150 million range.

150 revenue or 150 purchase price?

Maybe both.

Mark McGrath of Green River.

Hi, just a couple quick questions. On this whole question of guidance, I notice in the last call you mentioned that this was your expectation for a 25% type growth going forward. And I think you said that also in a newspaper article that happened over the quarter. And I was just curious to know is that -- is the base level from which that projected growth was off of, is that the $68 to $70 million of revenue for this year, or is that some other number?

No, it’s a 68 to 70 this year, and we’re talking about double digit growth off of that number. And that’s what we’re hoping and anticipating, but we’re not -- and that’s what I meant by that phrase. But, I’m not going to be providing guidance for the year until the end of the next quarter. But, to clarify what my previous statement, that was based on annual revenue.

OK. For this year--.

And that was in that range. But, I’ll give specific guidance for the year. Please understand that the timing of the order flow is in flux. It’s all happening very quickly and, therefore, I will be providing guidance for the quarter. And at the end of the year, I will be providing guidance for the Q1 and the year at the same time. So, that’s what our -- that’s the guidance.

OK. So your thought is now that it’s double digit percentage growth off of the 68 to 70 for next year?

Yes, that’s what I intended. And I want to emphasize that that’s not the guidance I’m giving now. But absolutely, that’s what I intended when I said -- when I offered double digit growth and it was double digit off of the $68 to $70 million.

This almost sounds like a legal conversation.

Well, it is, unfortunately. I apologize for that, but I am -- I spend an awful lot of time being cautious -- cautioned by attorneys for SOX, as you can probably speculate.

OK. I guess it just sort of makes one raise one’s eyebrows when you see the only, you know, $1.4 million of new sales booked in the quarter in relation to some prior statements about 25% type growth.

Well, remember the reason we’re talking about the growth is--. We booked $33 million for the year. But understand it is a timing issue. If you go back historically 2 or 3 years ago, I recall a $4 million quarter that we recovered entirely and showed growth over the previous year. And that was another transition period, a far more distinct one than this one, in which we had a program that generated 20 -- about 75% of our revenue stop in a month and we recovered from that and went on to build the year. We’re in much better shape to grow the business than we were in international the past.

Unfortunately, it would’ve been much simpler to explain if we could have spread the huge growth that we saw last year over a two-year period. But listen, we shipped it, we didn’t [expletive] away the profit. We put it -- well, you know, it’s easy to do, by the way. We put it in our war chest to do acquisitions and we invested it in R&D. And I am personally very optimistic and, by the way, continue to hold my four million shares.

OK. And I appreciate that. Two more quick ones. I noticed that you cited the same article from Aviation Week and Space in this press release as you did last press release. And I’m just -- just a couple quick ones on this. You know, how do you look at that 62% of the eligible fleet having been outfitted? How relevant is that number, in other words? Is there some segment of that population that is just never going to be retrofitted? That just doesn’t see it as cost effective?

I think that, from a practical sense -- and there’ll be some small percentage that I guess will never be retrofitted. There’ll be a number of aircraft they’ll just put on the ground and they won’t -- going to fly. But if you’re going to fly airplanes, especially with the cost of fuel today, you cannot operate an airplane and a 20,000 foot -- 25,000 foot range of -- you have to get up in the higher altitudes because of the operating costs, not only from fuel, but engine operating costs and delays is so strong and so prohibitive to stay at lower altitudes that I believe that virtually all of those airplanes.

Now, there will some airplanes, I will note, that may be included in that that can affect -- for instance, high performance turbo props can afford to fly below RVSM altitude, even though they may prefer to and, therefore, may not operate RVSM. But I can tell you there are airplanes right now with a surface ceiling of 30,000 feet, which is only 2,000 feet into the RVSM space, that are doing RVSM retrofits for $180,000 simply because the traffic is so -- there’s so much traffic at the lower altitude.

To answer your -- to summarize, I’d say -- my judgment says that at least 80% of that will be ultimately retrofitted. And it’s a question of how long you can endure the pain.

OK. And then that article is now six months old, is it your sense that -- how much of the paste has been squeezed out of the tube at this point, do you feel?

I’m sorry, I don’t -- I’m not sure I understand.

You’re quoting an article that is now six months old and I’m just curious to know your best guess, just as someone who looks probably at sales figures and orders every day, how much of the opportunity you feel is still left now six months afterwards--.

I still believe there’s two-thirds of the opportunity left. And the only reason we cite that article is because there has not been any other article recently. And rather than using our own numbers, we cite articles that we feel are fairly accurate and very objective for looking at the fleet. That’s the only reason we use that.

OK. And then last question is just on Flat Panel and maybe you could talk a little bit about competitive landscape. You talked about what a big market it is, but maybe you can just give us an overview of who else is competing international eh market and how their products and sort of perceived services is different than how you’re distinguished.

Yes, I would talk for two of the foremost suppliers -- maybe three -- foremost suppliers of the world, from our perspective is Honeywell, Collins and Thales. Those three manufacturers have been dominant suppliers and been supplying Flat Panels for almost 20 years, 15 years, and do an outstanding job. And have assessed the technical solution very accurately and provide a very high integrity solution that we fly all our airplanes. All the new airplanes contain those Flat Panel Displays.

Thales, all three manufacturers have developed special integrated circuits, custom integrated circuits, that generate the high quality images necessary for Flat Panel Display Systems in an aircraft. And those -- they chose to do those customs integrated circuits to -- and all three of them use their own -- is because that they could comply to FAA standards called DO-254, which has similar controls to software integrity controls that are used in all commercial airplanes. And they were able to provide adequate data for the FAA to approve their STC installations.

In the recent -- last five years, I guess, there’s been a number of companies that have produced very high performance, outstanding integrated circuits for generating nice graphical images for PCs. We all have them in our computers, the gaming computers included. Unfortunately, they would work well in aerospace applications, but the people that make these chips for gaming and produce 20 million of them have little interest in producing chips for commercial applications. But most importantly, because there’s not a -- relatively, it’s a tiny demand. But most importantly, in order for them to get certification of that chip to FAA standards, they would have to release all of the engineering data, design data, and provide an enormous amount of documentation. And they don’t -- they won’t do it, obviously, for obvious reasons.

So, the FAA has long analyzed whether this falls into the same category as microprocessors, which are broadly used. And they have concluded that a microprocessor can readily be -- its integrity can be readily checked on its own, but graphics chips cannot. So, you need some ability if you intend to use them to check them.

Well, with that long explanation, what that comes down to is we can use them. We can provide a level of display performance which is as good or better than any of our competitors at a small fraction of the price due to a development and an invention of ours that allows us to provide the same level of integrity on a chip.

What that means to us now is we can now produce a product at a fraction of the cost and a fraction of the power consumption as a result of a number of technical breakthroughs. And our product is now a third of the price of our competitors’, as little as an eighth of the price in some cases. Installation, time to retrofit, is less than a quarter of the time to retrofit power consumption and, therefore, cooling requirements is much smaller.

So, taking in balance all of these things, from an interest of our mutual customers, our cost is significantly lower. The FAA is providing us a TSO to both Part 23 and Part 25 applications, Part 25 meaning the most stringent commercial air transport, and our product being a quarter of the price and very easily retrofitted, gives us a huge opportunity, competitive advantage, but most importantly opens up a market that heretofore didn’t exist because the cost of retrofit is now more than justified, both in the maintenance of the -- by the increasing cost of the maintenance equipment and the demands of new display systems like terrain avoidance warning and various other safety systems.

So, in summary, those three are the major -- the premier competitors certainly in our space. And we are able to provide a very competitive product and its performance has been certainly equal to our competitors at a small fraction of the cost, and actually much smaller and lighter on installation. Most importantly, the continued work that we have done in the refinement of the design has led us now to a product that we believe is capable of going down into the very bottom end of the general aviation market, because our costs have been reduced to that level. And if we can get -- move a little further, it will be a stunning breakthrough to provide air transport quality equipment to single engine aircraft.

I just want to make sure I wrote this down right. So if I recall, the retrofitters, they’d say that your products are one-third to possibly one-fourth the price of what a Honeywell or a Rockwell Collins would offer?

That’s correct. You know, there’s clearly specifics, but that -- certainly based on our knowledge and their knowledge, I think that’s true -- that’s very accurate. And you can call them. And that would be good.

Michael Davies of Investec.

Good morning. Thanks, guys. I have a couple questions here. On the gross margins, what percentage do you see the reduction in the gross margins would be attributable to just the volume reductions? And do we see pricing coming into the question here?

No. The answer to pricing, no. The gross margins will be minorly affected because we’ve got fixed costs associated with procurement and overhead and manufacturing. But, it’s relatively small. It’s not -- we typically treat it -- although not in a strict accounting sense, but certainly from a long-term projection sense, we’ve looked at many of our variable costs as almost fixed costs because we don’t lay people off. We keep a tight ship. So, we don’t see a significant change in the gross margins. They will go down if the volume goes down, but we don’t intend the volume to go down very long.

All right. Now, do we have like a long-term operating margin that you see attainable?

Yes. I’ve always said -- and this is, you know, historically I’ve said that I have focused entirely on EPS as the criteria for performance, EPS and a strong positive cash flow. So that the gross margins, I believe, will come down only because I would like to expand the volume to maximize the EPS. And I think you can increase the volume by controlling your costs and, therefore, potentially and reasonably reducing your gross margins, increasing your volumes, but significantly increasing the EPS.

The concern you would have -- and this is a general philosophy, is you get concerned when your gross margins get too low because -- and when I -- too low, maybe in the 30% range, then in our opinion you become far too vulnerable to pricing -- changes in competitive pricing. With the margins we have now, we can withstand any short-term competitive onslaught. If somebody wanted -- nobody’s going to drive us our of the business by dropping a price. Put it that way.

OK. I have a couple other questions quickly on average number of Flat Panels going into a plane. Can you just talk about that for a second?

Yes. An average number -- I mean, it’s probably four. But a typical installation would be six. We have installations as few as two or three. The cost of the panels and the associated electronics has come down so much that the average installation is getting to be more and more panels. In other words, in the old days the panels were expensive and people would try to sneak by with two. With our installations, we haven’t seen anybody wanting to put fewer than three, and typically it’s six and as many as eight.

And as far as the FAA initiatives on the Terrain Awareness Ground Proximity, how is that coming into play now? I mean, is that becoming more of a focus?

Well, enhanced ground prox and TAWS, and I don’t know their specific dates, but those are mandatory. They’re going to -- they’re mandatory for air transport and I think biz jets. I don’t know exactly the timing. All of that is a good example of demands for yet another display or multitasking a given display, and makes things like our Flat Panel Update more attractive.

The next generation -- the next move, and it’s happening quickly now, is all the maps that are presently -- and books, as a pilot I’ve handled and most pilots have them, they’re provide principally by Jefferson, are now going all electronic and electronic displays. And our system and its special integrity monitor make it capable of operating -- when we put our display in, replacing and doing -- replacing all of the paper copies with an electronic flight [inaudible].

That sounds encouraging.

Well, that’s great. I mean, it’s -- trust me, it’s great for the pilots who end up, in the past, have had to replace a thousand sheets of paper every year in their books. So, this is a very good way to update it.

We’re also working on things like configuration and maintenance updates at the gates and at FPOs with a unique wireless communication link. We do do a broad range of products, including -- you know, not only Flat Panels, but our Engine Display Systems provide a huge improvement in the maintenance of the engine because we record all the exceedance and operating data automatically and replay literally. As an example, in a C-130, our Flat Panel System replaces 41 individual gauges -- 41 -- with 3 parts.

That’s compelling.

It’s an amazing -- it’s an amazing transition and it’s very cost effective.

All right. Maybe you could just discuss the military opportunities, if you can. Perhaps maybe talking about applications for non-aviation transport vehicles.

There are -- there’s a very large application for non-aviation vehicles, both in the Navy and in the Army, and we are pursuing those. I can’t talk about it right now, but we are pursuing those. There are a number of procurements that are active now, both in aviation in the Navy for Flat Panel Displays. So, there’s a very large demand.

I remember going to a Society for Information Displays Conference in Detroit some years ago. And the guy that heads up the Advanced Displays for the Air Force at Wright Patterson said I have to replace 365,000 gauges in the next 7 years because I can’t maintain them anywhere. Well, you’re clearly not going to replace one for one with Flat Panels. But, it gives you some perspective of the magnitude of the number of opportunities there are in the military, both in airborne and ground and sea-based vehicles.

Right. But your ability to address that market might be hammered by potential competitors out there that, in your aviation market, you have the TSOs and such that give you some exclusivity. How do you feel about seeing competitors entering that market?

Well, clearly different in that respect. We -- I mean, the performance standards, and I’d like to believe that integrity is integrity. I mean, we happened to see it more in airborne. But the same integrity requirements are in all applications.

But as a good example, we’ve remained extremely competitive on LCAK and have -- and there is a small business competitor that’s competing with that on some of our main programs and we’re fairly very well, I might add. So, our technology is certainly more than State-of-the-Art. It’s advanced State-of-the-Art. Our pricing structure -- the reason we’re looking at some of these other areas is that we continue to provide a huge price advantage in those other areas as well.

Selman Akyol of Stifel Nicolaus.

Thank you. A couple things, if I may. Most of the questions have been asked, but just for some clarification purposes. Did you say that 45% of the backlog currently is for Flat Panel Display?

I did. It’s approximately 45%. What is it exactly? Do you have--?

33% to be exact.

All right, 33 to be exact. I said 45. That probably included some of the--.

Stuff that’s coming in.

Stuff that’s coming in. It’s 33 exactly.

Got you. And then, going into Q4 on revenues, you said roughly two-thirds from Air Data, which obviously includes RVSM, and then one-third coming from the Flat Panel Display?

Yes. When you look at -- that’s roughly correct. Again, that’s very flexible in timing because you can move a month or two one way or the other, and it either comes in or comes out of the quarter.

Selman, this is Roman Ptakowski. Just to clarify the -- 33% is in the backlog. The expectation would be that about 45% would come from Flat Panel in this fourth quarter. So, those are the two percentages.

OK. So 45% of revenues comes from Flat Panel in Q4.

That’s the expectation.

OK. And then -- Geoff, I appreciate the predicament you’re in in terms of when you said you kind of had -- you’re out there talking with people who have indications of interest, but you can’t put them in backlog yet. I think -- I forgot your exact characterization of it. But, can you just sort of dollar-up those opportunities and say what the total might be?

Be tough to do. But, they’re more than just indications of interest. They are Memorandums of Agreement, so they really say you have been selected to provide this program. As an example, with Marshall’s, there’s no specific orders yet, but there is a selection and we are now in a negotiation for this--.

Quantities, spares--.

And so the number is pretty broad. I can only tell you that there are a couple of programs that are specific to quantities, but we have no sense of the timing. It has to be yet firmed out, whether it’s going to be in Q1 or Q4 or Q2. So, I’m sorry to be vague, but it’s difficult to be precise. I can tell you that the certifications and the applications that we are presently either awarded with or pursuing represent a market -- on specific airplanes -- a market which is more than double what our opportunity was for RVSM.

OK. In the Q3, can you split out what sales was between Air Data and Flat Panel?

Give you an approximation, yes.

About $0.5 million in Flat Panel, Selman, and the balance was in Air Data.

Got you.

Which includes both RVSM applications and non-RVSM applications.

We completed a significant part of the A-10 program as well, which was non-RVSM.

That’s right.

Right. I think probably on a go-forward basis, the base way to look at it is just Air Data and Flat Panel.

Right.

Exactly, because you can see -- I mean, any Air Data that we would ship from now on would be certainly capable of RVSM certification compliant.

Got you. And then my last question, in terms of just the backlog and the number itself and direction, do you think this is the low point? I mean, would you anticipate Q4 being higher than the third quarter?

Would I anticipate -- say again?

Would you anticipate the backlog at the end of Q4 being higher than it was at the end of Q3?

Well, we’re going to ship everything we can in Q4, but I would -- you know, clearly, we expect a growing demand. So, is it going to be bigger? I hope so. But there’s a typical year-end situation where, when you hit the year-end you would like to ship everything you can find in backlog. So, the backlog usually at the end of the year is lower. But, I don’t expect it to go any lower, put it that way. I would expect it to be equal to or better, and then growing quickly.

Remember, our lead time’s pretty [expletive] short so, yes, the backlog will grow. But as we get orders -- we can take orders and ship in the same quarter, as an example.

And that would be for both Air Data products as well as Flat Panel Displays?

Right. Our Flat Panel production capability, we’ve really focused on and we’re doing extremely well with it now.

We’re ready to take on the challenge and the expectation of very significant volume in the near future.

Thank you. This is -- we’re at 11:00. I’ve got time for one more question. And if you have further questions, of course, you can always call in. But, if I can take one more question now?

Bob McCullough of Summit Crest Capital.

Good morning. I notice that prepaid expenses, capitalized prepaid expenses doubled and receivables were up 50%. Any particular reason? And also--.

Well, the receivables usually pop up in the third month of our reporting periods, to start with. So, we have absolutely no problems at all with them. We’re actually in great shape on receivables. And given the fact that we had $17 million worth of revenues in the quarter, having $2.4 million of an increase in receivables is not concerning to us at all.

The receivables, as you can see, are on a days outstanding basis are probably under 40 days and have been for most of the year. Prepaid expenses and things like that -- these are just following a normal cycle that the Company has. There’s nothing outstanding there. Towards the end of the year we get a lot of things, like insurance and situations like that that we need to cover.

Also, what percent of capacity are you offering right now and--.

Percentage of what?

What percent of operating capacity are you operating -- capacity are you operating--.

Well, I think we’re probably at a relatively low percent of capacity, given the fact that we’re in a 48,000 square foot facility that we built to accommodate all the RVSM growth and beyond. And we currently run on one shift and the building is expandable by another 50%. So, we feel we could easily accommodate revenues of about 2 to 2.5 times what we’ve got now before we would feel under any pressure here.

And you mentioned last quarter that you were ramping up or higher in expectation of future orders. In terms of break-even revenue-wise, what -- and then earlier you mentioned that you consider some of your variable costs kind of fixed because you don’t lay off engineers. What type of revenue would you project to have to incur to reach break-even?

To reach a break-even point here?

Yes.

The only thing I can tell you is, when we were making the $28 million in revenue, we were doing 28% and 20% net after tax. I mean, to us, that’s not even a question that’s on the table. We don’t plan on going out of business and we plan on going upwards, not backwards.

Gentlemen, thank you very much. We appreciate it. If there are any further calls, we’re happy to take them -- call Jim or myself or Roman. You all have our number. And we -- in summary, we see an extremely positive outlook in the future. We’ve got a strong product offering. We think we’re in very good shape to address the markets that we see and we see very strong expansion. So, I’m optimistic and we are delighted to see your continued support and look forward to a really strong 2006. Thank you very much.

Thank you. This does conclude today’s teleconference. You may hang up your lines at this time and have a wonderful day.