**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-K**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe fiscal year ended September 30, 2005**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe transition period from                     to                     .**

**CommissionFile No. 0-31157**

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**INNOVATIVE SOLUTIONS AND SUPPORT, INC.**

(Exact name of registrantas specified in its charter)

| **Pennsylvania**                                |   | **23-2507402**                     |
|-------------------------------------------------|--------|------------------------------------|
| (State or other  jurisdiction of incorporation) |   | (IRS Employer  Identification No.) |
| **720 Pennsylvania Drive, Exton, Pennsylvania** |   | **19341**                          |
| (Address of  principal executive offices)       |   | (Zip Code)                         |

 

**(610) 646-9800**

(Registrant’s telephonenumber, including area code)

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**Securities registered pursuant to Section 12(b) of the Act:**None

Indicate by check markwhether registrant (1) has filed all reports required to be filed bysection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes xNo o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of the Registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K.x

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Act). Yes xNo o

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theAct). Yes o No x

The aggregate market valueof the Registrant’s common stock held by non-affiliates of the Registrant as ofMarch 31, 2005 was approximately $287 million. Shares of common stock held byeach executive officer and director and by each person who owns 10% or more ofour outstanding common stock have been excluded since such persons may bedeemed affiliates. This determination of affiliate status is not necessarily aconclusive determination for other purposes.

As of November 28,2005, there were 18,055,513 outstanding shares of the Registrant’s CommonStock.

**DocumentsIncorporated by Reference**

Portionsof the Registrant’s Proxy Statement for the 2006 Annual Meeting of Shareholdersto be filed prior to February 1, 2006 are incorporated by reference into Part IIIof this Report. Such Proxy Statement, except for the parts therein which havebeen specifically incorporated by reference, shall not be deemed “filed” forthe purposes of this Report on Form 10-K.

 

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**INNOVATIVE SOLUTIONS AND SUPPORT, INC.2005 Annual Report on Form 10-KTable of Contents**
|                   | ** ** | ** **                                                                                  | ** ** |       | **Page** | ** ** | ** ** |
|-------------------|------------|---------------------------------------------------------------------------------------------|------------|-------|----------|------------|------------|
| **Part I**   |       |                                                                                        |       |
| Item 1.           |       | Business                                                                                    |       | 3     |     |
| Item 1A.          |       | Risk Factors                                                                                |       | 13    |     |
| Item 1B.          |       | Unresolved Staff Comments                                                                   |       | 17    |     |
| Item 2.           |       | Properties                                                                                  |       | 17    |     |
| Item 3.           |       | Legal Proceedings                                                                           |       | 18    |     |
| Item 4.           |       | Submission of Matters to a Vote  of Security Holders                                        |       | 18    |     |
| **Part II**  |       |                                                                                        |       |
| Item 5.           |       | Market for the Registrant’s  Common Equity and Related Shareholder Matters             |       | 19    |     |
| Item 6.           |       | Selected Financial Data                                                                     |       | 20    |     |
| Item 7.           |       | Management’s Discussion and  Analysis of Financial Condition and Results of Operations |       | 21-27 |     |
| Item 7A.          |       | Quantitative and Qualitative  Disclosures About Market Risk                                 |       | 27    |     |
| Item 8.           |       | Financial Statements and  Supplementary Data                                                |       | 27-45 |     |
| Item 9.           |       | Changes in and Disagreements  with Accountants on Accounting and Financial Disclosure       |       | 46    |     |
| Item 9A.     |       | Controls and Procedures                                                                     |       | 46    |     |
| **Part III** |       |                                                                                        |       |
| Item 10.          |       | Directors and Executive  Officers of the Registrant                                         |       | 48    |     |
| Item 11.          |       | Executive Compensation                                                                      |       | 48    |     |
| Item 12.          |       | Security Ownership of  Certain Beneficial Owners and Management                             |       | 48    |     |
| Item 13.          |       | Certain Relationships and  Related Transactions                                             |       | 48    |     |
| Item 14.          |       | Principal Accounting Fees  and Services                                                     |       | 48    |     |
| **Part IV**  |       |                                                                                        |       |
| Item 15.          |       | Exhibits,  Financial Statement Schedules and Reports on Form 8-K                       |       | 49    |     |

 

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**PART I**

**Item 1.**                        Business

**Overview**

Innovative Solutions and Support, Inc. (the “Company”,“IS&S” or “We”) was founded in 1988. The Company designs, manufactures andsells flight information computers, flat-panel displays and advanced monitoringsystems to the Department of Defense (DoD), government agencies, defensecontractors, commercial air transport carriers, original equipmentmanufacturers (OEMs), and corporate/general aviation markets. The Company isalso positioning itself as a system integrator; this capability provides theCompany with the potential to generate more substantive orders over a diverseproduct base. The Company has demonstrated the ability to incorporate addedfunctionality such as charting, mapping and synthetic vision systems into itsFlat Panel Systems’ product line. Our strategy as both a manufacturer andintegrator is to leverage the latest technologies developed for the personalcomputer and telecommunications industries into advanced, cost-effectivesolutions for both the aviation industry and DoD. We believe this approach,combined with our industry experience, enables us to develop high-qualityproducts and systems, substantially reduce product time to market and achievecost advantages over the products offered by our competitors.

Historically, we have focused our efforts ondeveloping and marketing air data systems that measure, calculate and displaycritical flight information, such as airspeed and altitude, and instrumentsthat measure engine and fuel data, primarily for use in the aircraft retrofitmarket but also for the Original Equipment Manufacturer (OEM) market. As aresult of these efforts, a substantial portion of our revenues has been fromthe sale of air data systems that are critical for safe flight. Our air data equipmentbrings aircraft into compliance with government regulations; including ReducedVertical Separation Minimum (RVSM) requirements that have been phased in byregulatory authorities on all heavily traveled global flight routes. We believewe are one of three primary suppliers of RVSM products to the U.S. retrofitmarket.

Advances in technology are providing pilots increasingamounts of information that enhance both the safety and efficiency of flying.However, the limited amount of space in the cockpit coupled with inefficienciesassociated with currently used displays inhibits the display and integration ofthis information in a user-friendly manner.

In fiscal 2000, we introduced our flat-panel displaysystem, or COCKPIT/IPTM Cockpit Information Portal, which is the first in aseries of new products we have developed to enhance the management andintegration of cockpit information. Our COCKPIT/IPTM is the centerpiece of ourcockpit information management system that organizes and displays a multitudeof flight information. This system provides enhanced growth capability forsystems that will become available to pilots in the future. This informationmay be generated from a variety of sources, including our RVSM air data system,our engine and fuel instrumentation, or from third-party data and informationproducts.

In fiscal 2003 our COCKPIT/IPTM product line wasadvanced by the capture of two strategic programs. The first was the U.S. NavyLanding Craft Air Cushion (LCAC) Service Life Extension Program on which theCompany provided six large flat panel displays. The second award came fromBoeing to provide Aerial Refuel Operator Control Display Units and PilotsMission Display Units for Boeing’s Global Tanker Transport Aircraft.

In fiscal 2004 the COCKPIT/IPTM product line wasfurther advanced when the Federal Aviation Administration (FAA) awarded theCompany a Technical Standard Order (TSO) for the Company’s large Flat PanelDisplay. The TSO establishes the product as meeting the requirements that havebeen implemented by the FAA to ensure safe flight on a variety of aircrafttypes. The TSO awarded to the 

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Company addresses the moststringent Commercial Air Transport Market requirements as provided in Title 14of the Code of Federal Regulation, subpart 25, Commercial Air Transport.

In fiscal 2005 the Companyreceived several key Flat Panel Display System awards. The Royal NetherlandsAir Force selected our Flat Panel Display System for their KC-10 cockpitavionics update program. In addition, the Company teamed with ABX Air toupgrade B-767 cockpits with our Flat Panel Display Systems; the first B-767has been upgraded with our Primary Flight and Navigation Flat Panel DisplaySystem and has received FAA TSO Approval and STC Certification on 10/19/05. Wealso captured C-130 Flat Panel Engine Instrument Display System awardsfrom Lockheed Martin and Spar Aerospace for international customers. Further,Marshalls of Cambridge, a well respected European systems integrator, selectedthe Company for their common core avionics upgrade featuring our Flat PanelDisplay System. The Canadian Department of National Defense also selected ourFlat Panel Display System to retrofit their fleet of C-130 airplanes asdid Snow Aviation, an international engineering integrator.

**Our Industry**

A wide range of information, including airspeed andaltitude, is critical for the proper and safe operation of aircraft. Withadvances in technology, new types of information to assist pilots, such assatellite based weather depiction and ground terrain maps, are becomingavailable for display in cockpits. We believe that aircraft cockpits willincreasingly become information centers, capable of delivering additionalinformation that is either mandated by regulation or demanded by pilots toassist them in the safe and efficient operation of aircraft.

There are three general types of flight data: flightcritical aircraft control information such as air data, which includes aircraftspeed, altitude and rates of ascent and descent; aircraft heading and altitudeas well as engine data such as fuel and oil quantity and other enginemeasurements; navigation data such as radio position, flight management and GPSand alternative source information, which is information not originating on theaircraft, including weather depiction maps, GPS navigation and surface terrainmaps. Air data calculations are based primarily on air pressure measurementsderived from sensors on the aircraft. Engine data are determined by measuringvarious indices such as temperature, volume, RPM and pressure within anaircraft’s engines and other mechanical equipment. Alternative sourceinformation is typically derived from satellites or equipment located on landand fed by satellite or radio signals to the aircraft. Pilots can then displaythis information in the cockpit for reference and enhanced position awareness.

Traditionally, flight dataand other cockpit information were displayed on a series of separate analogdials. In the early 1980s, digital displays using cathode ray tubes began toreplace some of the individual analog displays. The industry has now begun todevelop color flat panel displays using active matrix liquid crystal displays(AMLCD) to replace traditional analog or digital displays. We expect that theability to display more information in a space-efficient and customizedplatform will become increasingly important as additional information, such asweather depiction maps, traffic information and surface terrain maps, becomesmandated by regulation or demanded by pilots. Accordingly, we believe that flatpanel displays, which can integrate and display a “suite” of information, willincreasingly replace individual displays as the method for delivering andordering information displayed in cockpits.

**AirData and Reduced Vertical Separation Minimum (RVSM)**

Pilots use air data for a number of importantpurposes, including maintaining safe separation from other aircraft. Untilrecently, aircraft on a similar flight path at altitudes between 29,000 and41,000 feet have been required to maintain a vertical separation of at least2,000 feet. As air travel has increased over the past decade, U.S. and globalaviation authorities sought ways to increase traffic flow on high trafficroutes. These organizations have developed RVSM for adoption in the mostcongested air space to reduce 

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vertical separationbetween aircraft from 2,000 feet to 1,000 feet. RVSM essentially doubles flightroutes within a vertical airspace, thereby increasing aircraft capacity on hightraffic routes throughout the world.

Safe travel on RVSM routes requires that an aircraft’saltimeter be extremely accurate, and aircraft flying RVSM routes must haveRVSM-certified equipment. RVSM has been in effect, as part of the internationalmandate, between 29,000 and 41,000 feet for certain North Atlantic routes sinceMarch 1997. Western Atlantic air routes commenced in 2001 and, as of January 2002,RVSM was phased in on Trans-Pacific and European air routes. We believe theNorth American market comprises over half of the total RVSM marketplace. WhileDomestic Reduced Vertical Separation Minimum (DRVSM) compliance was effectiveas of January 20, 2005, there still remains just under 30% of businessaircraft yet to be compliant according to a recently released FAA audit.

The Company was and iswell positioned to support the aviation industry’s needs in both a timely andcost effective manner. Our investment in a new manufacturing facility was madeto ensure we would have the production capacity to meet market demandsassociated with this mandate. It is clear the number of planes that need toreceive updated equipment in order to fly in RVSM space did not all make thecompliance deadline. Aircraft that are not RVSM compliant are commanding manythousands of dollars less in resale value than similar aircraft that haveundergone the upgrade. The cost-benefit pendulum is weighing in favor of havingthe work done. Accordingly, the demand is expected to continue into 2006.

**Flat Panel Displays**

Air data and other flightinformation have traditionally been displayed on analog instrumentation and,more recently, individual small digital displays. Within the last severalyears, color flat panel displays were introduced in aircraft cockpits. Flatpanel displays are LCD screens that can replicate the display of one or a suiteof analog or digital displays on one screen. Like other instrumentation, flatpanel displays can be installed in new aircraft or used to replace existingdisplays in aircraft already in use. LCDs are also being used for cabinentertainment, security monitoring on-board aircraft and as tacticalworkstations on military aircraft. The flat panel product line presentsnumerous advantages for the presentation of engine performance data as well.

**Engine and Fuel Displays**

Equipment data, such asengine and fuel related data, traditionally have been displayed on conventionalsolid-state displays. Engine and fuel displays provide information on engineactivity, including oil and hydraulic pressures and temperature. Thisinstrumentation includes individual and multiple displays clustered throughoutan aircraft’s cockpit. Engine and fuel displays tend to be replaced morefrequently than other displays due to increased obsolescence problems andnormal wear-and-tear. As the information displayed by this instrumentation isvital for safe and efficient flight, aircraft operators continue to purchaseindividual conventional engine and fuel displays to replace older ornon-functioning displays. Increasingly operators are beginning to replace theirindividual instruments with integrated Flat Panel Display Systems.

**Strategy**

Our objective is tobecome a leading supplier and integrator of cockpit information. We believe ourindustry experience and reputation, our technology and products and ourbusiness strategy provide a basis to achieve this objective. Key elements ofour strategy include:

·       *Maintaining our leadership in the air data markets.  *Webelieve that we are one of the largest suppliers of air data products to theU.S. retrofit market. Significant demand remains in retrofitting aging aircraftwith newer, more advanced and more supportable air data systems.

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·       *Establishing leadership in the flat panel displaymarket.  *We expect that over the next several years, manyaircraft will either be retrofitted or newly manufactured with flat paneldisplays. Given the versatility, visual appeal and lower cost of displaying aseries of instruments and other flight-relevant information on a single flatpanel, we believe that flat panel displays will increasingly replace individualanalog and digital instruments. We also believe our COCKPIT/IPTM has significantbenefits over the flat panel displays currently offered by our competitors,including its lower cost, larger size and enhanced viewing angles. Accordingly,we believe these advantages will allow us to generate significant revenues fromour COCKPIT/IPTM and gain significant market share within this market.

·       *Continuing our engineering and product developmentsuccesses.  *We have developed innovative products by combiningour avionics, engineering and design expertise with commercially availabletechnologies, components and products from non-aviation applications, includingthe personal computer and telecommunications industries. We believe ourprocesses allow us to bring products to market quickly and to control ourdevelopment costs. Our COCKPIT/IPTM is an example of our ability to engineer asuperior product through the selective application of non-avionic technology.

·       *Increasing our sales to the DoD, other government agencies, defensecontractors, commercial air transport and corporate/general aviation markets.*   Westrengthened efforts to diversify our sales to include all end user markets ofthe aviation industry, particularly legacy military aircraft programs and thecommercial air transport market, including national and regional carriers andother fleet operators as well as the corporate/general aviation market,primarily through aircraft modification centers, as well as the OEM market. Wehave begun building a sales and marketing force dedicated to expanding oursales efforts to these markets while at the same time maintaining our positionas a provider of avionics products for the DoD.

·       *Expanding our international presence.  *Weplan to increase our international sales through adding sales and marketingpersonnel and adding foreign offices. As large flat panel displays become moreprevalent throughout the world, we believe that European and otherinternational aircraft operators and aircraft modification centers willaccelerate their retrofitting activities, thereby increasing demand for largeflat panel displays.

·       *Growth through acquisitions or joint ventures.  *We maypursue strategic acquisitions or joint ventures as a means of growing ourbusiness with respect to both information management products and content. Wehave identified profiles of the types of companies we would like to acquire andare evaluating various potential forms of joint ventures. We may seek toacquire developers or suppliers of complementary products, technology orinformation, or we may acquire suppliers of similar products as a means ofincreasing our product offerings and market share.

**Our Products**

Our current line ofproducts includes:

*Air Data and RVSMSystems and Components*

Our air data and RVSM products calculate and displayvarious measures of air data, such as aircraft speed, altitude and rate ofascent and descent. The functionality of our traditional non-RVSM air datasystems and our RVSM systems is similar. However, our RVSM systems use advancedsensors to gather air pressure data and customized algorithms to interpretdata, thus allowing the system to more accurately calculate altitude and toqualify for RVSM certification.

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We sell individualcomponents as well as partial and complete air data systems. Our components andsystems include:

·       digitalair data computers, which calculate various air data parameters such asaltitude, airspeed, vertical speed, angle of attack and other information derivedfrom the measure of air pressure;

·       integratedair data computers and display units, which calculate and convey air datainformation;

·       altitudedisplays, which convey aircraft altitude measurements;

·       airspeeddisplays, which convey various types of airspeed measurements includingvertical airspeed and rates of ascent and descent; and

·       altitude alerters, whichallow the pilot to select a desired cruising altitude that the aircraft willreach and maintain, also provides warnings to pilots when an unacceptabledeviation occurs.

*Flat Panel DisplaySystems*

We developed a Flat Panel Display System that canreplace the conventional analog and digital displays currently used in acockpit and can also display additional information that is not now commonlydisplayed in the cockpit. Our Cockpit Information Portal COCKPIT/IPTM is capableof displaying nearly all types of air data, engine and fuel data, altitude,heading and navigational data as well as alternative source information. Astechnology and information delivery systems further develop, additionalinformation, such as surface terrain maps and data link messaging, will bedisplayed in the cockpit. We designed our COCKPIT/IPTM to be capable ofdisplaying information generated from a variety of sources, including our RVSMair data system, our engine and fuel instrumentation and third-party data andinformation products.

Our flat panel display system has demonstrated itsbroad capability by being selected by the U.S. Navy for application on aService Life Extension Program for the Landing Craft Air Cushion (LCAC)vehicle. In this program six IS&S flat panel displays replace the previousoutdated displays. This kit includes two sizes of displays—10-inch and 17-inch.This program is in current production. Over 75 LCACs exist in the U.S. Navyfleet.

The Flat Panel Display System’s broad capability wasfurther demonstrated when Boeing selected our displays for use on its new B767Global Tanker Transport Aircraft (GTTA). This new refueling and transportaircraft is intended to provide a significant upgrade in capability to airforces around the world. The aircraft has already been sold to Japan and Italy.The U.S. Air Force was originally expected to purchase this aircraft as areplacement for the KC-135 tanker. The United States Air Forcerequirement for 100 planes, however, is expected to be re-competed. The Companywill again have the opportunity to propose its Flat Panel System to whatevercompany is successful in the new competition. The Company’s equipment on the GTTAincludes two displays, a pilot mission display and an aerial refuelingoperators display control unit.

On July 2, 2004 the Federal AviationAdministration (FAA) awarded the Company a Technical Standard Order (TSO) forthe flat panel display or COCKPIT/IPTM. The TSO establishes our flat paneldisplay as meeting FAA requirements that have been put in place to ensure safeflight on a variety of aircraft types. The TSO awarded to the Company addressesthe most stringent Commercial Air Transport Market requirements as provided inTitle 14 of the Code of Federal Regulation, subpart 25, Commercial AirTransport.

The Company’s flat panel system awards were furtheradvanced when The Royal Netherlands Air Force selected our Flat Panel Systemfor their KC-10 cockpit avionics update program. The Company also teamedwith ABX Air to upgrade B-767 cockpits with our Flat Panel DisplaySystems; the first B-767 has been upgraded with our Primary Flight andNavigation Flat Panel Display System. We also recognized 

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C-130 Flat PanelEngine Instrument Display System awards from Lockheed Martin and Spar Aerospacefor international customers. Further, Marshalls of Cambridge, a well respectedEuropean systems integrator, selected the Company for their common coreavionics upgrade featuring our Flat Panel Display System. The CanadianDepartment of National Defense also selected our Flat Panel Display System toretrofit their fleet of C-130 airplanes as did Snow Aviation, aninternational engineering integrator.

On October 19, 2005 the FAA awarded the Company asecond TSO for the flat panel display or COCKPIT/IPTM. This TSO also establishesour flat panel display system as meeting FAA requirements that have been put inplace to ensure safe flight on a variety of aircraft types. This TSO alsoaddresses the most stringent Commercial Air Transport Market requirements asprovided in Title 14 of the Code of Federal Regulation, subpart 25, CommercialAir Transport. The STC states “It has been noted that this display systememploys an integrity monitoring system that assures integrity to acatastrophic/Level A design condition with the use of commercial graphicprocessors”.

In October 2005, theCompany in a teaming arrangement with ABX Air received FAA Supplemental TypeCertification (STC) of its Flat Panel Display System for use on B-767aircraft. ABX Air provided the aircraft and turnkey services includinginstallation kits, labor, pilot training and technical manual updates. The STCprovides B-767 operators with a low cost, rapidly implemented retrofit oftheir cockpit avionics with a modern pilot and copilot suite of high resolutionmulti-color LCD flat panel displays. Operators will also benefit from improveddispatch reliability, logistics savings, and adaptability to futurerequirements. The receipt of the STC positions the Company to pursue the morethan 1,700 B-757 and B-767 aircraft with similar needs for FlatPanel Display System upgrades. The STC also provides a foundation forincorporating the product into other airplanes as well.

*Engine and FuelDisplays*

We develop, manufacture and market engine and fueldisplays. Our solid-state multifunction displays convey information withrespect to fuel and oil levels as well as engine activity, such as oil andhydraulic pressure and temperature. This instrumentation includes individualand multiple displays clustered throughout an aircraft’s cockpit. Our displayscan be used in conjunction with our own engine and fuel data equipment or thatof other manufacturers.

Engine and fuel displays are found in all aircraft andare vital to the safe and proper flight of aircraft. In addition, the accurateconveyance of engine and fuel information is critical for the monitoring ofengine stress and the maintenance of engine parts. Engine and fuel displays tendto be replaced more frequently than other displays and have remained largelyunchanged since their introduction due to their low cost, standard design anduniversal use.

We believe that our engineand fuel displays are extremely reliable, and we have designed them to beprogrammable to adapt easily without major modification to most modernaircraft. Our products have been installed on C-130H, DC-9, DC-10,P3 and A-10 aircraft.

**Customers**

Our customers include,among others, the United States Government, Garrett, Bombardier Aerospace (themanufacturer of Learjet), Raytheon, Northwest Airlines, ABX Air, L-3,Spar Aerospace, Federal Express Corporation, The Boeing Company, LockheedMartin Corporation, Rockwell Collins, Gulfstream Aerospace Corporation, PlainAvionics and Star Aviation. The Company recorded sales with Star Aviation thatamounted to 2%, 10% and 11% of total sales for the years 2003, 2004 and 2005,respectively.

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**Retrofit Market**

Historically, the majority of our sales have come fromthe retrofit market. Among other reasons, we have pursued the retrofit marketbecause of its continued rapid growth in response to the increasing need tosupport the world’s aging fleet of aircraft.

Updating anindividual aircraft’s existing electronics equipment has become increasinglycommon as new technology makes existing instrumentation outdated while anaircraft is still structurally and mechanically sound. Retrofitting an aircraftis generally a substantially less expensive alternative to purchasing a new aircraft.We expect our main customers in the retrofit market to be:

·       theDoD and defense contractors;

·       aircraftoperators; and

·       aircraftmodification centers.

*Departmentof Defense and Defense Contractors.**  *We sell our products directly tothe DoD as well as to domestic and international defense contractors for enduse on military aircraft retrofit programs. DoD programs generally take one oftwo forms, a subcontract with a prime government contractor, such as Boeing orRockwell Collins, or a direct contract with the appropriate government agencysuch as the United States Air Force’s requirement for replacing Central AirData Computers on the fleet of A-10 aircraft. The government’s desire forcost-effective retrofitting of aircraft has led it to purchase commercialoff-the-shelf equipment rather than requiring the development of speciallydesigned products, which are usually more costly and take a longer time todevelop. These contracts tend to be on commercial terms, although some of thetermination and other provisions of government contracts described below aretypically applicable to these contracts. Each government agency or generalcontractor retains the right to terminate the contract at any time at itsconvenience. Upon such alteration or termination, we would be entitled to anequitable adjustment to the contract price so that we may receive the purchaseprice for already delivered items and reimbursement for allowable costsincurred.

*AircraftOperators.**  *Wealso sell our products to aircraft operators, including commercial airlines,cargo carriers and business and general aviation. Our products are used mostlyin the retrofitting of aircraft owned or operated by these customers, whichgenerally retrofit and maintain their aircraft themselves. Our commercial fleetcustomers include Northwest Airlines, Air Canada, Midcoast, MK Airlines, ABXAir, Federal Express, Kitty Hawk, ARC, Champion and Kelowna Flightcraft LTD. Wesell these customers a range of products from fuel quantity indicators to airdata systems.

*Aircraft ModificationCenters.**  *Basedon industry data, we believe there are approximately 12,800 private andcorporate aircraft in service in North America. The primary retrofit market forprivate and corporate jets is through aircraft modification centers, whichrepair and retrofit private aircraft in a manner similar to the way automechanics service a person’s car. We have established relationships with anumber of aircraft modification centers throughout the United States. Thesemodification centers essentially act as distribution outlets for our products.We believe that our air data systems and related components are being promotedby aircraft modification centers to update older or outdated equipment. Ourlarge modification center customers include Bombardier Learjet, GarrettAviation, Butler National (AVCON), Star Aviation, Duncan Aviation, PlainAvionics and Raytheon Aircraft Services.

**OEM Market**

We also market our products to original equipmentmanufacturers, particularly manufacturers of corporate and private jets as wellas to DoD contractors manufacturing military jets. Customers of our productsinclude Bombardier (the manufacturer of Learjet), Gulfstream, Boeing, Raytheon,Piaggio and Lockheed.

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Most aircraftmanufacturers equip their current production aircraft with RVSM-compliant airdata systems. In addition, we expect that as flat panel displays becomeincreasingly popular, OEMs will begin manufacturing an increasing percentage oftheir aircraft with flat panel displays, either as standard or optionalequipment. Most new high-end business aviation aircraft have flat paneldisplays as standard equipment.

**Backlog**

As of September 30,2004 and 2005, our backlog was $35.4 million and $12.9 million, respectively.The year over year decline in backlog reflects the passing of peak demand forRVSM related Air data products. It also reflects our short delivery cycle asproduct is quickly delivered to end users once an order is received.

**Sales and Marketing**

We have generally focused our sales efforts on theDoD, DoD contractors, aircraft operators and OEMs, and more recently onaircraft modification centers. We have recently increased our sales effortswith respect to the commercial and corporate aviation markets. To date, we havemade substantial use of third-party sales representatives for our salesefforts. We compensate these third-party sales representatives throughcommissions.

We believe that our ability to provide prompt andeffective repair and upgrade service is critical to our marketing efforts. Aspart of our customer service program, we offer a 24-hour hotline thatcustomers can call with respect to product repair or upgrade concerns. Weemploy field service engineers to service our equipment and, depending on theservice required, we may either dispatch a service crew to make necessaryrepairs or request that the customer return the product to us for repairs orupgrades at our facility. In the event repairs or upgrades are required to bemade at our facility, we provide spare products for use by our customers duringthe repair time. Our in-house turnaround repair times average 15 days andturnaround upgrade times average 30 days. Before returning our products tocustomers, all repaired or upgraded products are retested for airworthiness.

In connection with ourcustomer service program, we typically provide our customers with a two-yearwarranty on new products. We also offer our customers extended warranties ofvarying terms for additional fees.

**Government Regulation**

The manufacture and installation of our products inaircraft owned and operated in the United States is governed by FAAregulations. We maintain an FAA certified production facility. The mostsignificant of the product and installation regulations focus on TechnicalStandard Order (TSO) and Supplemental Type Certificate (STC) certifications.These certifications set forth the minimum general standards that a certaintype of equipment should meet. As required, we deliver our product in accordancewith FAA regulations.

Sales of our products to European or other non-U.S.owners of aircraft also typically require approval of the European AviationSafety Agency (EASA), the European counterpart of the FAA, or anotherappropriate governmental agency. EASA certification requirements for themanufacturing and installation of our products in European-owned aircraftmirror the FAA regulations. Much like the FAA certification process, the EASAhas established a process for granting European Certifications.

In addition toproduct-related regulations, we are also subject to the government’sprocurement regulations with respect to sales of our products to governmententities or government contractors. These regulations dictate the manner inwhich products may be sold to the government and set forth other requirementsthat must be met in order to do business with or on behalf of governmententities. For 

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example,pursuant to such regulations, the government agency or general contractor mayalter the price, quantity or delivery schedule of our products. In addition,the government agency or general contractor retains the right to terminate thecontract at any time at its convenience. Upon such alteration or termination,we would be entitled to an equitable adjustment to the contract price so thatwe may receive the purchase price for already delivered items and reimbursementfor allowable costs incurred.

**Manufacturing,Assembly and Materials Acquisition**

Our manufacturing activities consist primarily ofassembling and testing components and subassemblies and integrating them into afinished system. We believe that this method allows us to achieve relativelyflexible manufacturing capacity while minimizing expenses. We generallypurchase the components for our products from third-party vendors and assemblethem in a clean room environment to reduce impurities and improve theperformance of our products. Many of the components we purchase are standardproducts, although certain parts are made to our specifications.

When appropriate, we enterinto long-term supply agreements and use our relationships with long-termsuppliers to improve product quality and availability and to reduce deliverytimes and product costs. In addition, we are continually identifying alternativesuppliers for important component parts. Using component parts from newsuppliers in our products generally requires FAA certification of the entirefinished product if the newly sourced component varies significantly from ouroriginal drawings and specifications. To date, we have not experienced anysignificant delays in the delivery of our products caused by the inability toobtain either component parts or FAA approval of products incorporating newcomponent parts.

**Quality Assurance**

Product quality is ofvital importance to our customers, and we have taken steps to enhance theoverall quality of our products. We are ISO 9001 and AS 9100 certified. ISO9001 and AS 9100 standards are an international consensus on effectivemanagement practices with the goal of ensuring that a company can consistentlydeliver its products and related services in a manner that meets or exceedscustomer quality requirements. These standards allow us to represent to ourcustomers that we maintain high quality industry standards in the education ofour employees and the design and manufacture of our products. In addition, ourproducts undergo extensive quality control testing prior to being delivered tocustomers. As part of our quality assurance procedures, we maintain detailedrecords of test results and our quality control processes.

**Our Competition**

The market for our products is highly competitive andcharacterized by several industry niches in which a number of manufacturersspecialize. Our competitors vary in size and resources, and substantially allof our competitors are much larger and have substantially greater resources.With respect to air data systems and related products, our principalcompetitors include Kollsman Inc., Honeywell International Inc., Rockwell Collins, Inc.,Thales and Smiths PLC. With respect to flat panel displays, our principalcompetitors currently include Honeywell, Rockwell Collins, Inc., L-3Communications and Smiths. However, because the flat panel display industry isa new and evolving market, as the demand for flat panel displays increases, wemay face competition in this area from additional companies in the future.

We believe that theprincipal competitive factors in the markets we serve are cost, developmentcycle time, responsiveness to customer preferences, product quality, technologyand reliability. We believe that our significant and long-standing customerrelationships reflect our ability to compete favorably with respect to thesefactors.

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**IntellectualProperty and Proprietary Rights**

We rely on patents to protect our proprietarytechnology. We currently hold 15 U.S. patents and have 5 U.S. patentapplications pending relating to our technology. In addition, we have 6international patents and 19 international patent applications pending. Ourpatents have durations of between 3 and 18 years. Certain of these patents andpatent applications cover technology relating to air data measurement systemsand RVSM calibration techniques while others cover technology relating to flatpanel display systems and other aspects of our CIP solution. While we believethat these patents have significant value in protecting our technology, we alsobelieve that the innovative skill, technical expertise and the know-how of ourpersonnel in applying the technology reflected in our patents would bedifficult, costly and time consuming to reproduce.

While there are no pendinglawsuits against us regarding the infringement of any patents or otherintellectual property rights, we cannot be certain that such infringementclaims will not be asserted against us in the future.

**InnovativeSolutions and Support Website**

Our primary website is at *http://www.innovative-ss.com*. We make available, free ofcharge, at our corporate website our annual report on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-Kand amendments to those reports filed or furnished pursuant to Section 13(a) or15(d) of the Securities and Exchange Act of 1934, as amended, as soon asreasonably practicable after we electronically file such material with, orfurnish it to, the SEC.

**Our Employees**

As of September 30, 2005, we had 153 employees,69 were in our manufacturing and assembly operations, 51 in research anddevelopment, 9 in quality and 24 in selling & general administrativepositions.

Our future success dependson our ability to attract, train and retain highly qualified personnel. We planto hire additional personnel, including, in particular, sales and marketingpersonnel, during the next twelve months. Competition for such qualifiedpersonnel is intense and we may not be able to attract, train and retain highlyqualified personnel in the future. Our employees are not represented by a laborunion.

**Other**

On June 13, 2005, theCompany’s Board of Directors approved a three-for-two split of the Company’scommon stock. The stock split was in the form of a fifty percent (50%) stockdividend that was paid on July 7, 2005 to shareholders of record on June 23,2005. The issued and outstanding common stock and all share and per share amounts(except par value) have been retroactively restated in this report to giveeffect to this three-for-two stock split.

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**ExecutiveOfficers of the Registrant**

Thefollowing is a list of our executive officers, their ages and their positions:

| **Name**                              | ** ** | ** ** | ** ** | **Age**                                            | ** ** | **Position** |
|---------------------------------------|------------|------------|------------|----------------------------------------------------|------------|--------------|
| Geoffrey S. M. Hedrick |       | 63         |       | Chairman of the Board  and Chief Executive Officer |
| Roman G. Ptakowski                    |       | 57         |       | President                                          |
| James J. Reilly                       |       | 65         |       | Chief Financial Officer                            |

* *

*GeoffreyS. M. Hedrick* has been Chief Executive Officersince he founded IS&S in February 1988 and Chairman of the Board since1997. Prior to founding IS&S, Mr. Hedrick served as President andChief Executive Officer of Smiths Industries North American AerospaceCompanies. He also founded Harowe Systems, Inc. in 1971, which wassubsequently acquired by Smiths Industries. Mr. Hedrick has over 35 yearsof experience in the avionics industry, and he holds a number of patents in theelectronics, optoelectric, electromagnetic, aerospace and contamination-controlfields.

*RomanG. Ptakowski** *hasbeen President since March 2003. Prior to that, Mr. Ptakowski servedas a Group Vice President and General Manager and, before that, as a VicePresident of Sales and Marketing at B/E Aerospace, Inc. Previously, Mr. Ptakowskiheld a number of positions with increasing responsibility within ASEA BrownBoveri Power T&D Company, Inc. There, he was General Manager of theProtective Relay Division before leaving to join B/E Aerospace, Inc. Mr. Ptakowskireceived a B.S. in Electrical Engineering from New York University and a MBAfrom Duke University.

*James J. Reilly* hasbeen Chief Financial Officer since February 2000. From 1996 to 1999, Mr. Reillywas employed by B/E Aerospace, Inc., Seating Products Group, as VicePresident and Chief Financial Officer. From 1989 to 1996, Mr. Reilly wasemployed by E-Systems, Inc. as Vice President and Principal AccountingOfficer. Mr. Reilly received a Bachelor of Science degree and a MBA fromThe University of Hartford.

**Item 1A.     RiskFactors.**

*Risks Related toOur Business*

Our sales principally relate to air data and flatpanel systems products, and we cannot be certain that the market will continueto accept these or other products.

During fiscal 2005 and 2004, we derived 94% and 97%,respectively, of our revenues from the sale of air data systems and relatedproducts. We expect that revenues from our air data products will continue todecline as the peak demand associated with the FAA’s RVSM mandate has beenaccommodated. Accordingly, our revenues will decrease if new products (FlatPanel Display Systems) do not receive market acceptance or if our existingcustomers do not continue to incorporate our products in their retrofitting ormanufacturing of aircraft. In seeking new customers, it may be difficult forour products to displace competing products. Accordingly, we cannot assure youthat potential customers will accept our products or that existing customerswill not abandon them.

A portion of our sales has been, and we expect willcontinue to be, to defense contractors or government agencies in connectionwith government aircraft retrofit or original manufacturing contracts. Sales togovernment contractors and government agencies accounted for approximately 22%,7% and 20%, respectively, of our revenues during fiscal 2003, 2004 and 2005.Our revenues in this area could decline as a result of DoD spending cuts andgeneral budgetary constraints.

In addition, our revenues are concentrated with alimited number of customers. We derived 47% of our revenues during fiscal year2005 from 5 customers, Bombardier, Star Aviation, Garrett, FedEx and the DoD.We derived 46% of our revenues during fiscal year 2004 from 5 customers,Bombardier, Northwest 

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Airlines, Star Aviation,Plain Avionics and Raytheon. We expect a relatively small number of customersto account for a majority of our revenues for the foreseeable future. As aresult of our concentrated customer base, a loss of one or more of thesecustomers could adversely affect our revenues and results of operations.

The growth of our customerbase could be limited by delays or difficulties in completing the developmentand introduction of our planned products or product enhancements. If we fail toenhance existing products or to develop and achieve market acceptance for flatpanel displays and other new products that meet customer requirements, ourbusiness may not grow.

Although a substantialmajority of our revenues has come from sales of air data systems and relatedproducts, we currently spend a large portion of our research and developmentefforts in developing and marketing our flat panel display systems (CIP) andcomplementary products. Our ability to grow and diversify our operationsthrough the introduction and sale of new products, such as flat panel displaysystems, is dependent upon our success in continuing product development andengineering activities as well as our sales and marketing efforts and ourability to obtain requisite approvals to sell such products. Our sales growthwill also depend in part on the market acceptance of and demand for our CIP andfuture products. We cannot be certain that we will be able to develop,introduce or market our CIP or other new products or product enhancements in atimely or cost-effective manner or that any new products will receive market acceptanceor necessary regulatory approval.

We rely on third partysuppliers for the components of our air data systems products, and anyinterruption in the supply of these components could hinder our ability todeliver our products.

Our manufacturing processconsists primarily of assembling components purchased from our supply chain.These suppliers may not continue to be available to us. If we are unable tomaintain relationships with key third party suppliers, the development anddistribution of our products could be delayed until equivalent components canbe obtained and integrated into our products. In addition, substitution ofcertain components from other manufacturers may require FAA or other approval,which could delay our ability to ship products.

Our government retrofitprojects are generally pursuant to either a direct contract with a governmentagency or a subcontract with the general contractor to a government agency.Each contract includes various federal regulations that impose certain requirementson us, including the ability of the government agency or general contractor toalter the price, quantity or delivery schedule of our products. In addition,the government agency or general contractor retains the right to terminate thecontract at any time at its convenience. Upon alteration or termination ofthese contracts, we would be entitled to an equitable adjustment to thecontract price so that we may receive the purchase price for items we havedelivered and reimbursement for allowable costs we have incurred. Accordingly,because these contracts can be terminated, we cannot assure you that ourgovernment retrofit backlog will result in sales.

We depend on our key personnel to manage our businesseffectively, and if we are unable to retain our key employees, our ability tocompete could be harmed.

Our success depends on the efforts, abilities andexpertise of our senior management and other key personnel. With the exceptionof our President, we generally do not have employment agreements with ouremployees. There can be no assurance that we will be able to retain suchemployees, the loss of some of whom could hurt our ability to execute ourbusiness strategy. We intend to continue hiring key management and sales andmarketing personnel. Competition for such personnel is intense, and we may notbe able to attract or retain additional qualified personnel. We do not maintainkey man life insurance for our executive officers.

Our future success will depend in part on our abilityto implement and improve our operational, administrative and financial systemsand controls and to manage, train and expand our employee base. We 

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cannot assure you that ourcurrent and planned personnel levels, systems, procedures and controls will beadequate to support our future operations. If inadequate, we may not be able toexploit existing and potential market opportunities. Any delays or difficultieswe encounter could impair our ability to attract new customers or enhance ourrelationships with existing customers. Our revenue and operating results mayvary significantly from quarter to quarter, which may cause our stock price todecline.

Our revenues andoperating results may vary significantly from quarter to quarter due to anumber of factors, including:

·       demandfor our products;

·       capitalexpenditure budgets of aircraft owners and operators and the appropriationcycles of the U.S. government;

·       changesin the use of our products, including air data systems and flat panel displays;

·       delaysin introducing or obtaining government approval for new products;

·       newproduct introductions by competitors;

·       changesin our pricing policies or the pricing policies of our competitors; and

·       costsrelated to possible acquisitions of technologies or businesses.

We plan to increase our operating expenses to expandour sales and marketing operations and fund greater levels of productdevelopment. As a result, a delay in generating revenues could causesignificant variations in our operating results from quarter to quarter.

Our competition includes other manufacturers of airdata systems and flight information displays against whom we may not be able tocompete successfully.

The markets for our products are intensely competitiveand subject to rapid technological change. Our competitors includeKollsman, Inc., Honeywell International Inc., Rockwell Collins Inc.,Smiths Industries plc and L-3 Communications. Substantially all of ourcompetitors have significantly greater financial, technical and human resourcesthan we do. In addition, our competitors have much greater experience in andresources for marketing their products. As a result, our competitors may beable to respond more quickly to new or emerging technologies and customerpreferences or devote greater resources to the development, promotion and saleof their products than we can. Our competitors may also have greater namerecognition and more extensive customer bases that they can use to theirbenefit. This competition could result in price reductions, fewer customerorders, reduced gross margins and loss of market share.

We may not be able to identify or completeacquisitions or we may consummate an acquisition that adversely affects ouroperating results.

One of our strategies is to acquire businesses ortechnologies that will complement our existing operations. We have limitedexperience in acquiring businesses or technologies. There can be no assurancethat we will be able to acquire or profitably manage acquisitions orsuccessfully integrate them into our operations. Furthermore, certain risks areinherent in our acquisition strategy, such as the diversion of management’stime and attention and combining disparate company cultures and facilities.Acquisitions may have an adverse effect on our operating results, particularlyin quarters immediately following the consummation of such transactions, as weintegrate the operations of the acquired businesses into our operations. Onceintegrated, acquisitions may not perform as expected.

Our success depends on our ability to protect ourproprietary rights, and there is a risk of infringement. If we are unable toprotect and enforce our intellectual property rights, we may be unable tocompete effectively.

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Our success and ability to compete will depend in parton our ability to obtain and maintain patent or other protection for ourtechnology and products, both in the United States and abroad. In addition, wemust operate without infringing the proprietary rights of others.

We currently hold 15 U.S.patents and have 5 U.S. patent applications pending. In addition, we have 6 internationalpatents and 19 international patent applications pending. We cannot be certainthat patents will be issued on any of our present or future applications. Inaddition, our existing patents or any future patents may not adequately protectour technology if they are not broad enough, are successfully challenged orother entities are able to develop competing methods without violating ourpatents. If we are not successful in protecting our intellectual property,competitors could begin to offer products that incorporate our technology.Patent protection involves complex legal and factual questions and, therefore,is highly uncertain, and litigation relating to intellectual property is oftenvery time consuming and expensive. If a successful claim of patent infringementwere made against us or we are unable to develop non-infringing technology orlicense the infringed or similar technology on a timely and cost-effectivebasis, we might not be able to make some of our products.

*Risks Related toOur Industry*

If we are unable torespond to rapid technological change, our products could become obsolete andour reputation could suffer. Future generations of air data systems, engine andfuel displays and flat panel displays embodying new technologies or newindustry standards could render our products obsolete. The market for aviationproducts is subject to rapid technological change, new product introductions,changes in customer preferences and evolving industry standards. Our futuresuccess will depend on our ability to:

·       adaptto rapidly changing technologies;

·       adaptour products to evolving industry standards; and

·       developand introduce a variety of new products and product enhancements to address theincreasingly sophisticated needs of our customers.

Our future success will also depend on our developinghigh quality, cost-effective products and enhancements to our products thatsatisfy the needs of our customers and on our introducing these newtechnologies to the marketplace in a timely manner. If we fail to modify orimprove our products in response to evolving industry standards, our productscould rapidly become obsolete.

Our products are currently subject to directregulation by the U.S. Federal Aviation Administration (FAA), its Europeancounterpart, the European Aviation Safety Administration (EASA), and othercomparable organizations. Our products, as they relate to aircraftapplications, must be approved by the FAA, EASA or other comparableorganizations before they can be used in an aircraft. To be certified, we mustdemonstrate that our products are accurate and able to maintain certain levelsof repeatability over time. Although the certification requirements of the FAAand the EASA are substantially similar, there is no formal reciprocity betweenthe two systems. Accordingly, even though some of our products are FAA-approved,we may need to obtain approval from the EASA or other appropriate organizationsto have them certified for installation outside the United States.

Significant delay in receiving certification for newlydeveloped products or enhancements to our products or losing certification forour existing products could result in lost sales or delays in sales.Furthermore, the adoption of additional regulations or product standards, aswell as changes to the existing product standards, could require us to changeour products and underlying technology. We cannot assure you that we willreceive regulatory approval on a timely basis or at all.

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Because our products utilize sophisticated technologyand are deployed in complex aircraft cockpit environments, problems with theseproducts may arise that could seriously harm our reputation for qualityassurance and our business.

Ourproducts use complex system designs and components that may contain errors,omissions or defects, particularly when we incorporate new technologies intoour products or we release new versions or enhancements of our products.Despite our quality assurance process, errors, omissions or defects could occurin our current products, in new products or in new versions or enhancements ofexisting products after commercial shipment has begun. We may be required toredesign or recall those products or pay damages. Such an event could result inthe following:

·       delayor loss of revenues;

·       cancellationof customer contracts;

·       diversionof development resources;

·       damageto our reputation;

·       increasedservice and warranty costs; or

·       litigationcosts.

Although we currentlycarry product liability insurance, this insurance may not be adequate to coverour losses in the event of a product liability claim. Moreover, we may not beable to maintain such insurance in the future.

Weexpect to derive an increasing amount of our revenues from sales outside theUnited States, particularly in Europe. We have limited experience in marketingand distributing our products internationally. In addition, there are certainrisks inherent in doing business on an international basis, such as:

·       differingregulatory requirements for products being installed in aircraft;

·       legaluncertainty regarding liability;

·       tariffs,trade barriers and other regulatory barriers;

·       politicaland economic instability;

·       changesin diplomatic and trade relationships;

·       potentiallyadverse tax consequences;

·       theimpact of recessions in economies outside the United States; and

·       varianceand unexpected changes in local laws and regulations.

Currently, all of ourinternational sales are denominated in U.S. dollars. An increase in the valueof the dollar compared to other currencies could make our products lesscompetitive in foreign markets. In the future, we may be required to conductsales in local currencies, exposing us to changes in exchange rates that couldadversely affect our operating results.

**Item 1B.     UnresolvedStaff Comments.**

None

**Item 2.**                        Properties.

In fiscal 2001 wepurchased 7 and 1¤2acres of land in the Eagleview Corporate Park located in Exton, Pennsylvania, asuburban Philadelphia location. There we constructed a 44,800 square footdesign, 

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manufacturingand office facility. Land development approval allows for expansion of up to20,400 additional square feet. This would provide for a 65,200 square footfacility. The construction was principally funded with a Chester CountyIndustrial Revenue Bond. The building serves as security for the IndustrialRevenue Bond.

**Item 3.**                        LegalProceedings.

In the ordinary course ofour business, we are at times subject to various legal proceedings. We do notbelieve that any current legal proceedings will have a material adverse effecton our results of operations or financial position.

**Item 4.**                        Submissionof Matters to a Vote of Security Holders.

No matters were submitted to a vote of ourshareholders during the three months ended September 30, 2005.

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**Part II**

**Item 5.**                        Marketfor the Registrant’s Common Equity and Related Stockholder Matters.

Ourcommon stock has been traded on the Nasdaq National Market under the symbol “ISSC”since our initial public offering on August 4, 2000. The following tablelists the high and low per share sale prices for our common stock for theperiods indicated:

| ** **     | ** ** | **Fiscal 2004** | ** ** | **Fiscal 2005** | ** ** |
|----------------|------------|----------------------|------------|----------------------|------------|
| **Period**     | ** ** | ** **           | ** ** | **High**             | ** ** | **Low** | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $                    | 12.17      |                 | $          | 5.05 |   | $ | 23.65 |   | $ | 13.37 |   |
| Second Quarter |       | $                    | 11.40      |                 | $          | 7.93 |   | $ | 22.79 |   | $ | 17.71 |   |
| Third Quarter  |       | $                    | 14.40      |                 | $          | 9.23 |   | $ | 26.13 |   | $ | 19.07 |   |
| Fourth Quarter |       | $                    | 19.40      |                 | $          | 12.71 |   | $ | 23.50 |   | $ | 14.75 |   |
|                |            |                      |            |                      |            |  |  |  |  |  |  |  |  |  |  |

 

On November 28, 2005, there were 29 holders ofrecord of the shares of outstanding common stock.

We have not paid cashdividends on our common stock, and we do not expect to declare cash dividendson our common stock in the near future. We intend to retain any earnings tofinance the growth of our business.

**EquityCompensation Plan Information**

Thefollowing table gives information about our common stock that may be issuedupon the exercise of options, warrants and rights under all of our existingequity compensation plans and arrangements as of September 30, 2005,including the 1998 Stock Option Plan.

| **Plan Category**                                      | ** ** | ** ** | ** ** | **Number of Securities  to be issued upon  exercise of outstanding  options, warrants and rights** | ** ** | **Weighted-average  exercise price of  outstanding options,  warrants and rights** | ** ** | **Number of Securities  remaining available for  future issuance under  equity compensation  plans (excluding securities  reflected in second column)** | ** ** |
|-------------------------------------------------------------|------------|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  compensation plans approved by security holders     |       |       | 594,253    |                                                                                                                                                 |       |                                                                                                        | $          | 8.76                                                                                                                                                                                                                |       |   |   | 1,745,719 |   |   |
| Equity  compensation plans not approved by security holders |       |       | 0          |                                                                                                                                                 |       |                                                                                                        | $          | 0                                                                                                                                                                                                                   |       |   |   | 0 |   |   |
| Total                                                       |       |       | 594,253    |                                                                                                                                                 |       |                                                                                                        | $          | 8.76                                                                                                                                                                                                                |       |   |   | 1,745,719 |   |   |

 

The 2003 Restricted Stock Plan for non-employeedirectors was approved by shareholders at the Company’s February 26, 2004Annual Meeting of Shareholders. The Plan called for an annual award ofrestricted stock, having a fair market value of $25,000 as of the close ofbusiness on October 1, of the current fiscal year, for all eligiblenon-employee directors. The stock vest quarterly during the fiscal yearprovided the director was still serving on the board on the vesting date. Infiscal year 2005 the annual award was increased to $40,000 effective the fourthquarter of the fiscal year.

In the fiscal years ended September 30,2003, 2004 and 2005, awards to our non-employee directors under the Plan were29,817, 30,855 and 15,828 shares respectively.

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**Item 6.**                        SelectedFinancial Data.

The following tables present portions of ourconsolidated financial statements. You should read the following selectedconsolidated financial data set forth below together with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andour consolidated financial statements and related notes to our financialstatements appearing elsewhere herein. The selected statement of operationsdata for the years ended September 30, 2005, 2004 and 2003 and the balancesheet data as of September 30, 2005 and 2004 are derived from our auditedconsolidated financial statements included elsewhere in this Annual Report on Form 10-K.The selected statements of operations data for the years ended September 30,2002 and 2001 and the balance sheet data as of September 30, 2003, 2002and 2001 are derived from our audited consolidated financial statements thatare not included in this Annual Report on Form 10-K.

| ** **                            | ** ** | **Fiscal year ended September 30,** | ** ** |
|---------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                            | ** ** | **2001**                                                | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
| **Statement of Operations Data:**     |       |                                                    |       |   |   |   |   |   |   |   |   |
| Net sales                             |       | $                                                       | 34,384,562 |   | $ | 28,345,620 |   | $ | 28,168,752 |   | $ | 46,099,777 |   | $ | 63,264,359 |   |
| Cost of sales                         |       | 14,477,868                                              |       | 11,290,085 |   | 11,346,057 |   | 15,663,108 |   | 20,888,729 |   |
| Gross profit                          |       | 19,906,694                                              |       | 17,055,535 |   | 16,822,695 |   | 30,436,669 |   | 42,375,630 |   |
| Research and  development             |       | 4,371,570                                               |       | 4,755,422 |   | 3,376,849 |   | 4,811,156 |   | 6,057,889 |   |
| Selling, general  and administrative  |       | 5,777,929                                               |       | 5,732,886 |   | 5,890,362 |   | 7,567,959 |   | 8,898,622 |   |
| Total operating  expenses             |       | 10,149,499                                              |       | 10,488,308 |   | 9,267,211 |   | 12,379,115 |   | 14,956,511 |   |
| Operating income                      |       | 9,757,195                                               |       | 6,567,227 |   | 7,555,484 |   | 18,057,554 |   | 27,419,119 |   |
| Interest (income)  expense, net  |       | (2,196,401                                              | )          | (722,850 | ) | (450,421 | ) | (404,727 | ) | (1,764,246 | ) |
| Income before  income taxes           |       | 11,953,596                                              |       | 7,290,077 |   | 8,005,905 |   | 18,462,281 |   | 29,183,365 |   |
| Income tax  (expense) benefit, net    |       | (4,422,831                                              | )          | (1,879,799 | ) | (2,464,715 | ) | (6,530,084 | ) | (10,598,563 | ) |
| Net income                            |       | $                                                       | 7,530,765  |   | $ | 5,410,278 |   | $ | 5,541,190 |   | $ | 11,932,197 |   | $ | 18,584,802 |   |
| Net income per common  share:         |       |                                                    |       |   |   |   |   |   |   |   |   |
| Basic                                 |       | $                                                       | 0.39       |   | $ | 0.28 |   | $ | 0.30 |   | $ | 0.69 |   | $ | 1.04 |   |
| Diluted                               |       | $                                                       | 0.38       |   | $ | 0.28 |   | $ | 0.30 |   | $ | 0.67 |   | $ | 1.02 |   |
| Weighted average shares  outstanding  |       |                                                    |       |   |   |   |   |   |   |   |   |
| Basic                                 |       | 19,097,093                                              |       | 19,246,341 |   | 18,391,626 |   | 17,400,380 |   | 17,873,780 |   |
| Diluted                               |       | 19,926,726                                              |       | 19,604,081 |   | 18,743,661 |   | 17,928,180 |   | 18,259,856 |   |

 

| ** **                                                | ** ** | **September 30,** | ** ** |
|-----------------------------------------------------------|------------|------------------------|------------|
| ** **                                                | ** ** | **2001**               | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
| **Balance Sheet Data:**                                   |       |                   |       |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                                |       | $                      | 42,769,837 |   | $ | 52,245,754 |   | $ | 48,789,744 |   | $ | 65,867,167 |   | $ | 83,172,582 |   |
| Working capital                                           |       | 56,254,288             |       | 59,158,307 |   | 55,996,411 |   | 70,627,114 |   | 93,455,475 |   |
| Total Assets                                              |       | 68,051,426             |       | 72,616,685 |   | 69,876,625 |   | 87,468,627 |   | 107,034,878 |   |
| Debt and capital  lease obligations, less current portion |       | 4,252,635              |       | 4,235,000 |   | 4,235,000 |   | 4,255,681 |   | 4,248,113 |   |
| Total shareholders’  equity                          |       | $                      | 60,378,704 |   | $ | 64,726,210 |   | $ | 61,058,290 |   | $ | 75,454,987 |   | $ | 97,866,098 |   |

 

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**Item 7.**                        Management’sDiscussion and Analysis of Financial Condition and Results of Operations.

All statements made inthis Annual Report on Form 10-K, other than statements of historicalfact, are forward-looking statements. The words “anticipate”, “believe”, “estimate”,“expect”, “intend”, “may”, “plan”, “will”, “would”, “should”, “guidance”, “potential”,“continue”, “project”, “forecast”, and similar expressions, beliefs,assumptions, estimates and forecasts about our business and the industry andmarkets in which we operate are not guarantees of future performance andinvolve risks, uncertainties and assumptions, which are difficult to predict.Therefore, actual outcomes and results may differ materially from what isexpressed or implied by these forward-looking statements. Factors which mayaffect our business, financial condition and operating results are discussedunder “Risk Factors”. We expressly disclaim any intent or obligation to updatethese forward-looking statements.

**Overview**

Innovative Solutions and Support was founded in 1988.The Company designs, develops, manufactures and markets flight informationcomputers, large flat-panel displays and advanced monitoring systems thatmeasure and display critical flight information, including data relative toaircraft separation (RVSM), airspeed and altitude as well as engine and fueldata measurements.

Our sales are derived from the sale of our products tothe retrofit market and, to a lesser extent, original equipment manufacturers(OEMs). Our customers include the DoD and their commercial contractors,aircraft operators, aircraft modification centers and various OEMs. Althoughwe occasionally sell our products directly to the DoD, we primarily have soldour products to commercial customers for end use in DoD programs. Sales todefense contractors are on commercial terms, although some of the terminationand other provisions of government contracts are applicable to these contracts.

Our cost-of-sales is comprised of material componentspurchased through our supplier base and direct in-house assembly labor andoverhead costs. Many of the components we use in assembling our products arestandard, although certain parts are manufactured to meet our specifications.The overhead portion of cost of sales is primarily comprised of salaries andbenefits, building occupancy, supplies, and outside service costs related toour production, purchasing, material control and quality departments as well aswarranty costs.

We intend to continue investing in the development ofnew products that complement our current product offerings and will expenseassociated research and development costs as they are incurred.

Our selling, general andadministrative expenses consist of sales, marketing, business development,professional services and salaries and benefits for executive andadministrative personnel as well as facility costs, recruiting, legal,accounting and other general corporate expenses.

**Results of Operations**

**Fiscal Year Ended September 30,2005 Compared to Fiscal Year Ended September 30, 2004**

*Netsales.**  *Netsales increased $17.2 million or 37% to $63.3 million for the fiscal year endedSeptember 30, 2005 from $46.1 million in the fiscal year ended September 30,2004. The dollar rise in net sales was primarily due to increased demand forour Air Data Products. Flat Panel Display System sales increased from $1.1million in fiscal 2004 to $3.9 million in fiscal 2005, a 250% increase.One-half of the increased Air Data demand was attributable to military retrofitprograms. The balance was principally in response to commercial aviationupgrading their respective aircraft with up-to-date air data systems that fullymeet the Federal Aviation Administration’s (FAA) Reduced Vertical SeparationMinimum (RVSM) mandate. Several general aviation customers, including Garrett,Gulfstream, Bombardier, Star Aviation and AeroMech contributed to the year overyear growth.

21

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*Costof sales.*   Cost of sales increased $5.2 millionor 33% to $20.9 million, or 33% of net sales, for fiscal 2005 from $15.7million, or 34% of net sales, for fiscal 2004. The increase in the dollaramount was essentially due to higher sales in the period. The decline as apercent of net sales was primarily the result of fixed operating costs beingabsorbed over higher net sales in the current period.

*Researchand development.**  *Researchand development expenses increased $1.2 million, or 26%, to $6.1 million, or10% of net sales in fiscal 2005 from $4.8 million or 10% of net sales in fiscal2004. The dollar increase was principally due to increased salaries andassociated benefits. Expense on a percent to sales basis was essentiallyunchanged from year to year.

*Selling,general and administrative.**  *Selling, general and administrative expensesincreased $1.3 million or 18% to $8.9 million, or 14% of net sales, for fiscal2005 from $7.6 million, or 16% of net sales, for fiscal 2004. The increase inthe dollar amount was the result of higher wages, corporate governanceinitiatives and commissions due to higher net sales. The decrease as a percentof net sales was the result of higher net sales in the current period.

*Interest(income) expense, net.**  *Netinterest income increased $1.4 million or 336% to $1.8 million for fiscal 2005from $0.4 million in fiscal 2004. Net interest income for fiscal 2005 washigher because of higher interest rates in the period coupled with higheraverage cash balances.

*Incometax.**  *Incometax expense was $10.6 million in fiscal 2005 compared to $6.5 million in fiscal2004. The $4.1 million income tax increase was mostly the result of a higherprofit before tax in fiscal 2005. Tax rates in both years were essentially unchanged,ranging from 35.4% in fiscal 2004 to 36.3% in fiscal 2005.

*Net income.**  *As a result of the factorsdescribed above, net income increased $6.7 million or 56% to $18.6million, or 29% of net sales in fiscal 2005 from $11.9 million, or 26% of netsales in fiscal 2004. On a fully diluted basis, earnings per share (EPS)increased $0.35 or 52% to $1.02 during fiscal 2005 from $0.67 in fiscal 2004.

**Fiscal Year Ended September 30,2004 Compared to Fiscal Year Ended September 30, 2003**

*Netsales.**  *Netsales increased $17.9 million or 64% to $46.1 million for the fiscal year endedSeptember 30, 2004 from $28.2 million in the fiscal year ended September 30,2003. The rise in net sales was primarily due to increased demand for our AirData Display Units, Digital Air Data Computers and other related air dataproducts. The increased demand is in response to commercial aviation and airtransport customers continuing to upgrade their respective aircraft withup-to-date air data systems that fully meet the Federal Aviation Administration’s(FAA) Reduced Vertical Separation Minimum (RVSM) mandate. Several customers,including Garrett, Northwest Airlines, Bombardier, Plain Avionics, Raytheon,Star Aviation and AVCON contributed to the year over year growth.

*Costof sales.*   Cost of sales increased $4.3 millionor 38% to $15.7 million, or 34% of net sales, for fiscal 2004 from $11.3million, or 40% of net sales, for fiscal 2003. The increase in the dollaramount was essentially due to higher sales in the period. The decline as apercent of net sales was primarily the result of cost containment effortscoupled with fixed operating costs being absorbed over higher net sales in thecurrent period.

*Researchand development.**  *Researchand development expenses increased $1.4 million, or 42%, to $4.8 million, or10% of net sales in fiscal 2004 from $3.4 million or 12% of net sales in fiscal2003. The dollar increase was principally due to increased spending on the flatpanel program as the Company was in final stages of submitting its TechnicalStandard Order (TSO) application to the FAA. As a result of that effort theCompany was awarded a TSO certification for their Flat Panel Display on July 2,2004 by the FAA. On a percent to sales basis, fiscal 2004 was less than fiscal2003 by two percentage points because of higher net sales in the period.

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*Selling,general and administrative.**  *Selling, general and administrative expensesincreased $1.7 million or 28% to $7.6 million, or 16% of net sales, for fiscal2004 from $5.9 million, or 21% of net sales, for fiscal 2003. The increase inthe dollar amount was the result of higher wages, corporate governanceinitiatives and commissions due to higher net sales. The decrease as a percentof net sales was the result of higher net sales in the current period.

*Interest(income) expense, net.**  *Netinterest income decreased less than $0.1 million to $0.4 million in fiscal 2004as compared to net interest income of $0.5 million in fiscal 2003. Net interestincome for fiscal 2004 was lower because of lower interest rates in the period.

*Incometax.**  *Incometax expense was $6.5 million in fiscal 2004 compared to $2.5 million in fiscal2003. The $4.1 million income tax increase was the result of a higher profitbefore tax and a smaller research and development tax credit in fiscal 2004 ascompared to fiscal 2003.

*Net income.**  *As a result of the factorsdescribed above, net income increased $6.4 million or 115% to $11.9 million, or26% of net sales in fiscal 2004 from $5.5 million, or 20% of net sales infiscal 2003. On a fully diluted basis, earnings per share (EPS) increased $0.37or 124% to $0.67 during fiscal 2004 from $0.30 in fiscal 2003.

**Related-Party Transactions:**

The Company incurred legal fees of $127,990, $115,898and $137,000 with a law firm which is a shareholder of the Company for theyears ended September 30, 2003, 2004 and 2005, respectively. The fees paidand services rendered were comparable with the fees paid and services rendered priorto the law firm’s investment in the Company.

The Company derived net sales of $67,989, $124,652 and$83,000 for the years ended September 30, 2003, 2004 and 2005,respectively from an entity which is a shareholder, and purchased $5,612, $0and $0 of component parts used in the manufacturing process from this relatedparty during such years.

For the years ended September 30,2003, 2004 and 2005, respectively, we incurred service fees of $18,703,$124,932 and $33,000 with a commercial graphics firm controlled by anindividual who is married to a significant shareholder and the daughter of theCompany’s Chairman and Chief Executive Officer.

**Liquidity and Capital Resources**

Our primary sources of liquidity over the past threeyears has been cash flows from operations. We require cash principally tofinance inventory, payroll and accounts receivable.

Our cash flow provided from operating activities was$16.0 million in fiscal 2005 as compared to $16.1 million in fiscal 2004. Whilethe cash flows were essentially the same, there were several offsettingamounts, as follows: Net income was up $6.7 million, Inventory improved $3.6million and tax benefits contributed $1.3 million. Offsetting the increase inyear over year cash flow were Prepaid Expenses ($3.4) million, Accounts Payable($2.5) million and Accounts Receivable ($2.4) million. Cash flow provided byoperating activities was $16.1 million in fiscal 2004 as compared to $6.1million in fiscal 2003. The increase in year over year cash flow was primarilythe result of $6.4 million in increased net income coupled with a $3.6 millionimprovement in Accounts Receivable and a $1.0 million improvement in AccruedExpenses. These improvements were partially offset with a ($3.0) millionincrease in Inventory.

Our cash used in investing activities was $0.5 millionin fiscal 2005 as compared to $0.8 million used in fiscal 2004.

Our cash used in investing activities was $0.8 millionin fiscal 2004 as compared to $0.2 million used in fiscal 2003. The year overyear increase in investing activities primarily relates to additions ofengineering and manufacturing equipment needed to meet increased revenuedemand.

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Our cash inflow from financing activities equaled $1.8million in both fiscal 2005 and 2004. The cash inflow in fiscal 2005 was due tothe exercise of stock options. The inflow in fiscal 2004 was due to theexercise of stock options, $1.1 million, and the exercise of warrants, $0.7million. The ($9.4) million cash outflow from financing activities in fiscal2003 was the result of purchasing Company stock. The stock purchase wasinitially treated as Treasury Stock, which was retired in fiscal year 2005, andamounted to a total price of $9.4 million.

To accommodate our future growth, we purchased 7 and 1¤2acres of land in the Eagleview Corporate Park, Exton, Pennsylvania. There weconstructed a 44,800 square foot facility that is expandable to 65,200 squarefeet. Both the land and building cost approximate $6.5 million. Of this amount,$4.3 million was funded through an Industrial Development Bond (IDB) and theremainder from cash from operations.

Ourfuture capital requirements depend on numerous factors, including marketacceptance of our products, the timing and rate of expansion of our business,acquisitions, joint ventures and other factors. We have experienced increasesin our expenditures since our inception consistent with growth in ouroperations, personnel, and product line and we anticipate that our operationsand expenditures will continue to increase in the foreseeable future. Webelieve that our cash and cash equivalents, together with net proceeds from anynew credit facility we may enter into, will provide sufficient capital to fundour operations for at least the next twelve months. However, we may need toraise additional funds through public or private financing or otherarrangements in order to support more rapid expansion of our business than wecurrently anticipate. Further, we may develop and introduce new or enhancedproducts, respond to competitive pressures, invest in or acquire businesses ortechnologies or respond to unanticipated requirements or developments.

| ** **                                                     | ** ** | **Payments Due by Period** | ** ** |
|----------------------------------------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligations**                               | ** ** | ** **                                | ** ** | **Total** | ** ** | **Less than  1 Year** | ** ** | **1-3 Years** | ** ** | **4-5 Years** | ** ** | **After 5  Years** | ** ** |
| Interest on loan  from Chester County Industrial Dev. Auth.(1) |       | $                                         | 1,161,781  |   | $ | 116,178 |   | $ | 232,356 |   | $ | 232,356 |   | $ | 580,890 |   |
| Principal on  Chester County Industrial Loan                   |       | $                                         | 4,335,000  |   | $ | 100,000 |   |   |   |   |   | $ | 4,235,000 |   |
| Capital Leases                                                 |       | $                                         | 20,370     |   | $ | 7,257 |   | $ | 13,113 |   |   |   |   |   |
| Puchase  Obligations(2)                                        |       | $                                         | 729,838    |   | $ | 729,838 |   |   |   |   |   |   |   |
|                                                           |       | $                                         | 6,246,989  |   | $ | 953,273 |   | $ | 245,469 |   | $ | 232,356 |   | $ | 4,815,890 |   |
|                                                                |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          The interest on theIndustrial Development Bond assumes the current rate of 2.68%. The interestrate set by the remarketing agent is consistent with 30-day tax-exemptcommercial paper.

(2)          A“purchase obligation” is defined as an agreement to purchase goods or servicesthat is enforceable and legally binding on the company and that specifies allsignificant terms, including: fixed or minimum quantities to be purchased;fixed, minimum or variable price provisions; and the approximate timing of thetransaction. These amounts are primarily comprised of open purchase ordercommitments to vendors and subcontractors pertaining to fulfillment of ourcurrent order backlog.

**Off-Balance Sheet Arrangements**

The Company does not haveany off-balance sheet arrangements.

**Inflation**

We do not believe thatinflation has had a material effect on our financial position or results ofoperations during the past three years. However, we cannot predict the futureeffects of inflation.

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**Critical Accounting Policies**

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities, disclosure of contingent assets andliabilities at the date of the financial statements and the reported amount ofrevenues and expenses during the reporting period. The Company’s most criticalaccounting policies are revenue recognition, income taxes, allowance fordoubtful accounts, inventory valuation and warranty reserves.

The Company recognizes sales for products when thefollowing revenue recognition criteria are met: persuasive evidence of anarrangement exists, product delivery and acceptance has occurred, pricing isfixed or determinable, and collection is reasonably assured. The Companyrecognizes sales upon shipment of products to customers.

Sales related to certain long-term contracts requiringdevelopment and delivery of products over several years are accounted for underthe American Institute of Certified Public Accountants (AICPA) Statement ofPosition (SOP) 81-1, *Accounting forPerformance of Construction-Type and Certain Production-Type Contracts.*Weconsider the nature of these contracts as well as the types of products andservices provided when determining the appropriate accounting treatment for aparticular contract. Certain long-term contracts are recorded on apercentage-of-completion basis using cost-to-cost methodology to measureprogress toward completion.

The Company offers its customers extended warrantiesfor additional fees. These warranty sales are recorded as deferred revenue andrecognized as sales on a straight-line basis over the warranty period.

The Company enters into certain sales arrangementsthat include multiple deliverables as defined in Emerging Issues Task Force(EITF) Issue No. 00-21, *Accountingfor Revenue Arrangements with Multiple Deliverables*. Effective July 1,2003, the Company identifies all goods and/or services that are to be deliveredseparately under a sales arrangement and allocates revenue to each deliverablebased on fair value that is established with the customer during contractnegotiations. In general, revenues are separated between product sales andnon-recurring engineering services. The allocated revenue for each deliverableis then recognized using appropriate revenue recognition methods. Effective fortransactions entered into after October 1, 2003, the Company accounts fortransactions with software and non-software components under EITF Issue 03-5,“Applicability of AICPA Statement of Position 97-2, Software RevenueRecognition, to Non-Software Deliverables in an Arrangement ContainingMore-Than-Incidental Software.”

Income taxes are recorded in accordance with SFAS No. 109,*Accounting for Income Taxes.*Provisionsfor federal and state income taxes are calculated on reported financialstatement pre-tax income based on current tax law. The Company recognizesdeferred tax assets and liabilities for temporary differences between thefinancial reporting basis and the tax basis of the Company’s assets andliabilities and expected benefits of utilizing net operating losscarryforwards. The impact on deferred taxes of changes in tax rates and laws,if any, applied to the years during which temporary differences are expected tobe settled, are reflected in the consolidated financial statements in theperiod of enactment.

We maintain an allowance for doubtful accounts forestimated losses resulting from the inability of our customers to make requiredpayments. These allowances are determined by analyzing historical data andtrends. If actual losses are greater than estimated amounts or if the financialcondition of our customers were to deteriorate, resulting in an impairment oftheir ability to make payments, future results from operations could beadversely affected.

Inventories are written down for estimatedobsolescence equal to the difference between the cost of inventory and theestimated net realizable value based upon assumptions about future marketconditions. 

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If actual future demand ormarket conditions are less favorable than those projected by management,additional inventory write-downs may be required.

We offer warranties onsome products of various lengths. At the time of shipment, we establish areserve for the estimated cost of warranties based on our best estimate of theamounts necessary to settle future and existing claims using historical data onproducts sold as of the balance sheet date. The length of the warranty period,the product’s failure rates and the customer’s usage affects warranty cost. If theactual cost of warranties differs from our estimated amounts, future results ofoperations could be adversely affected.

**New Accounting Pronouncements**

In May 2005, the Financial Accounting StandardsBoard (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 154,“Accounting Changes and Error Corrections—a replacement of APB Opinion No. 20and FASB Statement No. 3”. SFAS No. 154 requires retrospectiveapplication to prior periods’ financial statements of changes in accountingprinciple, unless it is impracticable to determine either the period-specificeffects or the cumulative effect of the change. SFAS No. 154 also requiresthat retrospective application of a change in accounting principle be limitedto the direct effects of the change. Indirect effects of a change in accountingprinciple, such as a change in nondiscretionary profit-sharing paymentsresulting from an accounting change, should be recognized in the period of theaccounting change. SFAS No. 154 also requires that a change in depreciation,amortization, or depletion method for long-lived, nonfinancial assets beaccounted for as a change in accounting estimate effected by a change inaccounting principle. SFAS No. 154 is effective for accounting changes andcorrections of errors made in fiscal years beginning after December 15,2005. Early adoption is permitted for accounting changes and corrections oferrors made in fiscal years beginning after the date this Statement is issued. TheCompany will adopt the provisions of SFAS No. 154 as applicable beginningin fiscal 2007.

In December 2004, The FASB issued SFAS No. 123(R),“Share Based Payment”. Statement No. 123(R) requires all entities torecognize compensation expense in an amount equal to the fair value of sharebased payments granted to employees. This statement is effective for the firstfiscal year beginning after June 15, 2005. The Company will adoptStatement No. 123(R) beginning with the first quarter of fiscal 2006.Adoption of the statement will require the Company to record compensationexpense relating to the issuance of employee stock options. Currently, theCompany follows APB No. 25 which does not require the recognition ofcompensation expense relating to the issuance of stock options so long as thequoted market price of the Company’s stock at the date of grant is less than orequal to the amount an employee must pay to acquire the stock. We are currentlyevaluating the effect of SFAS 123R on our financial statements with the intentof implementing this standard in fiscal 2006. We expect the impact of thisstandard to be consistent with prior years pro forma.

In December 2004, the FASB issued FASB StaffPosition (FSP) FAS 109-1, “Application of FASB Statement No. 109,Accounting for Income Taxes, to the Tax Deduction on Qualified ProductionActivities Provided by the American Jobs Creation Act of 2004”. This FSPprovides guidance on the application of Statement 109 to the provisions withinthe American Jobs Creation Act of 2005 (the Act), which provides tax relief toU.S. domestic manufacturers. The FSP states that a manufacturer’s deductionprovided for under the Act should be accounted for as a special deduction inaccordance with Statement 109 and not as a tax rate reduction. The FSP alsoreminds preparers that the special deduction should be considered by anenterprise in (a) measuring deferred taxes when the enterprise issubjected to graduated tax rates, and (b) assessing whether a valuationallowance is necessary as required by Statement 109. This statement is effectiveimmediately. The Company has adopted this statement and it did not have amaterial impact on the Company’s financial position or results of operations.

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In November 2004, theFinancial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standards (SFAS) 151, “Inventory Costs”. This Statement amends theguidance in ARB No. 43, Chapter 4 “Inventory Pricing”, to clarify the accountingfor abnormal amounts of idle facility expense, freight, handling costs, andwasted material (spoilage). Paragraph 5 of ARB 43, Chapter 4 previously statedthat “... under some circumstances, items such as idle facility expense,excessive spoilage, double freight, and rehandling costs may be so abnormal asto require treatment as current period charges...”. This Statement requires thatthose items be recognized as current-period charges regardless of whether theymeet the criterion of “so abnormal”. In addition, this Statement requires thatallocation of fixed production overheads to the costs of conversion be based onthe normal capacity of the production facilities. This statement is effectivefor inventory costs incurred during fiscal years beginning after June 15,2005. The Company does not expect the adoption of this statement will have amaterial impact on its consolidated financial position or results ofoperations.

**Business Segments**

The Company operates inone principal business segment which designs, manufactures and sells flightinformation computers, large flat-panel displays and advanced monitoringsystems to the DoD, government agencies, defense contractors, commercial airtransport carriers and corporate/general aviation markets. The Company currentlyderives virtually all of its revenues from the sale of this equipment. Almostall of the Company’s sales, operating results and identifiable assets are inthe United States.

**Item 7A.**                Quantitativeand qualitative disclosures about market risk.

The Company’s operationsare exposed to market risks primarily as a result of changes in interest rates.The Company does not use derivative financial instruments for speculative ortrading purposes. The Company’s exposure to market risk for changes in interestrates relates to its cash equivalents and an industrial revenue bond. TheCompany’s cash equivalents consist of funds invested in money market accounts,which bear interest at a variable rate, while the industrial revenue bondcarries an interest rate that is consistent with 30-day tax-exemptcommercial paper. As the interest rates are variable, a change in interestrates earned on the cash equivalents or paid on the industrial revenue bond,would impact interest income and expense along with cash flows, but would notimpact the fair market value of the related underlying instruments.

**Item 8.**                        Financialstatements and supplementary data.

The financial statements of Innovative Solutions andSupport, Inc. listed in the index appearing under Item 8 herein are filedas part of this Report.

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**InnovativeSolutions and Support, Inc.INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**
|                                                          | ** ** | ** ** | **Page** |
|----------------------------------------------------------|------------|------------|----------|
| Report of Independent  Registered Public Accounting Firm |       | 29         |
| Consolidated Balance Sheets                              |       | 30         |
| Consolidated  Statements of Operations                   |       | 31         |
| Consolidated Statements of  Shareholders’ Equity    |       | 32         |
| Consolidated Statements of  Cash Flows                   |       | 33         |
| Notes  to Consolidated Financial Statements              |       | 34-45      |

 

 

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors and Shareholders ofInnovative Solutions and Support, Inc.Exton, Pennsylvania

We have audited the accompanying consolidated balancesheets of Innovative Solutions and Support, Inc. and subsidiaries (the “Company”)as of September 30, 2005 and 2004, and the related consolidated statementsof operations, cash flows, and shareholders’ equity for the three years thenended. These consolidated financial statements are the responsibility of theCompany’s management. Our responsibility is to express an opinion on theseconsolidated financial statements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statementspresent fairly, in all material respects, the financial position of the Companyas of September 30, 2005 and 2004, and the results of its operations andits cash flows for the years then ended in conformity with accountingprinciples generally accepted in the United States of America.

Wehave also audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the effectiveness of the Company’sinternal control over financial reporting as of September 30, 2005, basedon the criteria established in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission and our report dated December 7, 2005 expressed anunqualified opinion on management’s assessment of the effectiveness of theCompany’s internal control over financial reporting and an unqualified opinionon the effectiveness of the Company’s internal control over financialreporting.

| /s/ DELOITTE & TOUCHE LLP   |   |
|-------------------------------------------|--------|
| Philadelphia, Pennsylvania                |   |
| December 7, 2005                     |   |
|                                           |        |  |

 

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**INNOVATIVE SOLUTIONS AND SUPPORT, INC.CONSOLIDATED BALANCE SHEETS**

| **ASSETS**                                                                                                                                                                                                                  | ** ** | **As of**                   | ** **  | **As of**                   | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|-------------|----------------------------------|------------|
| ** **                                                                                                                                                                                                                  | ** ** | **September 30, 2004** | ** **  | **September 30, 2005** | ** ** |
| Current Assets:                                                                                                                                                                                                             |       |                             |        |                             |       |   |   |   |   |
| Cash and cash equivalents                                                                                                                                                                                                   |       |                             | $           | 65,867,167                       |       |   |   | $ | 83,172,582 |   |   |
| Accounts receivable, less allowance for doubtful  accounts of $100,000 at September 30, 2004 and 2005                                                                                                                       |       |                             | 5,003,100   |                             |       |   | 5,479,936 |   |   |
| Inventories                                                                                                                                                                                                                 |       |                             | 5,191,628   |                             |       |   | 3,911,626 |   |   |
| Deferred income taxes                                                                                                                                                                                                       |       |                             | 984,111     |                             |       |   | 956,070 |   |   |
| Prepaid expenses and other current assets                                                                                                                                                                                   |       |                             | 665,276     |                             |       |   | 4,028,498 |   |   |
| Total current assets                                                                                                                                                                                                        |       |                             | 77,711,282  |                             |       |   | 97,548,712 |   |   |
| Property and Equipment:                                                                                                                                                                                                     |       |                             |        |                             |       |   |   |   |   |
| Computers and test equipment                                                                                                                                                                                                |       |                             | 3,933,326   |                             |       |   | 4,278,748 |   |   |
| Corporate airplane                                                                                                                                                                                                          |       |                             | 2,998,161   |                             |       |   | 2,998,161 |   |   |
| Furniture and office equipment                                                                                                                                                                                              |       |                             | 622,364     |                             |       |   | 734,038 |   |   |
| Manufacturing facility                                                                                                                                                                                                      |       |                             | 5,414,986   |                             |       |   | 5,420,741 |   |   |
| Land                                                                                                                                                                                                                        |       |                             | 1,021,245   |                             |       |   | 1,021,245 |   |   |
|                                                                                                                                                                                                                        |       |                             | 13,990,082  |                             |       |   | 14,452,933 |   |   |
| Less- Accumulated depreciation and amortization                                                                                                                                                                             |       |                             | (4,369,851  | )                                |       |   | (5,091,881 | ) |   |
| Net property and equipment                                                                                                                                                                                                  |       |                             | 9,620,231   |                             |       |   | 9,361,052 |   |   |
| Deposits and other assets                                                                                                                                                                                                   |       |                             | 137,114     |                             |       |   | 125,114 |   |   |
| Total assets                                                                                                                                                                                                                |       |                             | $           | 87,468,627                       |       |   |   | $ | 107,034,878 |   |   |
| **LIABILITIES AND SHAREHOLDERS' EQUITY**                                                                                                                                                                                    |       |                             |        |                             |       |   |   |   |   |
| CURRENT LIABILITIES:                                                                                                                                                                                                        |       |                             |        |                             |       |   |   |   |   |
| Current portion of notes payable                                                                                                                                                                                            |       |                             | $           | 100,000                          |       |   |   | $ | 100,000 |   |   |
| Current portion of capitalized lease obligations                                                                                                                                                                            |       |                             | 7,257       |                             |       |   | 7,257 |   |   |
| Accounts payable                                                                                                                                                                                                            |       |                             | 1,696,247   |                             |       |   | 305,516 |   |   |
| Accrued expenses                                                                                                                                                                                                            |       |                             | 4,754,641   |                             |       |   | 3,503,814 |   |   |
| Deferred revenue                                                                                                                                                                                                            |       |                             | 526,023     |                             |       |   | 176,650 |   |   |
| Total current liabilities                                                                                                                                                                                                   |       |                             | 7,084,168   |                             |       |   | 4,093,237 |   |   |
| Note payable                                                                                                                                                                                                                |       |                             | 4,235,000   |                             |       |   | 4,235,000 |   |   |
| Long-term portion of capitalized lease obligations                                                                                                                                                                          |       |                             | 20,681      |                             |       |   | 13,113 |   |   |
| Deferred revenue                                                                                                                                                                                                            |       |                             | 261,934     |                             |       |   | 191,463 |   |   |
| Deferred income taxes                                                                                                                                                                                                       |       |                             | 411,857     |                             |       |   | 635,967 |   |   |
| Commitments and contingencies                                                                                                                                                                                               |       |                             | —      |                             |       |   | — |   |   |
| Shareholders'  Equity:                                                                                                                                                                                                      |       |                             |        |                             |       |   |   |   |   |
| Preferred stock, 10,000,000 shares authorized,  $.001par value, of which 200,000 shares are authorized as Class A  Convertible stock. No shares issued and outstanding at September 30,  2004 and 2005. |       |                             | —      |                             |       |   | — |   |   |
| Common stock, $.001 par value: 75,000,000 shares  authorized, 20,272,995 and 18,047,425 shares issued and outstanding at  September 30, 2004 and 2005                                                   |       |                             | 20,273      |                             |       |   | 18,047 |   |   |
| Additional paid-in capital                                                                                                                                                                                                  |       |                             | 48,712,289  |                             |       |   | 41,926,318 |   |   |
| Retained earnings                                                                                                                                                                                                           |       |                             | 37,336,182  |                             |       |   | 55,921,733 |   |   |
| Treasury stock, at cost, 2,535,039 and 0 shares at  September 30, 2004 and 2005                                                                                                                                             |       |                             | (10,613,757 | )                                |       |   | — |   |   |
| Total shareholders' equity                                                                                                                                                                                                  |       |                             | 75,454,987  |                             |       |   | 97,866,098 |   |   |
| Total liabilities  and shareholders' equity                                                                                                                                                                                 |       |                             | $           | 87,468,627                       |       |   |   | $ | 107,034,878 |   |   |

 

The accompanying notes are an integral part of these statements.

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**INNOVATIVE SOLUTIONS ANDSUPPORT, INC.CONSOLIDATED STATEMENTS OF OPERATIONS**

| ** **                            | ** ** | **For the Fiscal Year Ended September 30,** | ** ** |
|---------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                            | ** ** | **2003**                                                                  | ** ** | **2004** | ** ** | **2005** | ** ** |
| Net sales                             |       | $                                                                         | 28,168,752 |   | $ | 46,099,777 |   | $ | 63,264,359 |   |
| Cost of sales                         |       | 11,346,057                                                                |       | 15,663,108 |   | 20,888,729 |   |
| Gross profit                          |       | 16,822,695                                                                |       | 30,436,669 |   | 42,375,630 |   |
| Operating expenses:                   |       |                                                                      |       |   |   |   |   |
| Research and development              |       | 3,376,849                                                                 |       | 4,811,156 |   | 6,057,889 |   |
| Selling, general and administrative   |       | 5,890,362                                                                 |       | 7,567,959 |   | 8,898,622 |   |
|                                       |       | 9,267,211                                                                 |       | 12,379,115 |   | 14,956,511 |   |
| Operating income                      |       | 7,555,484                                                                 |       | 18,057,554 |   | 27,419,119 |   |
| Interest income                       |       | 582,023                                                                   |       | 532,745 |   | 1,939,397 |   |
| Interest expense                      |       | (131,602                                                                  | )          | (128,018 | ) | (175,151 | ) |
| Income before income taxes            |       | 8,005,905                                                                 |       | 18,462,281 |   | 29,183,365 |   |
| Income taxes                          |       | 2,464,715                                                                 |       | 6,530,084 |   | 10,598,563 |   |
| Net income                            |       | $                                                                         | 5,541,190  |   | $ | 11,932,197 |   | $ | 18,584,802 |   |
| Net Income Per Common  Share:         |       |                                                                      |       |   |   |   |   |
| Basic                                 |       | $                                                                         | 0.30       |   | $ | 0.69 |   | $ | 1.04 |   |
| Diluted                               |       | $                                                                         | 0.30       |   | $ | 0.67 |   | $ | 1.02 |   |
| Weighted Average Shares  Outstanding: |       |                                                                      |       |   |   |   |   |
| Basic                                 |       | 18,391,626                                                                |       | 17,400,380 |   | 17,873,780 |   |
| Diluted                               |       | 18,743,661                                                                |       | 17,928,180 |   | 18,259,856 |   |

 

The accompanying notes are an integral part of these statements.

31

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**INNOVATIVE SOLUTIONS AND SUPPORT, INC.CONSOLIDATED STATEMENTSOF SHAREHOLDERS’ EQUITY**

| ** **                                     | ** ** | **Common  Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Retained  Earnings** | ** ** | **Treasury  Stock** | ** ** | **Total**  | ** ** |
|------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|------------------------|------------|---------------------|------------|------------|------------|
| **Balance,  September 30, 2002**               |       | $                 | 13,052     |                             | $          | 46,093,605             |       | $                   | 19,869,553 |       | $          | (1,250,000 | ) | $ | 64,726,210 |   |
| Exercise of options to purchase common stock   |       | 9                 |       | 19,191                           |       | —                 |       | —              |       | 19,200     |       |
| Issuance of stock  to directors                |       | 20                |       | 135,428                          |       | —                 |       | -                   |       | 135,448    |       |
| Purchase of  treasury stock                    |       | —            |       | —                           |       | —                 |       | (9,363,757          | )          | (9,363,757 | )          |
| Net income                                     |       | —            |       | —                           |       | 5,541,190              |       | —              |       | 5,541,190  |       |
| **Balance, September 30, 2003**                |       | 13,081            |       | 46,248,224                       |       | 25,410,743             |       | (10,613,757         | )          | 61,058,291 |       |
| Exercise of options to purchase common stock   |       | 133               |       | 1,553,662                        |       | —                 |       | —              |       | 1,553,795  |       |
| Exercise of  warrants to purchase common stock |       | 281               |       | 614,317                          |       | —                 |       | —              |       | 614,598    |       |
| Issuance of stock  to directors                |       | 20                |       | 296,086                          |       | —                 |       | —              |       | 296,106    |       |
| Net income                                     |       | —            |       | —                           |       | 11,932,197             |       | —              |       | 11,932,197 |       |
| **Balance, September 30, 2004**                |       | 13,515            |       | 48,712,289                       |       | 37,342,940             |       | (10,613,757         | )          | 75,454,987 |       |
| Exercise of options to purchase common stock   |       | 201               |       | 3,562,132                        |       |                   |       |                |       | 3,562,333  |       |
| Effect of stock  split (3 -for-2)              |       | 6,009             |       |                             |       | (6,009                 | )          |                |       | —     |       |
| Issuance of stock  to directors                |       | 12                |       | 263,964                          |       |                   |       |                |       | 263,976    |       |
| Retirement of  Treasury Stock                  |       | (1,690            | )          | (10,612,067                      | )          |                   |       | 10,613,757          |       | —     |       |
| Net income                                     |       |              |       |                             |       | 18,584,802             |       |                |       | 18,584,802 |       |
| **Balance,  September 30, 2005**               |       | $                 | 18,047     |                             | $          | 41,926,318             |       | $                   | 55,921,733 |       | $          | — |   | $ | 97,866,098 |   |

 

The accompanying notes are an integral part of these statements.

32

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**INNOVATIVE SOLUTIONS AND SUPPORT, INC.CONSOLIDATED STATEMENTSOF CASH FLOWS**

| ** **                                                                                    | ** ** | **For the Fiscal Year Ended September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                                                                    | ** ** | **2003**                                                                  | ** ** | **2004** | ** ** | **2005** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                        |       |                                                                      |       |   |   |   |   |
| Net income                                                                                    |       | $                                                                         | 5,541,190  |   | $ | 11,932,197 |   | $ | 18,584,802 |   |
| Adjustments to  reconcile net income to net cash provided  by (used in) operating activities: |       |                                                                      |       |   |   |   |   |
| Depreciation and amortization                                                                 |       | 714,210                                                                   |       | 729,993 |   | 797,990 |   |
| Write off of software deposit                                                                 |       | 101,738                                                                   |       | — |   | — |   |
| Loss on Disposal of Fixed Assets                                                              |       | 50,453                                                                    |       | 1,660 |   | 1,253 |   |
| Excess and obsolete inventory expense                                                         |       | (78,495                                                                   | )          | (118,298 | ) | 32,697 |   |
| Disposal of obsolete inventory                                                                |       | —                                                                    |       | 163,856 |   | 23,522 |   |
| Deferred income taxes                                                                         |       | 99,599                                                                    |       | 83,680 |   | 252,151 |   |
| Compensation expense for stock issued to  directors                                           |       | 135,448                                                                   |       | 296,106 |   | 263,976 |   |
| Tax benefit from exercise of stock options                                                    |       | —                                                                    |       | 381,469 |   | 1,716,659 |   |
| (Increase)  decrease in:                                                                      |       |                                                                      |       |   |   |   |   |
| Accounts receivable                                                                           |       | (1,654,786                                                                | )          | 1,952,107 |   | (476,836 | ) |
| Inventories                                                                                   |       | 590,496                                                                   |       | (2,396,538 | ) | 1,223,783 |   |
| Prepaid expenses and other                                                                    |       | (260,555                                                                  | )          | (55,966 | ) | (3,363,222 | ) |
| Increase  (decrease) in:                                                                      |       |                                                                      |       |   |   |   |   |
| Accounts payable                                                                              |       | 331,492                                                                   |       | 1,117,941 |   | (1,390,731 | ) |
| Accrued expenses                                                                              |       | 601,500                                                                   |       | 1,647,350 |   | (1,250,827 | ) |
| Deferred revenue                                                                              |       | (110,372                                                                  | )          | 357,514 |   | (419,844 | ) |
| Net cash provided by operating activities                                                     |       | 6,061,918                                                                 |       | 16,093,071 |   | 15,995,373 |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                        |       |                                                                      |       |   |   |   |   |
| Purchases of property and equipment                                                           |       | (156,260                                                                  | )          | (791,393 | ) | (528,064 | ) |
| Net cash used in investing activities                                                         |       | (156,260                                                                  | )          | (791,393 | ) | (528,064 | ) |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                        |       |                                                                      |       |   |   |   |   |
| Proceeds from exercise of stock options                                                       |       | 19,200                                                                    |       | 1,127,991 |   | 1,845,674 |   |
| Proceeds from exercise of warrants                                                            |       | —                                                                    |       | 658,934 |   | — |   |
| Purchase of treasury stock                                                                    |       | (9,363,757                                                                | )          | — |   | — |   |
| Repayment of capitalized lease obligations                                                    |       | (17,111                                                                   | )          | (11,180 | ) | (7,568 | ) |
| Net cash provided by (used in) financing  activities                                          |       | (9,361,668                                                                | )          | 1,775,745 |   | 1,838,106 |   |
| Net increase (decrease) in cash and cash  equivalents                                         |       | (3,456,010                                                                | )          | 17,077,423 |   | 17,305,415 |   |
| Cash and cash  equivalents, beginning of year                                                 |       | 52,245,754                                                                |       | 48,789,744 |   | 65,867,167 |   |
| Cash and cash  equivalents, end of year                                                       |       | $                                                                         | 48,789,744 |   | $ | 65,867,167 |   | $ | 83,172,582 |   |
| **Supplemental  Cash flow Information:**                                                      |       |                                                                      |       |   |   |   |   |
| Cash Paid For:                                                                                |       |                                                                      |       |   |   |   |   |
| Interest                                                                                      |       | $                                                                         | 56,868     |   | $ | 53,711 |   | $ | 102,192 |   |
| Income Taxes                                                                                  |       | $                                                                         | 1,948,658  |   | $ | 5,991,777 |   | $ | 8,600,619 |   |

                                                                                                                                                                                                                                                                                                                                                                                                         

The accompanying notes are an integral part of these statements.

33

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**INNOVATIVE SOLUTIONS AND SUPPORT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1.   Background:**

Innovative Solutions and Support, Inc., (the “Company”),was incorporated in Pennsylvania on February 12, 1988. The Company’sprimary business is the design, manufacture and sale of flight informationcomputers; large flat panel displays and advanced monitoring systems to theDoD, defense contractors, commercial air transport and corporate/generalaviation markets.

On June 13,2005, the Company’s Board of Directors approved a three-for-two split of theCompany’s common stock. The stock split was in the form of a fifty percent(50%) stock dividend that was paid on July 7, 2005 to shareholders ofrecord on June 23, 2005. The issued and outstanding common stock and allshare and per share amounts (except par value) have been retroactively restatedin this report to give effect to this three-for-two stock split. A transferfrom Retained Earnings to Common Stock of $6,009 was required as a result of nochange to par value.

**2.   Concentrations:**

*Major Customers andProducts*

In fiscal 2003, 2004 and 2005 the Company derived 51%,46% and 47% of net sales from five customers, although not all the samecustomers in each year. The accounts receivable related to the current fivecustomers was $405,767 at September 30, 2005.

In addition, sales of airdata systems and components were 88%, 97% and 94% of total sales for the yearsended September 30, 2003, 2004 and 2005, respectively. Flat Panel saleswere 4%, 2% and 6% of net sales in the years ended September 30, 2003,2004 and 2005. Sales to government contractors and agencies accounted forapproximately 22%, 7% and 20% respectively, of the Company’s net sales duringfiscal 2003, 2004 and 2005.

*Major Suppliers*

The Company currently buysseveral of its components from sole source suppliers. Although there are a limitednumber of manufacturers of the particular components, management believes thatother suppliers could provide similar components on comparable terms.

*Concentration ofCredit Risk*

Financial instruments that potentially subject theCompany to concentration of credit risk consist principally of cash balancesand accounts receivables. The Company invests its excess cash wherepreservation of principal is the major consideration. The Company’s customerbase principally consists of companies within the aviation industry. TheCompany routinely requests advance payments and or letters of credit from newcustomers.

TheCompany also maintains a reserve for doubtful accounts in the amount of$100,000 and had accounts receivable write-offs of $0 and $2,500 in fiscal 2004and 2005, respectively.

**3.   SummaryOf Significant Accounting Policies:**

*Principles ofConsolidation*

The consolidated financialstatements include the accounts of the Company and its subsidiaries. Allmaterial inter-company balances and transactions have been eliminated.

34

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**INNOVATIVE SOLUTIONS AND SUPPORT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

*Use of Estimates*

Preparation ofconsolidated financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect reported amounts of assets andliabilities, and disclosure of contingent assets and liabilities, at the dateof the financial statements and the reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimates.

*Cash and CashEquivalents*

Highly liquid investmentspurchased with an original maturity of three months or less are classified ascash equivalents. Cash equivalents at September 30, 2004 and 2005 consistof funds invested in money market accounts with financial institutions.

*Inventories*

Inventoriesare stated at the lower of cost (first-in, first-out) or market and consist ofthe following:

| ** **      | ** ** | **September 30,** | ** ** |
|-----------------|------------|------------------------|------------|
| ** **      | ** ** | **2004**               | ** ** | **2005** | ** ** |
| Raw materials   |       | $                      | 1,928,005  |   | $ | 1,696,050 |   |
| Work-in-process |       | 2,573,932              |       | 1,151,828 |   |
| Finished goods  |       | 689,691                |       | 1,063,748 |   |
|            |       | $                      | 5,191,628  |   | $ | 3,911,626 |   |

 

*Property andEquipment*

Property and equipment arestated at cost. Depreciation is provided using an accelerated method over theestimated useful lives of the assets (the lesser of three to seven years orover the lease term), except for the airplane and manufacturing facility, whichis depreciated over a straight-line method. Major additions and improvementsare capitalized, while maintenance and repairs that do not improve or extendthe life of assets are charged to expense as incurred. Depreciation expense was$702,210, $717,993 and $785,990 for the fiscal years ended 2003, 2004 and 2005.

*Long-Lived Assets*

The Company assesses theimpairment of long-lived assets in accordance with SFAS No. 144, *Accounting for the Impairment or Disposal of Long-Lived Assets*.This statement requires that long-lived assets be reviewed for impairmentwhenever events or changes in circumstances indicate that the carrying amountof an asset may not be recoverable. Also, in general, long-lived assets to bedisposed of should be reported at the lower of the carrying amount or fairvalue less cost to sell. The Company considers historical performance andfuture estimated results in its evaluation of potential impairment and thencompares the carrying amount of the asset to the estimated future cash flowsexpected to result from the use of the asset. If the carrying amount of theasset exceeds the estimated expected undiscounted future cash flows, theCompany measures the amount of the impairment by comparing the carrying amountof the asset to its fair value. The estimation of fair value is generallymeasured by discounting expected future cash flows. No impairment charges wererecorded in fiscal 2003, 2004, and 2005.

35

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**INNOVATIVE SOLUTIONS AND SUPPORT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

*Revenue Recognition*

The Company recognizes sales of products when thefollowing revenue recognition criteria are met: persuasive evidence of anarrangement exists, product delivery and acceptance has occurred, pricing isfixed or determinable, and collection is reasonably assured. The Companyessentially recognizes sales upon shipment of products to customers.

Sales related to certain long-term contracts requiringdevelopment and delivery of products over several years are accounted for underthe American Institute of Certified Public Accountants (AICPA) Statement ofPosition (SOP) 81-1, *Accounting forPerformance of Construction-Type and Certain Production-Type Contracts*and the amounts are not significant for fiscal years 2003, 2004 and 2005.

The Company offers its customers extended warrantiesfor additional fees. These warranty sales are recorded as deferred revenue andrecognized as sales on a straight-line basis over the warranty period.

The Company enters intocertain sales arrangements that include multiple deliverables as defined inEmerging Issues Task Force (EITF) Issue No. 00-21, *Accounting for Revenue Arrangements with MultipleDeliverables.*Effective July 1, 2003, the Company identifiesall goods and/or services that are to be delivered separately under a salesarrangement and allocates revenue to each deliverable based on fair value thatis established using vendor-specific objective evidence. In general, revenuesare separated between product sales and non-recurring engineering services. Theallocated revenue for each deliverable is then recognized using appropriaterevenue recognition methods.

*Warranty*

Estimated cost to repairor replace products under warranty is provided when sales of product arerecorded.

*Income Taxes*

Income taxes are recordedin accordance with SFAS No. 109, “Accounting for Income Taxes” (see Note7).

*Research andDevelopment*

Research and developmentcharges incurred for product enhancements and future product development arerecorded as expense as incurred.

*Comprehensive Income*

Pursuant to SFAS No. 130,“Reporting Comprehensive Income,” the Company would be required to classifyitems of other comprehensive income by their nature in a financial statementand display the accumulated balance of other comprehensive income separatelyfrom retained earnings and additional paid-in capital in the equity section ofa statement of financial position. Comprehensive income consists of net incomeand there were no items of other comprehensive income for any of the periodspresented.

36

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**INNOVATIVE SOLUTIONS AND SUPPORT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

*Fair Value ofFinancial Instruments*

The estimated fair valueamounts presented in these consolidated financial statements have beendetermined by the Company using available market information and appropriatemethodologies. The Company’s financial instruments consist primarily of cashand cash equivalents, accounts receivable, accounts payable, accruedliabilities and debt instruments. The carrying values of these assets andliabilities are considered to be representative of the respective fair valuesbased on pertinent information available to management as of September 30,2004 and 2005.

*Stock Options*

Stock-based employee compensation is recognized usingthe intrinsic value method in accordance with Accounting Principles BoardOpinion (APB) No. 25, “Accounting for Stock Issued to Employees.” Fordisclosure purposes, pro forma net income and net income per share data areprovided in accordance with SFAS No. 123, “Accounting for Stock-BasedCompensation,” as if the fair value method had been applied.

UnderSFAS No. 123, compensation cost related to stock options granted toemployees is computed based on the fair value of the stock option at the dateof grant using the Black-Scholes option pricing model. Had the Companyrecognized compensation cost for its stock option plans consistent with theprovisions of SFAS 123, the Company’s pro forma net income for the periodsended September 30, 2003, 2004 and 2005 would have been as follows:

| ** **                                                                                                                                                  | ** ** | **Fiscal Year Ended  September 30, 2003** | ** ** | **Fiscal Year Ended  September 30, 2004** | ** ** | **Fiscal Year Ended  September 30, 2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| Net income:                                                                                                                                                 |       |                                                          |       |                                                          |       |                                                          |       |   |   |   |   |   |   |
| As reported                                                                                                                                                 |       |                                                          | $          | 5,541,190                                                     |       |                                                          |       | $ | 11,932,197 |   |   |   | $ | 18,584,802 |   |   |
| Deduct: Total stock based employee compensation  expense determined under the fair value based method for all awards,  net of related tax effects |       |                                                          | $          | (634,144                                                      | )          |                                                          |       | $ | (745,329 | ) |   |   | $ | (814,736 | ) |   |
| Pro forma                                                                                                                                                   |       |                                                          | $          | 4,907,046                                                     |       |                                                          |       | $ | 11,186,868 |   |   |   | $ | 17,770,066 |   |   |
| Basic EPS:                                                                                                                                                  |       |                                                          |       |                                                          |       |                                                          |       |   |   |   |   |   |   |
| As reported                                                                                                                                                 |       |                                                          | $          | .30                                                           |       |                                                          |       | $ | .69 |   |   |   | $ | 1.04 |   |   |
| Pro forma                                                                                                                                                   |       |                                                          | $          | .27                                                           |       |                                                          |       | $ | .64 |   |   |   | $ | .99 |   |   |
| Diluted EPS:                                                                                                                                                |       |                                                          |       |                                                          |       |                                                          |       |   |   |   |   |   |   |
| As reported                                                                                                                                                 |       |                                                          | $          | .30                                                           |       |                                                          |       | $ | .67 |   |   |   | $ | 1.02 |   |   |
| Pro forma                                                                                                                                                   |       |                                                          | $          | .26                                                           |       |                                                          |       | $ | .63 |   |   |   | $ | .97 |   |   |

 

*New AccountingPronouncements*

In May 2005, the Financial Accounting StandardsBoard (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 154,“Accounting Changes and Error Corrections—a replacement of APB Opinion No. 20and FASB Statement No. 3”. SFAS No. 154 requires retrospectiveapplication to prior periods’ financial statements of changes in accountingprinciple, unless it is impracticable to determine either the period-specificeffects or the cumulative effect of the change. SFAS No. 154 also requiresthat retrospective application of a change in accounting principle be limitedto the direct effects of 

37

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**INNOVATIVE SOLUTIONS AND SUPPORT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

the change. Indirecteffects of a change in accounting principle, such as a change innondiscretionary profit-sharing payments resulting from an accounting change,should be recognized in the period of the accounting change. SFAS No. 154also requires that a change in depreciation, amortization, or depletion methodfor long-lived, nonfinancial assets be accounted for as a change in accountingestimate effected by a change in accounting principle. SFAS No. 154 iseffective for accounting changes and corrections of errors made in fiscal yearsbeginning after December 15, 2005. Early adoption is permitted foraccounting changes and corrections of errors made in fiscal years beginningafter the date this Statement is issued. The Company will adopt the provisionsof SFAS No. 154 as applicable beginning in fiscal 2007.

In December 2004, The FASB issued SFAS No. 123(R),“Share Based Payment”. Statement No. 123(R) requires all entities torecognize compensation expense in an amount equal to the fair value of sharebased payments granted to employees. This statement is effective for the firstfiscal year beginning after June 15, 2005. The Company will adoptStatement No. 123(R) beginning with the first quarter of fiscal 2006.Adoption of the statement will require the Company to record compensationexpense relating to the issuance of employee stock options. Currently, theCompany follows APB No. 25 which does not require the recognition ofcompensation expense relating to the issuance of stock options so long as thequoted market price of the Company’s stock at the date of grant is less than orequal to the amount an employee must pay to acquire the stock. We are currentlyevaluating the effect of SFAS 123R on our financial statements with the intentof implementing this standard in fiscal 2006. We expect the impact of thisstandard to be consistent with prior years pro forma.

In December 2004, the FASB issued FASB StaffPosition (FSP) FAS 109-1, “Application of FASB Statement No. 109,Accounting for Income Taxes, to the Tax Deduction on Qualified ProductionActivities Provided by the American Jobs Creation Act of 2004”. This FSPprovides guidance on the application of Statement 109 to the provisions withinthe American Jobs Creation Act of 2005 (the Act), which provides tax relief toU.S. domestic manufacturers. The FSP states that a manufacturer’s deductionprovided for under the Act should be accounted for as a special deduction inaccordance with Statement 109 and not as a tax rate reduction. The FSP alsoreminds preparers that the special deduction should be considered by anenterprise in (a) measuring deferred taxes when the enterprise issubjected to graduated tax rates, and (b) assessing whether a valuationallowance is necessary as required by Statement 109. This statement is effectiveimmediately. The Company adopted this statement and it did not have a materialimpact on the Company’s financial position or results of operations.

In November 2004, theFinancial Accounting Standards Board (FASB) issued Statement of Financial AccountingStandards (SFAS) 151, “Inventory Costs”. This Statement amends the guidance inARB No. 43, Chapter 4 “Inventory Pricing”, to clarify the accounting forabnormal amounts of idle facility expense, freight, handling costs, and wastedmaterial (spoilage). Paragraph 5 of ARB 43, Chapter 4 previously stated that “...under some circumstances, items such as idle facility expense, excessivespoilage, double freight, and rehandling costs may be so abnormal as to requiretreatment as current period charges...”. This Statement requires that those itemsbe recognized as current-period charges regardless of whether they meet thecriterion of “so abnormal”. In addition, this Statement requires thatallocation of fixed production overheads to the costs of conversion be based onthe normal capacity of the production facilities. This statement is effectivefor inventory costs incurred during fiscal years beginning after June 15,2005. The Company does not expect the adoption of this statement will have amaterial impact on its consolidated financial position or results ofoperations.

38

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**INNOVATIVE SOLUTIONS AND SUPPORT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

**4.**   Net Income PerShare:

Net income per share is calculated pursuant to SFAS No. 128,“Earnings per Share” (EPS). Basic EPS excludes potentially dilutive securitiesand is computed by dividing net income by the weighted-average number of Commonshares outstanding for the period. Diluted EPS is computed assuming theconversion or exercise of all dilutive securities such as preferred stock,options and warrants.

UnderSFAS No. 128, the Company’s granting of certain stock options, warrantsand convertible preferred stock resulted in potential dilution of basic EPS.The following table summarizes the differences between basic weighted-averageshares outstanding and diluted weighted-average shares outstanding used tocompute diluted EPS.

| ** **                                      | ** ** | **For the Fiscal Year Ended September 30,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **2003**                                                                  | ** ** | **2004** | ** ** | **2005** | ** ** |
| Weighted average  number of shares—basic   |       | 18,391,626                                                                |       | 17,400,380 |   | 17,873,780 |   |
| Effect of dilutive  securities:                 |       |                                                                      |       |   |   |   |   |
| Stock Options                                   |       | 65,695                                                                    |       | 417,764 |   | 386,076 |   |
| Warrants                                        |       | 286,340                                                                   |       | 110,036 |   | 0 |   |
| Weighted average number  of shares—diluted |       | 18,743,661                                                                |       | 17,928,180 |   | 18,259,856 |   |

 

The number of incrementalshares from the assumed exercise of stock options and warrants is calculated byusing the treasury stock method. For the fiscal years ended September 30,2003, 2004 and 2005, there were 329,730, 12,587 and 50,500 options outstanding,respectively, that were excluded from the computation of diluted earnings pershare as the effect would be anti-dilutive.

**5.   Accrued Expenses:**

Accruedexpenses consist of the following:

| ** **                          | ** ** | **September 30,** | ** ** |
|-------------------------------------|------------|------------------------|------------|
| ** **                          | ** ** | **2004**               | ** ** | **2005** | ** ** |
| Salary, Benefits  and payroll taxes |       | $                      | 1,198,267  |   | $ | 881,602 |   |
| Warranty                            |       | 757,476                |       | 770,845 |   |
| Income Taxes  payable               |       | 1,797,508              |       | 1,051,963 |   |
| Other                               |       | 1,001,390              |       | 799,404 |   |
|                                |       | $                      | 4,754,641  |   | $ | 3,503,814 |   |

 

**6.   Warranty:**

The Company provides for the estimated cost of productwarranties at the time revenue is recognized. Warranty cost is recorded as costof sales in the financial statements. While the Company engages in extensiveproduct quality programs and processes, the Company’s warranty obligation isaffected by product failure rates and the related material, labor and deliverycosts incurred in correcting a product failure. Should actual product failurerates, material or labor costs differ from the Company’s estimates, revisionsto the estimated warranty liability would be required.

39

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**INNOVATIVE SOLUTIONS AND SUPPORT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

Warrantycost and accrual information for the fiscal period ended September 30,2004 is highlighted below:

| Warranty accrual  at September 30, 2003                 |   | $        | 842,541 |   |
|---------------------------------------------------------|--------|----------|---------|--------|
| Accrual expense for year ended September 30,  2004 |   | 227,292  |    |
| Warranty costs for year ended September 30,  2004  |   | (145,957 | )       |
| Change in estimate of warranty liability                |   | (166,400 | )       |
| Warranty accrual  at September 30, 2004            |   | $        | 757,476 |   |

 

Warrantycost and accrual information for the fiscal period ended September 30,2005 is highlighted below:

| Warranty accrual  at September 30, 2004                |   | $        | 757,476 |   |
|-------------------------------------------------------------|--------|----------|---------|--------|
| Accrual expense for the year ended  September 30, 2005 |   | 186,558  |    |
| Warranty costs for the year ended September 30,  2005  |   | (173,189 | )       |
| Warranty accrual at September 30, 2005                 |   | $        | 770,845 |   |

 

**7.   Income Taxes:**

Componentsof income taxes are as follows:

| ** **                     | ** ** | **For the Fiscal Year Ended September 30,** | ** ** |
|--------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                     | ** ** | **2003**                                                                  | ** ** | **2004** | ** ** | **2005** | ** ** |
| Current  Provision:            |       |                                                                      |       |   |   |   |   |
| Federal                        |       | $                                                                         | 2,252,101  |   | $ | 6,155,438 |   | $ | 9,592,641 |   |
| State                          |       | 113,015                                                                   |       | 601,943 |   | 753,772 |   |
|                           |       | 2,365,116                                                                 |       | 6,757,381 |   | 10,346,413 |   |
| Deferred  Provision (Benefit): |       |                                                                      |       |   |   |   |   |
| Federal                        |       | 99,382                                                                    |       | (195,414 | ) | 102,434 |   |
| State                          |       | 217                                                                       |       | (31,883 | ) | 149,716 |   |
|                           |       | 99,599                                                                    |       | (227,297 | ) | 252,150 |   |
|                           |       | $2,464,715                                                                |       | $ | 6,530,084 |   | $ | 10,598,563 |   |
|                                |            |                                                                           |            |  |  |  |  |  |  |  |

 

Followingis a reconciliation of the statutory federal rate to the Company’s effectiveincome tax rate:

| ** **                                  | ** ** | **For the Fiscal Year  Ended September 30,** | ** ** |
|---------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                  | ** ** | **2003**                                                         | ** ** | **2004** | ** ** | **2005** | ** ** |
| Federal statutory  tax rate                 |       | 34.0                                                             | %          | 35.0 | % | 35.0 | % |
| State income  taxes, net of federal benefit |       | 0.9                                                              |       | 2.2 |   | 1.9 |   |
| Research and  development tax credits       |       | -3.5                                                             |       | -1.4 |   | -0.4 |   |
| Other                                       |       | -0.6                                                             |       | -0.4 |   | -0.2 |   |
|                                        |       | 30.8                                                             | %          | 35.4 | % | 36.3 | % |

 

Thedeferred tax effect of temporary differences giving rise to the Company’sdeferred tax assets and liabilities consists of the components below. As of September 30,2003 and 2004, the Company had a 

40

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**INNOVATIVE SOLUTIONS AND SUPPORT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

cumulative net operating loss (NOL) in its subsidiary(that holds the Company airplane) of $2,268,929 and $31,687 respectively. TheCompany utilized $2,237,242 of this NOL for the period ended September 30,2004 and the remaining $31,687 during the current period leaving a zero balanceat September 30, 2005.

| ** **                      | ** ** | **September 30,  2004** | ** ** | **September 30,  2005** | ** ** |
|---------------------------------|------------|------------------------------|------------|------------------------------|------------|
| Deferred tax assets—       |       |                         |       |                         |       |   |   |   |   |
| Deferred revenue                |       |                         | $          | 123,887                      |       |   |   | $ | 102,372 |   |   |
| Reserves and accruals           |       |                         | 1,003,897  |                         |       |   | 949,295 |   |   |
| State NOL carryforward          |       |                         | 2,756      |                         |       |   | — |   |   |
|                            |       |                         | 1,130,540  |                         |       |   | 1,051,667 |   |   |
| Deferred tax  liabilities— |       |                         |       |                         |       |   |   |   |   |
| Depreciation                    |       |                         | (529,587   | )                            |       |   | (731,564 | ) |   |
| Other                           |       |                         | (28,699    | )                            |       |   | — |   |   |
|                            |       |                         | (558,286   | )                            |       |   | (731,564 | ) |   |
|                            |       |                         | $          | 572,254                      |       |   |   | $ | 320,103 |   |   |

 

**8.   Notes Payable:**

TheCompany entered into a $4,335,000 loan agreement dated August 1, 2000 withthe Chester County, Pennsylvania Industrial Development Authority. The purposeof the loan was to fund the construction of the Company’s new office andmanufacturing facility. The loan matures in 2015 and carries an interest rateset by the remarketing agent that is consistent with 30-day tax-exemptcommercial paper. The future maturities of this note payable are as follows asof September 30, 2005:

| 2006—       |   | $ | 100,000   |   |
|------------------|--------|---|-----------|--------|
| 2007—       |   | $ | 150,000   |   |
| 2008—       |   | $ | 200,000   |   |
| 2009—       |   | $ | 250,000   |   |
| 2010—       |   | $ | 250,000   |   |
| thereafter— |   | $ | 3,385,000 |   |

 

The loan agreement requires the Company to maintaincertain financial covenants including a ratio of liabilities to earnings beforeinterest, taxes and depreciation and amortization (EBITDA), fixed charge ratioand a minimum tangible net worth. The Company was in compliance with thecovenants of the loan agreement as of September 30, 2004 and 2005.

The interest costassociated with this debt was $52,000 for fiscal 2004 and $100,000 for fiscal2005. The interest rate on this debt was 2.68% at September 30, 2005. TheCompany also is required to maintain a letter of credit in the amount of$5,000,000 covering this debt.

**9.   Savings Plan:**

The Company sponsors avoluntary defined contribution savings plan covering all employees. The Companydoes not contribute to the plan.

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**INNOVATIVE SOLUTIONS AND SUPPORT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

**10.   Shareholders’Equity:**

*Common Stock*

The Company issued 29,817,30,855 and 15,828 shares of Common stock to non-employee directors, with fairvalues of $135,428, $296,086 and $263,964 for the years ended September 30,2003, 2004 and 2005, respectively. The fair value of the Common Stock wascharged to selling, general and administrative expense in the accompanyingconsolidated statements of operations based on the fair market value of thestock on the vesting date for fiscal years 2003 and 2004, and on the fairmarket value on the grant date for fiscal year 2005. The Company accrued$60,048 at September 30, 2005 for director shares earned during the yearbut not issued until after year-end.

*Stock Options*

The Company’s 1998 StockOption Plan (the “Plan”) provides for the granting of incentive andnonqualified stock options to employees, officers, directors and independent contractorsand consultants. Through September 30, 2005, no stock options have beengranted to independent contractors or consultants under this plan.

Incentive stock optionsgranted under the Plan must be at least equal to the fair value of the Commonstock on the date of grant. Nonqualified stock options granted under the Planmay be less than, equal to or greater than the fair value of the Common stockon the date of grant. The number of shares of Common stock the Company hasreserved for awards under the Plan was increased, by shareholder vote at the March 31,2005 Annual Meeting of Shareholders, from 1,889,025 to 3,389,025 shares.

UnderSFAS No. 123, compensation cost related to stock options granted toemployees is computed based on the fair value of the stock option at the dateof grant using the Black-Scholes option pricing model. The Company has electedthe disclosure method of SFAS No. 123. Had the Company recognizedcompensation cost for its stock option plans consistent with the provisions ofSFAS 123, the Company’s pro forma net income for fiscal 2003, 2004 and 2005would have been as follows:

| ** **   | ** ** | **Fiscal year EndedSeptember 30,** | ** ** |
|--------------|------------|---------------------------------------------------|------------|
| ** **   | ** ** | **2003**                                          | ** ** | **2004** | ** ** | **2005** | ** ** |
| Net Income:  |       |                                              |       |   |   |   |   |
| As reported  |       | $                                                 | 5,541,190  |   | $ | 11,932,197 |   | $ | 18,584,802 |   |
| Pro forma    |       | $                                                 | 4,907,046  |   | $ | 11,186,868 |   | $ | 17,770,066 |   |
| Basic EPS:   |       |                                              |       |   |   |   |   |
| As reported  |       | $                                                 | 0.30       |   | $ | 0.69 |   | $ | 1.04 |   |
| Pro forma    |       | $                                                 | 0.27       |   | $ | 0.64 |   | $ | 0.99 |   |
| Diluted EPS: |       |                                              |       |   |   |   |   |
| As reported  |       | $                                                 | 0.30       |   | $ | 0.67 |   | $ | 1.02 |   |
| Pro forma    |       | $                                                 | 0.26       |   | $ | 0.63 |   | $ | 0.97 |   |

 

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**INNOVATIVE SOLUTIONS AND SUPPORT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

Theweighted-average fair value of the stock options granted during the fiscalyears ended September 30, 2003, 2004 and 2005 were $4.31, $10.72 and$19.13 respectively. The fair value of each option grant is estimated on thegrant date using the Black-Scholes option pricing model with the followingassumptions:

| ** **                                | ** ** | **Fiscal Year Ended  September 30,** | ** ** |
|-------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                | ** ** | **2003**                                            | ** ** | **2004** | ** ** | **2005** | ** ** |
| Expected dividend  rate                   |       | —                                              |       | — |   | — |   |
| Expected  volatility                      |       | 67.4                                                | %          | 67.4 | % | 66.4 | % |
| Weighted average  risk-free interest rate |       | 1.5                                                 | %          | 1.5 | % | 2.0 | % |
| Expected lives (years)                    |       | 10                                                  |       | 10 |   | 7.35 |   |

 

Informationrelative to the Plan is as follows:

| ** **                                      | ** ** | ** **  | ** ** | **Range of** | ** ** | **Weighted** | ** ** |
|-------------------------------------------------|------------|-------------|------------|-------------------|------------|--------------|------------|
| ** **                                      | ** ** | ** **  | ** ** | **Exercise**      | ** ** | **Average**  | ** ** |
| ** **                                      | ** ** | ** **  | ** ** | **Weighted**      | ** ** | **Exercise** | ** ** |
| ** **                                      | ** ** | **Options** | ** ** | **Prices**        | ** ** | **Price**    | ** ** |
| Outstanding at  September 30, 2002         |       | 715,382     |       | $                 | 1.46       |         | -          |   | $ | 10.00 |   |   | $ | 6.93 |   |   |
| Granted                                         |       | 337,500     |       | 4.00              |       | -            |       | 5.11 |   |   | 4.31 |   |   |
| Exercised                                       |       | (13,155     | )          | 1.46              |       | -            |       | 1.46 |   |   | 1.46 |   |   |
| Cancelled                                       |       | (140,409    | )          | 4.21              |       | -            |       | 10.00 |   |   | 8.07 |   |   |
| Outstanding at September 30, 2003          |       | 899,318     |       | $                 | 1.46       |         | -          |   | $ | 9.90 |   |   | $ | 5.85 |   |   |
| Granted                                         |       | 190,500     |       | 5.41              |       | -            |       | 18.21 |   |   | 10.72 |   |   |
| Exercised                                       |       | (200,108    | )          | 1.83              |       | -            |       | 9.64 |   |   | 5.86 |   |   |
| Cancelled                                       |       | (49,023     | )          | 4.21              |       | -            |       | 10.13 |   |   | 8.61 |   |   |
| Outstanding at September 30, 2004          |       | 840,687     |       | $                 | 1.46       |         | -          |   | $ | 18.21 |   |   | $ | 6.79 |   |   |
| Granted                                         |       | 117,000     |       | 15.41             |       | -            |       | 22.35 |   |   | 19.13 |   |   |   |
| Exercised                                       |       | (291,734    | )          | 1.46              |       | -            |       | 12.22 |   |   | 6.46 |   |   |   |
| Cancelled                                       |       | (71,700     | )          | 4.00              |       | -            |       | 21.17 |   |   | 12.51 |   |   |   |
| Outstanding at September 30, 2005          |       | 594,253     |       | $                 | 1.46       |         | -          |   | $ | 22.35 |   |   | $ | 8.76 |   |   |   |
| Options  exercisable at September 30, 2005 |       | 250,754     |       | $                 | 1.46       |         | -          |   | $ | 18.21 |   |   | $ | 6.08 |   |   |   |

 

At September 30, 2005, 1,745,719 shares wereavailable for grant under the 1998 stock option plan.

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**INNOVATIVE SOLUTIONS AND SUPPORT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

Thefollowing table summarizes information concerning outstanding and exercisableoptions at September 30, 2005:

| **Options Outstanding**               | ** ** | ** **             | ** ** |
|---------------------------------------|------------|------------------------|------------|
| ** **                            | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted-** | ** ** | ** ** | ** ** | **Options Exercisable** | ** ** |
| ** **                            | ** ** | ** **             | ** ** | ** ** | ** ** | **Outstanding** | ** ** | **Average** | ** ** | **Weighted-** | ** ** | ** ** | ** ** | **Weighted-** | ** ** |
| ** **                            | ** ** | ** **             | ** ** | ** ** | ** ** | **As of** | ** ** | **Remaining** | ** ** | **Average** | ** ** | **As of** | ** ** | **Average** | ** ** |
| **Range of Exercise ** | ** ** | **September 30,** | ** ** | **Contractual** | ** ** | **Exercise** | ** ** | **September 30,** | ** ** | **Exercise** | ** ** |
| **Prices**                            | ** ** | **2005**               | ** ** | **Life** | ** ** | **Price** | ** ** | **2005** | ** ** | **Price** | ** ** |
| $  0.00                     |       | -                      |       | 5.00 |   |   | 228,404 |   |   |   | 5.8 |   |   |   | $ | 4.02 |   |   |   | 133,305 |   |   |   | $ | 3.85 |   |   |
| $  5.01                     |       | -                      |       | 10.00 |   |   | 198,449 |   |   |   | 6.5 |   |   |   | $ | 7.62 |   |   |   | 101,849 |   |   |   | $ | 7.71 |   |   |
| $10.01                                |       | -                      |       | 15.00 |   |   | 63,900 |   |   |   | 8.6 |   |   |   | $ | 13.50 |   |   |   | 12,300 |   |   |   | $ | 13.63 |   |   |
| $15.01                                |       | -                      |       | 20.00 |   |   | 66,500 |   |   |   | 9.3 |   |   |   | $ | 17.17 |   |   |   | 3,300 |   |   |   | $ | 17.52 |   |   |
| $20.01                                |       |                   |       | 22.35 |   |   | 37,000 |   |   |   | 9.6 |   |   |   | $ | 21.04 |   |   |   | 0 |   |   |   | $ | 0.00 |   |   |
|                                  |       |                   |       |   |   |   | 594,253 |   |   |   | 7.3 |   |   |   | $ | 8.76 |   |   |   | 250,754 |   |   |   | $ | 6.08 |   |   |

 

*Warrants*

In connection with theissuance of subordinated notes, the Company issued warrants to purchase1,101,855 shares of Common stock at an exercise price of $1.46 per share. Infiscal 2004 the remaining 420,955 warrants were exercised. As a result therewere no outstanding warrants at September 30, 2004 or 2005.

**11.   Commitments and Contingencies:**

*Capital Lease*

The Company leases certainequipment under capital leases with terms of five years and implicit interestrates of 4.3%. The capitalized cost of $39,119 and the related accumulatedamortization of $18,749 have been included in property and equipment at September 30,2005. The balance due on these leases was $27,938 and $20,370 as of September 30,2004 and 2005 respectively. The payments for fiscal 2006, 2007, and 2008 are$7,892, $8,231 and $4,247 respectively.

*Operating Leases*

Rent expense underoperating leases totaled $26,024, $20,010 and $19,994 for the years ended September 30,2003, 2004 and 2005, respectively. As of September 30, 2005, there were nooperating leases in effect.

*Product Liability*

The Company currently hasproduct liability insurance of $50,000,000, which management believes is adequateto cover potential liabilities that may arise.

*EmploymentAgreement*

In March 2003, theCompany entered into an employee agreement with an employee for an annualsalary of $250,000. There are no other employee agreements with any otherofficer of the Company.

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**INNOVATIVE SOLUTIONS AND SUPPORT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

*Legal Proceedings*

From time to time, theCompany is subject to various legal proceedings in the ordinary course ofbusiness. Management does not believe that any of the current legal proceedingswill have a material adverse effect on the Company’s operations or financialcondition.

**12.   Related-Party Transactions:**

The Company incurred legal fees of $127,990, $115,898and $137,000 with a law firm which is a shareholder of the Company for theyears ended September 30, 2003, 2004 and 2005, respectively. The fees paidand services rendered were comparable with the fees paid and services renderedprior to the law firm’s investment in the Company.

The Company derived net sales of $67,989, $124,652 and$83,000 for the years ended September 30, 2003, 2004 and 2005,respectively from an entity which was a shareholder, and purchased $5,612, $0and $0 of component parts used in the manufacturing process from this relatedparty during such years.

For the years ended September 30,2003, 2004 and 2005, respectively, we incurred service fees of $18,703, $124,932and $33,000 with a commercial graphics firm controlled by an individual who ismarried to a significant shareholder and the daughter of the Company’s Chairmanand Chief Executive Officer.

**13.   QuarterlyFinancial Data (unaudited):**

| ** **                         | ** ** | **First Quarter** | ** ** | **Second Quarter** | ** ** | **Third Quarter** | ** ** | **Fourth Quarter** | ** ** |
|------------------------------------|------------|------------------------|------------|-------------------------|------------|------------------------|------------|-------------------------|------------|
| ** **                         | ** ** | **2004**               | ** ** | **2005**                | ** ** | **2004**               | ** ** | **2005**                | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** | **2005** | ** ** |
| Net Sales                          |       | $                      | 8,523,336  |                    | $          | 18,978,804             |       | $                       | 10,895,287 |   | $ | 19,001,021 |   | $ | 12,269,653 |   | $ | 17,101,620 |   | $ | 14,411,501 |   | $ | 8,182,914 |   |
| Cost of Sales                      |       | 3,481,411              |       | 6,182,143               |       | 3,662,841              |       | 5,777,273               |       | 4,056,372 |   | 5,846,912 |   | 4,462,484 |   | 3,082,402 |   |
| Gross Profit                       |       | 5,041,925              |       | 12,796,661              |       | 7,232,446              |       | 13,223,748              |       | 8,213,281 |   | 11,254,708 |   | 9,949,017 |   | 5,100,512 |   |
| Operating Income                   |       | 2,392,030              |       | 9,496,663               |       | 3,874,069              |       | 9,371,352               |       | 4,759,781 |   | 7,263,946 |   | 7,031,674 |   | 1,287,157 |   |
| Net Income                         |       | 1,607,350              |       | 6,192,803               |       | 2,574,081              |       | 6,273,839               |       | 3,285,608 |   | 4,898,713 |   | 4,465,158 |   | 1,219,446 |   |
| Net Income Per Share—Basic    |       | $                      | 0.09       |                    | $          | 0.35                   |       | $                       | 0.15       |   | $ | 0.35 |   | $ | 0.19 |   | $ | 0.27 |   | $ | 0.25 |   | $ | 0.07 |   |
| Net Income Per  Share—Diluted |       | $                      | 0.09       |                    | $          | 0.34                   |       | $                       | 0.14       |   | $ | 0.34 |   | $ | 0.18 |   | $ | 0.27 |   | $ | 0.25 |   | $ | 0.07 |   |

 

The sum of the quarterlyper share amounts may not equal per share amounts reported for year endedfiscal 2004 and 2005. This is due to changes in the number of weighted-averageshares outstanding and the effects of rounding for each period.

**14.   Business Segments**

The Company operates in one principal business segmentwhich designs, manufactures and sells flight information computers, flat paneldisplays and advanced monitoring systems to the DoD, government agencies,commercial air transport carriers and corporate/general aviation markets. TheCompany currently derives virtually all of its revenues from the sale of thisequipment. Almost all of the Company’s sales, operating results andidentifiable assets are in the United States.

45

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**Item9.**                        Changes inand disagreements with accountants on accounting and financial disclosure.

None

**Item9A.**                Controls andprocedures

(a)           Anevaluation was performed under the supervision and with the participation ofthe Company’s management, including its Chief Executive Officer, or CEO, andChief Financial Officer, or CFO, of the effectiveness of the Company’sdisclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgatedunder the Securities Exchange Act of 1934, as amended (the “Exchange Act”) asof September 30, 2005. Based on that evaluation, the Company’s management,including the CEO and CFO, concluded that the Company’s disclosure controls andprocedures are effective to provide reasonable assurance that information requiredto be disclosed by the Company in reports that it files or submits under theExchange Act, is recorded, processed, summarized and reported as specified inSecurities and Exchange Commission rules and forms.

(b)          Therewere no changes in the Company’s internal control over financial reportingidentified in connection with the evaluation of such controls that occurredduring the Company’s most recent fiscal quarter that has materially affected,or is reasonably likely to materially affect, the Company’s internal controlover financial reporting.

**Management’sReport on Internal Control over financial reporting**

Management of InnovativeSolutions & Support, Inc. and its subsidiaries (the Company) isresponsible for establishing and maintaining adequate internal control overfinancial reporting. The Company’s internal control over financial reporting isa process designed under the supervision of the Company’s principal executiveofficer and principal financial officer to provide reasonable assuranceregarding the reliability of financial reporting and the preparation of theCompany’s financial statements for external purposes in accordance withaccounting principles generally accepted in the United States of America.

The Company’s internalcontrol over financial reporting includes policies and procedures that (1) pertainto the maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the Company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the Company arebeing made only in accordance with authorizations of management and directorsof the Company; and (3) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use, or disposition of theCompany’s assets that could have a material effect on the financial statements.

Due to its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements and, even when determined to be effective, can onlyprovide reasonable, not absolute, assurance with respect to financial statementpreparation and presentation. Projections of any evaluation of effectiveness tofuture periods are subject to risk that controls may become inadequate as aresult of changes in conditions or deterioration in the degree of compliance.

As of September 30,2005, management assessed the effectiveness of the Company’s internal controlover financial reporting based on the criteria established in Internal Control—IntegratedFramework issued by the Committee of Sponsoring Organizations of the TreadwayCommission (COSO). Based on this assessment, management has determined that theCompany’s internal control over financial reporting as of September 30,2005 is effective.

Our management’sassessment of the effectiveness of our internal control over financialreporting has been audited by Deloitte & Touche LLP, an independentregistered public accounting firm, as stated in their report which is includedherein.

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors and Shareholders ofInnovative Solutions and Support, Inc.Exton, Pennsylvania

We have audited management’s assessment, included inthe accompanying Management’s Report on Internal Controls over FinancialReporting, that Innovative Solutions and Support, Inc. and subsidiaries(the “Company”) maintained effective internal control over financial reportingas of September 30, 2005, based on criteria established in *Internal Control—Integrated Framework* issued by theCommittee of Sponsoring Organizations of the Treadway Commission. The Company’smanagement is responsible for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting. Our responsibility is to express an opinionon management’s assessment and an opinion on the effectiveness of the Company’sinternal control over financial reporting based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinions.

A company’s internal control over financial reportingis a process designed by, or under the supervision of, the company’s principalexecutive and principal financial officers, or persons performing similarfunctions, and effected by the company’s board of directors, management, andother personnel to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of the inherent limitations of internalcontrol over financial reporting, including the possibility of collusion orimproper management override of controls, material misstatements due to erroror fraud may not be prevented or detected on a timely basis. Also, projectionsof any evaluation of the effectiveness of the internal control over financialreporting to future periods are subject to the risk that the controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that theCompany maintained effective internal control over financial reporting as of September 30,2005, is fairly stated, in all material respects, based on the criteriaestablished in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission.Also in our opinion, the Company maintained, in all material respects,effective internal control over financial reporting as of September 30,2005, based on the criteria established in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission.

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We havealso audited, in accordance with the standards of the Public Company AccountingOversight Board (United States), the consolidated financial statements as ofand for the year ended September 30, 2005 of the Company and our reportdated December 7, 2005, expressed an unqualified opinion on thosefinancial statements.

| /s/ DELOITTE & TOUCHE LLP |   |
|-------------------------------|--------|
| Philadelphia, Pennsylvania    |
| December 7, 2005              |

 

**PART III**

**Item 10.**                 Directorsand executive officers of the registrant.

This information (otherthan the information relating to executive officers included in Part IItem 1.) will be included in our Proxy Statement relating to our Annual Meetingof Shareholders, which will be filed within 120 days after the close of ourfiscal year covered by this Report, and is hereby incorporated by reference tosuch Proxy Statement. We have adopted a written code of business conduct andethics, known as our code of conduct, which applies to all of our directors,officers, and employees, including our president and chief executive officerand our chief financial officer. Our code of conduct is available on ourInternet website, *www.innovative-ss.com*. Our codeof conduct may also be obtained by contacting investor relations at (610) 646-9800.Any amendments to our code of conduct or waivers from the provisions of thecode for our directors and our officers will be disclosed on our Internetwebsite promptly following the date of such amendment or waiver.

**Item 11.**                 Executivecompensation.

This information will beincluded in our Proxy Statement relating to our Annual Meeting of Shareholders,which will be filed within 120 days after the close of our fiscal year coveredby this Report, and is hereby incorporated by reference to such ProxyStatement.

**Item 12.**                 Securityownership of certain beneficial owners and management.

This information will beincluded in our Proxy Statement relating to our Annual Meeting of Shareholders,which will be filed within 120 days after the close of our fiscal year coveredby this Report, and is hereby incorporated by reference to such ProxyStatement.

**Item 13.**                 Certainrelationships and related transactions.

This information will beincluded in our Proxy Statement relating to our Annual Meeting of Shareholders,which will be filed within 120 days after the close of our fiscal year coveredby this Report, and is hereby incorporated by reference to such ProxyStatement.

**Item 14.**                 Principalaccounting fees and services

This information will be included in our ProxyStatement relating to our Annual Meeting of Shareholders, which will be filedwithin 120 days after the close of our fiscal year covered by this Report, andis hereby incorporated by reference to such Proxy Statement.

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**PART IV**

**Item 15.**                 Exhibits,financial statement schedules.

(a)           The following documentsare filed as part of this report:

(1)         *FinancialStatements*

See index to Financial Statements at Item 8 on page 28of this report.

(2)   *Financial Statement Schedules*

Schedules have been omitted because they are notapplicable or are not required or the information required to be set forththerein is included in the financial statements or notes thereto.

(3)   The following exhibits are filed as part of,or incorporated by reference into this report:
| Exhibit  Number | ** ** | ** **                                                                                                             | ** ** | **Exhibit Title** |
|-----------------|------------|------------------------------------------------------------------------------------------------------------------------|------------|-------------------|
| 3.1#            |       | Articles of  Incorporation of IS&S.                                                                                |
| 3.2#            |       | Bylaws of  IS&S.                                                                                                   |
| 10.1*#          |       | IS&S 1988  Incentive Stock Option Plan.                                                                            |
| 10.2*#          |       | IS&S 1998  Stock Option Plan.                                                                                      |
| 10.8@           |       | Bond Purchase  Agreement.                                                                                              |
| 10.9@           |       | Reimbursement,  Credit and Security Agreement.                                                                         |
| 10.11@          |       | Trust Indenture.                                                                                                       |
| 10.12*†    |       | Employment Agreement by and between Roman G.  Ptakowski and IS&S dated March 29, 2003.                             |
| 21              |       | Subsidiaries of  IS&S.                                                                                             |
| 23.1            |       | Consent of Deloitte  and Touche LLP.                                                                                   |
| 31.1            |       | Certification of  Chief Executive Officer pursuant to Rule 13a-14(a)                                                   |
| 31.2            |       | Certification of  Chief Financial Officer Pursuant to Rule 13a-14(a)                                                   |
| 32.1            |       | Certification  Pursuant to U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002. |

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*                    Constitutes amanagement contract or compensatory plan or arrangement required to be filed asan exhibit to this form.

#                 Incorporated byreference from the Registrant’s Registration Statement on Form S-1 (File No. 333-96584)filed with the Commission on May 9, 2000, as amended.

@              Incorporated byreference from the Registrant’s Form 10-K filed with the Commission forfiscal year 2000.

†                    Incorporatedby reference from the registrant’s Form 10-Q filed with the Commission forthe quarter ended March 31, 2003.

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

|        | INNOVATIVE  SOLUTIONS  AND SUPPORT,  INC. |
|--------|------------------------------------------------|
|   | By:                                            | /s/ GEOFFREY S. M. HEDRICK |
|   |                                           | **Geoffrey S. M. Hedrick** |
|   | * *                                       | ***Chairman of the Board and*** |
|   | * *                                       | ***Chief Executive Officer*** |
|   | Dated:                                         | December 12, 2005 |

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, this report has been signed by the following persons on behalf ofthe Registrant and in the capacities and on the dates indicated.

|                                                  | **Signature** | ** **                 | ** ** | ** **        | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|--------------------------------------------------|---------------|----------------------------|------------|-------------------|-----------|------------|------------|------------|----------|------------|
| /s/ GEOFFREY S. M. HEDRICK                  |          | Chairman of the Board  and |       | December 12, 2005 |
| **Geoffrey S. M. Hedrick**                       |          | Chief Executive Officer    |       |              |
| **(Principal Executive Officer)**                |          |                       |       |              |
| /s/ ROMAN G. PTAKOWSKI                      |          | President                  |       | December 12, 2005 |
| **Roman G. Ptakowski**                           |          |                       |       |              |
| **(President))**                                 |          |                       |       |              |
| /s/ JAMES J. REILLY                         |          | Chief Financial  Officer   |       | December 12, 2005 |
| **James J. Reilly**                              |          |                       |       |              |
| **(Principal Financial and Accounting Officer)** |          |                       |       |              |
| /s/ GLEN R. BRESSNER                        |          | Director                   |       | December 12, 2005 |
| **Glen R. Bressner**                             |          |                       |       |              |
| /s/ WINSTON J. CHURCHILL                    |          | Director                   |       | December 12, 2005 |
| **Winston J. Churchill**                         |          |                       |       |              |
| /s/ BENJAMIN A. COSGROVE                    |          | Director                   |       | December 12, 2005 |
| **Benjamin A. Cosgrove**                         |          |                       |       |              |
| /s/ IVAN M. MARKS                           |          | Director                   |       | December 12, 2005 |
| **Ivan M. Marks**                                |          |                       |       |              |
| /s/ ROBERT E. MITTELSTAEDT, JR.             |          | Director                   |       | December 12, 2005 |
| **Robert E. Mittelstaedt, Jr.**             |          |                       |       |              |
| /s/ ROBERT H. RAU                           |          | Director                   |       | December 12, 2005 |
| **Robert H. Rau**                                |          |                       |       |              |

 

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