To the "Thread,"
I write this on Friday evening, well after the close of the markets.
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Simula held a very small conference call this afternoon, including only "analysts" that follow the company on the call. In all probability, the list wasn't very long, and representatives of the Red Chip Review (Marcus Robbins), Brean Murray (Steve Slawson), and HD Brous (Debra Fiakas) were the only parties to the conversation.
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Following (and because of) that conversation, I held my own discussion with senior management, the highlights of which follow:
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The third quarter numbers will not meet Wall Street's expectations for a variety of reasons. In the order of importance, they are inefficient production of 16G seats and delays (not cancellations) in three separate government related programs.
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The 16G seating problem is merely one of indigestion, as the rapid ramp of sales (Simula shipped $ 1.3 million in seats this week, which was slightly more than it shipped in the entire 1997/1 quarter) has led to inefficiencies of production. Those inefficiencies are easy to understand, and essentially involve Simula's vendors not being able to keep up with orders thus depriving SMU of materials in a smooth manner, as well as the necessity of producing seats on overtime rather than incurring "straight-time" costs. In addition, although raw material inventory cost is now declining as a consequence of the higher production runs from Simula, the original higher cost inventory is still being worked through the system. Thus, for accounting purposes, third quarter (and early fourth quarter) shipments will be less profitable than those made in the future.
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The overtime and vendor performance issues are currently being resolved, as Simula has gone to a second shift (with only straight time being paid) and new vendors have been engaged to provide raw materials on a more timely basis. The December and March quarters should show some additional improvement from what was obviously a terrible third quarter, but the real benefits of consolidating the San Diego facilities (which is currently under contract and being set up to begin production some time around the end of March) will be a dramatic improvement in profit margins beginning in the second quarter of 1998.
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The current plan is to finish shipping ordered seatpacks this quarter (and will result in nearly $ 12-13 million in 16G seats in the December period) and then to intentionally reduce production beginning in 1998/1 to approximately $ 10 million a quarter in order to begin to efficiently meet profit goals. Simula will probably ship something slightly in excess of $ 40 million in 16G seats for 1998, but efficient utilization of resources and better managed growth will result in good profitability. I would expect that once the company travels somewhat further down the learning curve, it will be able to generate 1999 sales at least 50% higher than what is planned for next year.
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On the government product side of the business, there were three mini-hiccups that caused a revenue shortfall in 1997/3. The fell into the following areas:
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1) the C17 program...Simula's vendors didn't deliver raw materials on time for the manufacturing process. Because the program is accounted for on a "percentage of completion" basis, the inability to get appropriate materials resulted in unabsorbed overhead (because insufficient "completion" didn't allow for revenue recognition). This program is fully funded and the revenues aren't "lost," but with appropriate material supplies not scheduled to be in until at least 1998/1, the "profits" from the program are pushed out a couple of quarters.
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2) cockpit airbags...expected production and revenue recognition in quarters 3 and 4 are being delayed slightly, as poor quality gas generators on order from United Technologies didn't meet appropriate testing standards. The government requested that United be replaced with another vendor, and with one now in place, testing has to be done again. Accordingly, though the program is fully funded (and Simula has gotten orders for an additional 3 programs), the costs of the programs were not offset by the expected revenues. In addition, because the personnel working on the program were assigned to other projects (so they wouldn't be spending the entire quarter doing nothing), those projects were essentially full R&D with no offsetting revenue inflows. This problem should also be resolved by the first quarter.
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3) BABS, or bulkhead airbag systems...Simula has not yet received full certification for the program by the FAA, despite the fact that all originally planned tests have been met successfully. The FAA has decided to require some additional testing, as the publicity surrounding auto airbags has them wanting to check the effect of deployment on out-of-position passengers. This appears to be a political issue, as the FAA is afraid that if deployment of the airbag results in injury to a passenger, it will be targeted by the public as being "at fault." Frankly, I think this is ridiculous, as BABS is the only product that meets the FAA's own regulations on bulkhead seating, and there is no point in even having the regulations if a system isn't deployed to meet the threat. I can not predict when this program will be back on track, as its timing is subject to the FAA's internal policy issues, but it is obvious that the bulkhead threat has to be met in some fashion and the only product in development that meets the original FAA requirements is BABS.
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The company is planning to make an announcement prior to Monday's opening indicating it will not meet analyst estimates for the third quarter, and indeed that it will have a loss. At the moment, for all of the aforementioned reasons, I judge the loss will be approximately 15 - 20 cents. Most of the large investors (many of whom I have developed a personal relationship with) have been expecting an in-the-red result for at least the last couple of weeks, and this is surely the reason why the stock has come down 30% from the high reached earlier this year.
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My guess is that there will be some additional selling on the news, although I do not expect this to be substantial in either price or volume terms.
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Up until now, I have only focused on the negatives, but the positives are more compelling. ITS was profitable in quarter 3, and will be very profitable (on approximately $ 4-5 million in sales) in quarter 4. As you know from my posting of yesterday, the nation's insurers have funded a program to test ITS in side-impact pole tests. The results were spectacular, and the testing was carried on in the presence of representatives of numerous car companies and NHTSA.
Yesterday's publication of the results led to Simula being contacted today by major first tier suppliers, and it appears that the new Regulations will be promulgated by NHTSA within roughly 30-45 days. I expect that taped replays of the testing will be shown in various television markets over the next few weeks, and I understand that some of the country's smaller markets have already shown the videos of the test. The public demand for side-impact head protection is just beginning to grow and will be further nurtured by such publicity. In short order, it will result (in my view) in a large number of additional ITS contracts for SMU. Moreover, if the auto companies or first tier suppliers want to include this product in their mid-1999 model year cars, they will have to act within the next six months in order that sufficient time be left to complete the engineering studies necessary for manufacture. That timetable would result in SMU having incremental revenue flow beginning in early 1999, with a hockey-stick shaped growth curve starting in the middle of that year.
Lastly, there has apparently been the first real-world accident where ITS effected the survivability of a side-impact collision. Although details are still sketchy (but full engineering studies will be available in a couple of months) a woman driving a BMW 740 Series automobile was hit from the side by a truck. The force of the accident was sufficient to cause the truckdriver to go to the hospital, but proper deployment of the ITS (and the resultant reduced head and neck trauma for the driver) allowed the woman to walk away from the accident.
With rollover and side-impact collisions the second and third leading cause of auto fatalities, it appears abundantly clear that this product will generate very significant and dramatically growing demand over the next several years.
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As some will say (and I will agree) it is certainly possible that the senior people could have done a better job handling the government revenue delay, as a portion of them are specifically due to revenue recognition issues that could have been better dealt with by more closely monitoring vendor performance. And, the 16G problems are simply the result of too far, too fast. (Or as my father used to occasionally tell me, "Your eyes eat more than your mouth.") That issue was exacerbated by management's unwillingness to turn away new customers (despite the fact that they were turning out seats at a loss) because they knew that there was a substantial risk that they would lose future, profitable business if the initial customer orders were not accepted and performance guarantees met. The "fix" for 16G is already underway, and though we have suffered a 1-2 quarter setback, I am absolutely confident that by the latter part of 1998/1 (when the San Diego facilities are consolidated), the company's financial results will be substantially better reading.
Have a good evening. |
