1. Business
General
Tel-Instrument Electronics Corp (“Tel”, “TIC” or the “Company”) has been in business since 1947, and is a leading designer and manufacturer of avionics test and measurement solutions for the global commercial air transport, general aviation, and government/military aerospace and defense markets. The Company designs, manufactures and sells instruments to test and measure, and calibrates and repairs a wide range of airborne navigation and communication equipment.
Tel’s instruments are used to test navigation and communications equipment installed in aircraft, both on the flight line (“ramp testers”) and in the maintenance shop (“bench testers”), and range in list price from $7,500 to $80,000 per unit. Tel continues to develop new products in anticipation of customers’ needs and to maintain its strong market position. Its development of multifunction testers has made it easier for customers to perform ramp tests with less operator training, a fewer number of test sets, and lower product support costs.
In the past few years, the Company was competitively awarded three major military contracts, CRAFT, ITATS and the TS-4530A programs, discussed below.
The Company has become a major manufacturer and supplier of IFF (Identification Friend or Foe) flight line test equipment. If the production options on the three programs described below are exercised in full, these programs have aggregate revenue of approximately $60 million over the next few years. The products under these contracts represent cutting edge technology and, together with derivative products, should provide Tel with a competitive advantage for years to come. Revenues from these programs will be the foundation for substantial growth for the next few years.
Tel has built a solid infrastructure to support a rapidly growing business and the outlook for the Company is positive with significant revenue expected over the next few years as a result of these new programs and other new products.
We continue to evaluate other attractive potential market opportunities although our current capital structure and engineering backlog limits our flexibility at this time.
CRAFT “Communications/Navigation (COMM/NAV) Radio Frequency (RF) Avionics Flight line Tester”) (AN/USM-708 and AN/USM-719) with the U.S. Navy
The AN/USM-708, the basic CRAFT test set, is a key product for the Company as it represents a new generation technology product. The AN/USM-708 and AN/USM-719 (IFF only) contract was competitively awarded to the Company by the United States Navy, and includes a maximum delivery of 1,200 units, if all options are exercised. This contract is approximately a $31 million multi-year, firm-fixed-price, indefinite-delivery/indefinite-quantity contract for the systems engineering, design and integration, fabrication, testing, and production of an AN/USM-708 test set with sonobuoy simulator capabilities. The AN/USM-708 CRAFT unit combines advanced IFF (including Mode 5 encryption technology) navigation, communication, and sonobuoy test capabilities in a portable test set, which will utilize a flexible and expandable digital-signal-processing-based architecture. Both the AN/USM-708 and the AN/USM-719 have been certified by the AIMS Program Office for Mode 5 system integration purposes. This represents the culmination of a multi-year, multi-million investment by the Company in Mode 5 technology and will provide a significant competitive advantage in the years to come as the U.S. and our NATO allies migrate to this leading edge IFF technology.
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Item 1. Business (continued)
General (continued)
The contract for the AN/USM-708 and AN/USM-719 is a significant milestone for the Company, because the development of this proprietary technology, which has been funded by the Company, will establish Tel’s position as a leader in the industry, and will meet the U.S. Navy’s test requirements for years to come. The Company believes that, given the unique nature of this design, this product could generate sales to other military customers. The Company has already received orders for a limited number of units of the TR-420, a modified CRAFT test set, from customers other than the U.S. Navy. The AN/USM-708 contract also includes options for units testing encrypted communications and advanced data link functions, which, if exercised, would represent a major expansion in the Company’s core business. The Company believes that the core technology in the AN/USM-708 can be the foundation for additional military and commercial products. In May 2011, the U.S. Navy evaluated the CRAFT AN/USM- 708 and found it suitable for use in the fleet.
The Company has received pilot production orders and shipped 248 units of the AN/USM-719 (IFF only) totaling approximately $5.2 million. In addition, the Company has received orders for 182 units of the AN/USM-708 under this contract, totaling approximately $4.2 million. The Company has also received orders for approximately $4.7 million for testing, documentation and qualification units. On April 8, 2011, the Company received an order from the U.S. Navy for an additional 732 units of the AN/USM-708 totaling approximately $16.2 million. The Company received the production release during 2012 and produced and invoiced 173 of these units. Most of the CRAFT 719 and 708 units are being held at the Company in a “ship-in-place” arrangement pending receipt of the required frequency allocation form the FAA which is expected to be secured in the 2013 fiscal year.
In March 2012, the U.S. Navy placed a temporary hold on CRAFT 708 production shipments to correct issues discovered in prior CRAFT 719 deliveries and incorporate the final AIMS approved software configuration which includes several product enhancements. The U.S. Navy requested that the Company perform a Root Cause Analysis on the issues seen in the CRAFT 719 units. On June 14, 2012, the U.S. Navy, based upon observations at the Company’s facility, indicated that the Company’s Root Cause Analysis was adequate and that the Company has made progress in addressing the quality issues found in the production of the CRAFT units. As a result, the U.S. Navy granted the Company permission to resume limited production, a combination of new units and rework units. Once these units are completed, the U.S. Navy will assess these units and a determination will be made with respect to resumption of full rate production. The Company expects to resume production during the second quarter of the current fiscal year.
The issues identified with the CRAFT units will require that all CRAFT 719 and CRAFT 708 units be updated with revised software and TIC will revalidate all of the 460 ship-in-place units at TIC before they are shipped to the customer. (These ship-in-place units had been built and paid for by the U.S. Navy but could not be shipped to the field due to regulatory restrictions.) TIC and the U.S. Navy have been working to finalize an upgraded test procedure for these units. The test procedure needed to be upgraded to reflect the extensive changes to the units over the last few years. The U.S. Navy has also verified and approved these new test procedures and reviewed TIC’s quality assurance procedures. The U.S. Navy has also indicated that additional foreign military sales (“FMS”) are expected for the CRAFT product, and the Company is also actively quoting orders for other customers.
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ITATS (“Intermediate Level TACAN Test Set”) (AN/ARM-206) with the U.S. Navy
The AN/ARM-206 or ITATS is a bench test set combining advanced digital technology with state of the art automated testing capabilities. This product will represent an important expansion to Tel’s current product line, and the automated testing capabilities will provide a significant labor savings benefit to our customers. This contract with the U.S. Navy has options for approximately 148 units with a total value of over $12 million; the initial work authorization was $4.4 million. Tel is working with an engineering sub-contractor and, as a result, this program has not required as much Tel engineering design effort as needed for the AN/USM-708. Given the unique nature of the design, this unit could also generate significant sales to other military customers, both domestically and overseas. In June 2010, the Company received a production order for 102 units amounting to approximately $5.3 million, although a production release has not yet been issued. During technical evaluation the U.S. Navy determined that the product needed enhancements to adequately meet the U.S Navy’s requirements. Many of these enhancements represent changes in scope for the product, and changes in scope requested by the government are generally paid for by the government.
In July 2011, the Company secured a $599,000 contract modification from the U.S. Navy to incorporate product enhancements to the ITATS AN/ARM-206 TACAN test set resulting from U.S. Navy technical evaluation testing. The AN/ARM-206 ITATS program is proceeding well with the enhancements funded by the U.S. Navy last year now substantially complete and the platform verification substantially completed by the U.S. Navy. TIC is in the process of performing final bench level verification testing on these units and expects to secure a production release on the 102 unit U.S. Navy production delivery order later this summer. It is expected that this product will enter full rate production this calendar year.
TS-4530 IFF test set with the U.S. Army Aviation and Missile Command
In February 2009, the Company was awarded a five year firm fixed price indefinite-delivery/indefinite-quantity (IDIQ) contract by the U.S. Army Aviation and Missile Command with a maximum dollar value of approximately $44 million, depending on the number of units purchased (see Item 3, Pending Legal Proceedings).
The Company’s win of the critical TS-4530A Mode 5 Army program represents a major event for our future. This award, in conjunction with our Navy CRAFT Mode 5 program, provides TEL with undisputed market leadership in the Mode 5 Identification Friend or Foe (“IFF”) business and should provide a constant revenue stream for many years. The Company has already received approximately $22.5 million in delivery orders on the TS-4530A program out of a maximum contract value of approximately $44 million. In contrast to the multi-year CRAFT program, this is an accelerated development program that takes full advantage of the significant investment that the Company has made in its proprietary Mode 5 technology.
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TS-4530 IFF test set with the U.S. Army Aviation and Missile Command (continued)
This contract includes an initial order for pre-production of 20 Mode 5 conversion kits for the Army’s existing TS-4530 IFF test sets and 20 new Mode 5 test sets, which have been delivered. The IDIQ portion of the contract will entail the production of up to 2,980 Mode 5 conversion kits and up to 1,980 new production test sets. The Company has already received production orders for 2,409 Mode 5 conversion kits and 621 new production test sets. These Mode 5 conversion kits and new IFF test sets will incorporate Tel’s proprietary electronics and IFF technology in addition to Mode S Enhanced Surveillance (”EHS”) and Automatic Dependent Surveillance - Broadcast (“ADS-B”) test functionality.