**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 
| **x**      | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE** |
|------------|------------|--------------------------------------------------------------------------------------------|
| ** ** | ** ** | **ACT  OF 1934**                                                                           |

 

For the quarterly period ended December 31, 2007

 

OR

 
| **o**      | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE** |
|------------|------------|---------------------------------------------------------------------------------------------|
| ** ** | ** ** | **ACT  OF 1934**                                                                            |

 

[For the transition period from                                       to                                       ]

 

Commission File No. 0-31157

 

**INNOVATIVESOLUTIONS AND SUPPORT, INC.**

(Exact name of registrant as specified in its charter)

 

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

 

**(610) 646-9800**

(Registrant’s telephone number, including area code)

 

Indicateby check mark whether registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.
|   | Yes    x |   | No    o |
|--------|------------------------------|--------|-----------------------------|

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition or “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 
|   | o    Large  accelerated filer |   | x    Accelerated  filer |   | o    Non-accelerated  filer |
|--------|---------------------------------------------------|--------|---------------------------------------------|--------|-------------------------------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).

 
|   | Yes    o |   | No    x |
|--------|------------------------------|--------|-----------------------------|

 

Asof February 1, 2008, there were 16,898,354 shares of the Registrant’sCommon Stock, with par value of $.001 per share, outstanding.

 

 

 

----

 

 

**INNOVATIVE SOLUTIONS AND SUPPORT, INC.**

 

### **FORM 10-Q December 31, 2007**

### ** **

**INDEX**

 

|              | ** **                                                           | **Page No.** |
|-------------------|----------------------------------------------------------------------|-------------------|
|              |                                                                 |              |
| **PART I.**  | **FINANCIAL INFORMATION**                                            | —            |
|              |                                                                 |              |
| Item 1.           | Financial Statements  (Unaudited)                                    |              |
|              |                                                                 |              |
|              | Condensed Consolidated  Balance Sheets — December 31, 2007 |              |
|              | and September 30,  2007                                         | 3                 |
|              |                                                                 |              |
|              | Condensed Consolidated  Statements of Operations —              |              |
|              | Three Months Ended  December 31, 2007 and 2006                  | 4                 |
|              |                                                                 |              |
|              | Condensed Consolidated  Statements of Cash Flows —              |              |
|              | Three Months Ended  December 31, 2007 and 2006                  | 5                 |
|              |                                                                 |              |
|              | Notes to Condensed  Consolidated Financial Statements                | 6 – 10       |
|              |                                                                 |              |
| Item 2.           | Managements Discussion  and Analysis of Financial Condition          |              |
|              | and Results of  Operations                                           | 10 – 14      |
|              |                                                                 |              |
| Item 3.           | Quantitative and  Qualitative Disclosures about Market Risk          | 15                |
|              |                                                                 |              |
| Item 4.           | Controls and Procedures                                              | 15                |
|              |                                                                 |              |
| **PART II.** | **OTHER INFORMATION**                                                |              |
|              |                                                                 |              |
| Item 1.           | Legal Proceedings                                                    | 16                |
|              |                                                                 |              |
| Item 1A           | Risk Factors                                                         | 16                |
|              |                                                                 |              |
| Item 2.           | Unregistered Sales of  Equity Securities and use of Proceeds         | 16                |
|              |                                                                 |              |
| Item 3.           | Defaults upon Senior  Securities                                     | 16                |
|              |                                                                 |              |
| Item 4.           | Submission of Matters  to a Vote of Security Holders                 | 16                |
|              |                                                                 |              |
| Item 5.           | Other Information                                                    | 16                |
|              |                                                                 |              |
| Item 6.           | Exhibits                                                             | 16                |
|              |                                                                 |              |
| **SIGNATURES**    |                                                                 |

 

 

 

2

----

 

**PART I—FINANCIAL INFORMATION**

**Item 1—FinancialStatements**

**INNOVATIVESOLUTIONS AND SUPPORT, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEET**

**(unaudited)**

 

| **ASSETS**                                                                    | ** ** | **As of**             | ** ** | **As of**              | ** ** |
|-------------------------------------------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                                                                    | ** ** | **December 31, 2007** | ** ** | **September 30, 2007** | ** ** |
| Current Assets:                                                               |       |                  |       |                   |       |
| Cash and cash equivalents                                                     |       | $                     | 43,819,458 |                   | $          | 49,151,078 |   |
| Accounts receivable                                                           |       | 5,109,240             |       | 6,248,606              |       |
| Inventories                                                                   |       | 9,637,230             |       | 9,363,795              |       |
| Deferred income taxes                                                         |       | 1,033,030             |       | 899,895                |       |
| Prepaid expenses and other current assets                                     |       | 7,749,392             |       | 6,208,804              |       |
|                                                                          |       |                  |       |                   |       |
| Total current assets                                                          |       | 67,348,350            |       | 71,872,178             |       |
|                                                                          |       |                  |       |                   |       |
| Property and Equipment:                                                       |       |                  |       |                   |       |
| Computers and test equipment                                                  |       | 5,579,698             |       | 5,444,737              |       |
| Corporate airplane                                                            |       | 3,058,627             |       | 3,058,627              |       |
| Furniture and office equipment                                                |       | 1,033,542             |       | 1,016,954              |       |
| Manufacturing facility                                                        |       | 5,557,048             |       | 5,557,048              |       |
| Land                                                                          |       | 1,021,245             |       | 1,021,245              |       |
|                                                                          |       | 16,250,160            |       | 16,098,611             |       |
| Less - Accumulated depreciation and amortization                              |       | (6,951,713            | )          | (6,721,274             | )          |
|                                                                          |       |                  |       |                   |       |
| Net property and equipment                                                    |       | 9,298,447             |       | 9,377,337              |       |
|                                                                          |       |                  |       |                   |       |
| Deferred income taxes                                                         |       | 643,511               |       | 328,060                |       |
|                                                                          |       |                  |       |                   |       |
| Other assets                                                                  |       | 3,006,590             |       | 3,008,210              |       |
|                                                                          |       |                  |       |                   |       |
| Total assets                                                                  |       | $                     | 80,296,898 |                   | $          | 84,585,785 |   |
|                                                                          |       |                  |       |                   |       |
| **LIABILITIES AND SHAREHOLDERS' EQUITY**                                      | ** ** | ** **            | ** ** | ** **             | ** ** |
|                                                                          |       |                  |       |                   |       |
| Current Liabilities                                                           |       |                  |       |                   |       |
| Current portion of capitalized lease obligations                              |       | $                     | 9,908      |                   | $          | 9,908 |   |
| Accounts payable                                                              |       | 5,092,254             |       | 4,077,789              |       |
| Accrued expenses                                                              |       | 3,099,201             |       | 4,670,832              |       |
| Deferred revenue                                                              |       | 272,549               |       | 660,415                |       |
|                                                                          |       |                  |       |                   |       |
| Total current liabilities                                                     |       | 8,473,912             |       | 9,418,944              |       |
|                                                                          |       |                  |       |                   |       |
| Note payable                                                                  |       | 4,335,000             |       | 4,335,000              |       |
| Long-term portion of capitalized lease obligations                            |       | 45,128                |       | 47,542                 |       |
| Deferred revenue                                                              |       | 32,902                |       | 50,520                 |       |
| 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 December 31, 2007 and September 30, 2007                   |       | —                |       | —                 |       |
|                                                                          |       |                  |       |                   |       |
| Common stock, $.001 par value: 75,000,000 shares authorized,  18,166,734      |       | 18,167                |       | 18,161                 |       |
| and 18,161,172 shares issued at December 31, 2007 and September 30,  2007     |       |                  |       |                   |       |
| Additional paid-in capital                                                    |       | 44,818,781            |       | 44,607,993             |       |
| Retained earnings                                                             |       | 40,659,436            |       | 44,194,053             |       |
| Treasury stock, at cost, 1,272,510, shares at December 31, 2007               |       |                  |       |                   |       |
| and September 30, 2007                                                        |       | (18,086,428           | )          | (18,086,428            | )          |
|                                                                          |       |                  |       |                   |       |
| Total shareholders' equity                                                    |       | 67,409,956            |       | 70,733,779             |       |
|                                                                          |       |                  |       |                   |       |
| Total liabilities and  shareholders' equity                                   |       | $                     | 80,296,898 |                   | $          | 84,585,785 |   |

 

 

The accompanying notesare an integral part of these statements.

 

 

 

3

----

 

 

**INNOVATIVE SOLUTIONS AND SUPPORT, INC.CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS********(unaudited)**

 

 

| ** **                                   | ** ** | **Three Months  Ended** | ** ** | **Three Months  Ended** | ** ** |
|----------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                   | ** ** | **December 31  2007**   | ** ** | **December 31  2006**   | ** ** |
| Net sales:                                   |       |                    |       |                    |       |
| Product                                      |       | $                       | 3,899,788  |                    | $          | 3,182,028 |   |
| Engineering - modification & development |       | 835,859                 |       | 246,620                 |       |
| Total net sales                              |       | 4,735,647               |       | 3,428,648               |       |
|                                         |       |                    |       |                    |       |
| Cost of sales                                |       |                    |       |                    |       |
| Product                                      |       | 2,770,099               |       | 1,747,216               |       |
| Engineering - modification & development |       | 888,960                 |       | 286,729                 |       |
| Total cost of sales                          |       | 3,659,059               |       | 2,033,945               |       |
| Gross profit                                 |       | 1,076,588               |       | 1,394,703               |       |
|                                         |       |                    |       |                    |       |
| Operating expenses:                          |       |                    |       |                    |       |
| Research and development                     |       | 1,740,668               |       | 1,324,354               |       |
| Selling, general and administrative          |       | 5,935,906               |       | 3,059,015               |       |
| Total operating expenses                     |       | 7,676,574               |       | 4,383,369               |       |
| Operating loss                               |       | (6,599,986              | )          | (2,988,666              | )          |
|                                         |       |                    |       |                    |       |
| Interest income                              |       | 589,361                 |       | 816,273                 |       |
| Interest expense                             |       | (50,539                 | )          | (50,760                 | )          |
| Loss before income taxes                     |       | (6,061,164              | )          | (2,223,153              | )          |
| Income tax benefit                           |       | (1,939,223              | )          | (1,124,709              | )          |
| Net loss                                     |       | $                       | (4,121,941 | )                       | $          | (1,098,444 | ) |
|                                         |       |                    |       |                    |       |
| Net loss per common share:                   |       |                    |       |                    |       |
| Basic                                        |       | $                       | (0.24      | )                       | $          | (0.07 | ) |
| Diluted                                      |       | $                       | (0.24      | )                       | $          | (0.07 | ) |
|                                         |       |                    |       |                    |       |
| Weighted average shares  outstanding:        |       |                    |       |                    |       |
| Basic                                        |       | 16,893,547              |       | 16,824,933              |       |
| Diluted                                      |       | 16,893,547              |       | 16,824,933              |       |

 

 

The accompanyingnotes are an integral part of these statements.

 

 

 

 

4

----

 

 

**INNOVATIVESOLUTIONS AND SUPPORT, INC.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(unaudited)**

** **

 

| ****                                                                                                | ** ** | **For the Three  Months Ended** | ** ** | **For the Three  Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                                                                          | ** ** | **December 31,   2007**         | ** ** | **December 31,   2006**         | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES:**                                                          | ** ** | ** **                      | ** ** | ** **                      | ** ** |
| Net loss                                                                                            |       | $                               | (4,121,941 | )                               | $          | (1,098,444 | ) |
| Adjustments to reconcile net income (loss) to net cash  provided by (used in) operating activities: |       |                            |       |                            |       |
| Depreciation and amortization                                                                       |       | 245,239                         |       | 199,178                         |       |
| Share-based compensation expense:                                                                   |       |                            |       |                            |       |
| Stock options                                                                                       |       | 129,136                         |       | 111,871                         |       |
| Nonvested stock awards                                                                              |       | 50,000                          |       | 49,943                          |       |
| Tax benefit (expense) from share-based arrangements:                                                |       |                            |       |                            |       |
| Stock options                                                                                       |       | 10,439                          |       | 129,994                         |       |
| Nonvested stock awards                                                                              |       | 6,286                           |       | (1,036                          | )          |
| Excess tax benefits from share-based payments arrangements                                          |       | (9,685                          | )          | (122,811                        | )          |
| (Gain) loss on disposal of fixed assets                                                             |       | (3,000                          | )          | 551                             |       |
| Deferred income taxes                                                                               |       | (448,586                        | )          | 256,663                         |       |
| (Increase) decrease in:                                                                             |       |                            |       |                            |       |
| Accounts receivable                                                                                 |       | 1,139,366                       |       | 1,572,384                       |       |
| Inventories                                                                                         |       | (273,435                        | )          | 254,876                         |       |
| Prepaid expenses and other current assets                                                           |       | (1,540,588                      | )          | (1,376,651                      | )          |
| Other non current assets                                                                            |       | (6,180                          | )          | —                          |       |
| Increase (decrease) in:                                                                             |       |                            |       |                            |       |
| Accounts payable                                                                                    |       | 1,014,465                       |       | 138,322                         |       |
| Accrued expenses                                                                                    |       | (984,307                        | )          | (390,708                        | )          |
| Deferred revenue                                                                                    |       | (405,484                        | )          | (397,825                        | )          |
| Net cash used in operating activities                                                               |       | (5,198,275                      | )          | (673,693                        | )          |
|                                                                                                |       |                            |       |                            |       |
| **CASH FLOWS FROM INVESTING  ACTIVITIES:**                                                          | ** ** | ** **                      | ** ** | ** **                      | ** ** |
| Purchases of property and equipment                                                                 |       | (158,549                        | )          | (26,762                         | )          |
| Proceeds on sale of fixed assets                                                                    |       | 3,000                           |       | —                          |       |
| Net cash used in investing activities                                                               |       | (155,549                        | )          | (26,762                         | )          |
|                                                                                                |       |                            |       |                            |       |
| **CASH FLOWS FROM FINANCING  ACTIVITIES:**                                                          | ** ** | ** **                      | ** ** | ** **                      | ** ** |
| Proceeds from exercise of stock options                                                             |       | 14,933                          |       | 203,792                         |       |
| Repayment of capitalized lease obligations                                                          |       | (2,414                          | )          | (2,025                          | )          |
| Excess tax benefits from share-based payments arrangements                                          |       | 9,685                           |       | 122,811                         |       |
| Net cash provided by financing activities                                                           |       | 22,204                          |       | 324,578                         |       |
|                                                                                                |       |                            |       |                            |       |
| Net decrease in cash and  cash equivalents                                                          |       | (5,331,620                      | )          | (375,877                        | )          |
| Cash and cash equivalents,  beginning of year                                                       |       | 49,151,078                      |       | 62,984,829                      |       |
|                                                                                                |       |                            |       |                            |       |
| Cash and cash equivalents,  end of year                                                             |       | $                               | 43,819,458 |                            | $          | 62,608,952 |   |
|                                                                                                |       |                            |       |                            |       |
| **SUPPLEMENTAL DISCLOSURE OF CASH  FLOW INFORMATION**                                               | ** ** | ** **                      | ** ** | ** **                      | ** ** |
| Cash paid for interest                                                                              |       | $                               | 40,439     |                            | $          | 40,529 |   |
| Cash received from income tax refund                                                                |       | $                               | (4,593     | )                               | $          | — |   |

 

 

The accompanyingnotes are an integral part of these statements.

 

 

 

5

----

 

 

**Innovative Solutions and Support Inc.Notes to Condensed Consolidated Financial Statements**

 

**1. Basis of Presentation:**

 

Innovative Solutions andSupport, Inc. (the “Company”) was incorporated in Pennsylvania on February 12,1988. The Company’s primary business is the design, manufacture and sale offlat panel display systems, flight information computers and advancedmonitoring systems for military, government, commercial air transport andcorporate aviation markets.

 

The balance sheet as of December 31,2007, the statement of operations for the three months  ended December 31, 2007 and 2006 and thestatements of cash flows for the three months ended December  31, 2007 and2006 have been prepared by the Company without audit. In the opinion ofmanagement, all adjustments, consisting of normal and recurring adjustments,necessary to present fairly the financial position, results of operations andcash flows at December 31, 2007 and for all periods presented have beenmade.

 

Certain information andfootnote disclosures normally included in financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America have been condensed or omitted. It is suggested that these financialstatements be read in conjunction with the financial statements and notesthereto included in the Company’s Form 10-K for the year ended September 30,2007 as filed with the Securities and Exchange Commission. The results ofoperations for the three months ended December 31, 2007 are not necessarilyindicative of the operating results for the full year.

 

**2. Net income per Share**

 

Net income per share (“EPS”)is calculated using the principles of SFAS No. 128, “Earnings Per Share.”

 

For each of the threemonth periods ended December 31, 2007 and 2006, there were 569,000 optionsto purchase common stock outstanding that were excluded from the computation ofdiluted earnings per share as the effect would be antidilutive.

 

**3. Concentrations**

 

For the three monthsended December 31, 2007, one customer accounted for 70% of net sales. Forthe three months ended December 31, 2006, three customers accounted for15%, 12% and 10% of net sales or 37% on a combined basis.

 

**4. Inventories**

 

Inventories are stated atthe lower of cost (first-in, first-out) or market and consist of the following:

 

**                                               **
| ** **      | ** ** | **December 31** | ** ** | **September 30** | ** ** |
|-----------------|------------|-----------------|------------|------------------|------------|
| ** **      | ** ** | **2007**        | ** ** | **2007**         | ** ** |
| Raw materials   |       | $               | 6,297,344  |             | $          | 6,420,184 |   |
| Work-in-process |       | 2,262,207       |       | 2,216,111        |       |
| Finished goods  |       | 1,077,679       |       | 727,500          |       |
|            |       | $               | 9,637,230  |             | $          | 9,363,795 |   |

 

**5.Warranty**

 

The Company provides forthe estimated cost of product warranties at the time revenue is recognized.Warranty cost is recorded as cost of sales and the reserve balance recorded asan accrued expense in the financial statements. While the Company engages inextensive product quality programs and processes, the Company’s warrantyobligation is affected by product failure rates and the related material, laborand delivery costs incurred in correcting a product failure. Should actualproduct failure rates, material or labor costs differ from the Company’sestimates, further revisions to the estimated warranty liability would berequired.

 

 

 

6

----

 

 

Warranty cost and accrualinformation for the three months ended December 31, 2007 is highlighted below:

 
| Warranty accrual at  September 30, 2007                       |   | $       | 592,524 |   |
|---------------------------------------------------------------|--------|---------|---------|--------|
| Accrued expense for the  three months ended December 31, 2007 |   | 71,509  |    |
| Warranty costs for the  three months ended December 31, 2007  |   | (39,552 | )       |
|                                                          |   |    |    |
| Warranty accrual at  December 31, 2007                        |   | $       | 624,481 |   |

 

 

**6. Share-Based Compensation**

 

Effective October 1,2005 the Company adopted the provisions of SFAS No.123(R), Share-Based Payment(“SFAS 123(R)”), using the modified prospective approach and now accounts forshare-based compensation applying the fair value method for expensing stockoptions and non-vested stock awards.

 

Total share-basedcompensation expense was $179,000 and $162,000 for the three months ended December 31,2007 and 2006, respectively. The total income tax benefit recognized in thestatement of operations for share-based compensation arrangements was $57,000and $82,000 for the three months ended December 31, 2007 and 2006,respectively. Compensation expense related to share-based awards is recorded asa component of general and administrative expense.

 

The Company maintains the1998 Stock Option Plan (the “Plan”) and the 2003 Restricted Stock Plan (the “RestrictedPlan”). These plans were approved by the Company’s shareholders.

 

**Stock Options**

 

The Plan provides for thegranting of incentive and nonqualified stock options to employees, officers,directors and independent contractors and consultants. Through December 31,2007 no stock options have been granted to independent contractors orconsultants under this Plan.  Total compensationexpense was $129,000 and $112,000 for the three months ended December 31,2007 and 2006, respectively.  Incentivestock options granted under the Plan have exercise prices that must be at leastequal to the fair value of the common stock on the date of grant. Nonqualifiedstock options granted under the Plan have exercise prices that may be lessthan, equal to or greater than the fair value of the common stock on the dateof grant. The Company has reserved 3,389,000 shares of Common Stock for awardsunder the plan. As of December 31, 2007 there were 1,686,000 sharesremaining and available for grant under the Plan.

 

A summary of optionactivity under the Plan as of December 31, 2007 and changes during theperiod then ended is as follows:

 

| ** **                         | ** ** | ** **  | ** ** | ** **           | ** ** | **Weighted Average** | ** ** | **Aggregate** | ** ** |
|------------------------------------|------------|-------------|------------|----------------------|------------|----------------------|------------|---------------|------------|
| ** **                         | ** ** | ** **  | ** ** | **Weighted Average** | ** ** | **Remaining**        | ** ** | **Intrinsic** | ** ** |
| ** **                         | ** ** | **Options** | ** ** | **Exercise Price**   | ** ** | **Contractual Life** | ** ** | **Value**     | ** ** |
| Outstanding at September  30, 2007 |       | 572,959     |       | $                    | 10.30      |                 |       |          |       |   |
| Granted                            |       | —      |       | —               |       |                 |       |          |       |
| Exercised                          |       | (2,097      | )          | 7.12                 |       |                 |       |          |       |
| Cancelled                          |       | (2,000      | )          | 11.72                |       |                 |       |          |       |
|                               |       |        |       |                 |       |                 |       |          |       |
| Outstanding at December  31, 2007  |       | 568,862     |       | $                    | 10.31      |                 | 5.85       |          | $          | — |   |
| Exercisable at December  31, 2007  |       | 392,962     |       | $                    | 7.31       |                 | 4.95       |          | $          | 934,939 |   |

 

 

There were no optionsgranted during the three months ended December 31, 2007. Theweighted-average grant date fair value of individual options granted during thethree months ended December 31, 2006 was $16.30. The total intrinsic valueof options exercised during the three months ended December 31, 2007 and2006 was $27,000 and $388,000, respectively.

 

 

 

7

----

 

 

The followingtable summarizes information about stock options under the Plan at December 31,2007:

 

| **Options Outstanding** | ** ** | **Options Exercisable** | ** **       |
|-------------------------|------------|-------------------------|------------------|
| ** **              | ** ** | ** **              | ** **       | **Weighted-** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **              | ** ** | **Outstanding**         | ** **       | **Average** | ** ** | **Weighted-** | ** ** | ** ** | ** ** | **Weighted-** | ** ** |
| ** **              | ** ** | **As of**               | ** **       | **Remaining** | ** ** | **Average** | ** ** | **As of** | ** ** | **Average** | ** ** |
| **Range of Exercise**   | ** ** | **December 31,**        | ** **       | **Contractual** | ** ** | **Exercise** | ** ** | **December 31,** | ** ** | **Exercise** | ** ** |
| **Prices**              | ** ** | **2007**                | ** **       | **Life** | ** ** | **Price** | ** ** | **2007** | ** ** | **Price** | ** ** |
| $                       | 0.00       | -                       |   5.00 |   | 204,963 |   | 4.98 |   | $ | 4.18 |   | 203,763 |   | $ | 4.18 |   |
| $                       | 5.01       | -                       | 10.00            |   | 140,699 |   | 3.97 |   | 7.70 |   | 118,199 |   | 7.60 |   |
| $                       | 10.01      | -                       | 15.00            |   | 110,000 |   | 7.62 |   | 14.03 |   | 37,600 |   | 13.89 |   |
| $                       | 15.01      | -                       | 20.00            |   | 48,200 |   | 7.35 |   | 16.81 |   | 23,400 |   | 16.77 |   |
| $                       | 20.01      | -                       | 26.97            |   | 65,000 |   | 8.54 |   | 24.16 |   | 10,000 |   | 20.84 |   |
|                    |       |                    |             |   |   |   |   |   |   |   |   |   |   |
|                    |       |                    |             | 568,862 |   | 5.85 |   | 10.31 |   | 392,962 |   | 7.31 |   |
|                         |            |                         |                  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

The fair value ofeach option grant is estimated on the date of grant using the Black-Scholesoption pricing model. Options are exercised over a maximum term of ten yearsfrom the date of grant and typically vest over periods of five years from thegrant date. The expected term of options represents the period of time that theoptions granted are expected to be outstanding and is based on historicalexperience. Expected volatility is based on historical volatility of theCompany’s stock. The risk free interest rate is based on U.S. Treasuries withconstant maturities in effect at the time of the grant. Compensation expensefor employee stock options also includes an estimate for forfeitures and isrecognized ratably over the vesting term. The table below sets forth the fairvalue assumptions used to record compensation expense for the periodidentified:

 

| ****                                      | ** ** | **Three Months  Ended** | ** ** | **Three Months  Ended** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                | ** ** | **December 31, 2007**   | ** ** | **December 31, 2006**   | ** ** |
| Expected lives (years)                    |       | 8.6                     |       | 8.8                     |       |
| Weighted average risk-free  interest rate |       | 2.3                     | %          | 2.1                     | %          |
| Expected volatility                       |       | 64.4                    | %          | 64.7                    | %          |
| Expected dividend rate                    |       | —                  | %          | —                  | %          |

 

 

As of December 31,2007, there was approximately $1.3 million of unrecognized compensation cost,net of forfeitures, related to non-vested stock options, which is expected tobe recognized over a period of approximately 5 years.

 

**Non-vestedStock**

 

The Restricted Plan fornon-employee directors was approved by shareholders at the Company’s February 26,2004 Annual Meeting of Shareholders. The Plan calls for an annual award ofnon-vested stock having a fair market value of $40,000 as of the close ofbusiness on October 1 of the current fiscal year for all eligiblenon-employee directors. The stock is awarded in four quarterly installmentsduring the fiscal year provided the director is still serving on the board onthe quarterly issue date. Total expense was $50,000 for each of the three monthperiods ended December 31, 2007 and 2006. As of December 31, 2007,there was an estimated $150,000 of unrecognized compensation expense related tononvested stock awards under the Company’s Restricted Plan. That cost isexpected to be recognized over the balance of the fiscal year. The followingtable outlines restricted stock awards for the three months ended December 31,2007:

 

| ** **                     | ** ** | **Non-vested**   | ** ** | **Weighted Average** | ** ** |
|--------------------------------|------------|------------------|------------|----------------------|------------|
| ** **                     | ** ** | **Stock Awards** | ** ** | **Share Price**      | ** ** |
| Balance at September 30,  2007 |       | 3,465            |       | $                    | 14.43      |   |
| Granted                        |       | 10,525           |       | 19.00                |       |
| Issued                         |       | (3,465           | )          | 14.43                |       |
| Cancelled                      |       | —           |       | —               |       |
| Balance at December 31,  2007  |       | 10,525           |       | $                    | 19.00      |   |

 

 

 

 

8

----

 

 

**7. Stock Repurchase Program**

 

On December 28,2005 the Company’s Board of Directors approved a common stock repurchaseprogram to acquire up to 2,000,000 shares of its outstanding common stock. Theprogram was in effect until December 31, 2006. Over the course of theprogram the Company repurchased 1,272,510 shares of its common stock at anaverage cost of $14.21 per share.

 

**8. Notes Payable**

 

The Company entered intoa $4,335,000 loan agreement dated August 1, 2000 with the Chester County,Pennsylvania Industrial Development Authority. The purpose of the loan was tofund the construction of the Company’s new office and manufacturing facility.The loan matures in 2015 and carries an interest rate set by the remarketingagent that is consistent with 30-day tax-exempt commercial paper. The loanagreement includes an optional redemption schedule that allows the Company theoption of forgoing any principal pay-down of the outstanding balance and,accordingly, the balance of the notes payable will be due in 2015.

 

The loan agreementrequired the Company to maintain certain financial covenants including a ratioof liabilities to earnings before interest, taxes and depreciation andamortization (EBITDA), a fixed charge ratio and a minimum tangible net worth.As of December 31, 2006, the Company was in violation of these financialcovenants. The defaults were subsequently waived and an amendment to theagreement was entered into with the lender whereby the existing covenants weresuspended until the fiscal quarter ending on June 30, 2008.

 

In November 2007 theCompany and the lender signed an amendment to the loan agreement which deletedexisting financial covenants and replaced them with only one restrictivecovenant that requires the Company to maintain at all times unencumbered cashand marketable securities having a market value of at least $20 million. TheCompany was in compliance with this covenant as of December 31, 2007.

 

**9. NewAccounting Pronouncements**

 

In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurements*(“SFAS 157”). SFAS 157 defines fair value, establishes a framework formeasuring fair value in generally accepted accounting principles, and expandsdisclosures about fair value measurements. This statement does not require anynew fair value measurements; however, the application of this Statement maychange current practice for some entities. SFAS 157 is effective for fiscalyears beginning after November 15, 2007. The Company is currentlyevaluating the impact of this pronouncement.

 

**10.Income Taxes**

 

The Company adopted theprovisions of FASB Interpretation 48, “Accounting for Uncertainty in IncomeTaxes” (FIN 48), on October 1, 2007. Previously, the Company had accountedfor tax contingencies in accordance with SFAS No. 5, “Accounting forContingencies.” At the adoption date of October 1, 2007, the Companyapplied FIN 48 to all tax positions for which the statute of limitationsremained open. As a result of the implementation of FIN 48, the Companyrecognized a decrease of approximately $587,000 in the liability forunrecognized tax benefits, which was accounted for as an increase to the October 1,2007 balance of retained earnings

 

The amount ofunrecognized tax benefits as of October 1, 2007 was approximately $330,000,all of which, if ultimately recognized, would reduce the Company’s annualeffective tax rate. There have been no material changes in unrecognized taxbenefits since October 1, 2007.

 

The Company is subject toincome taxes in the U.S. federal and various state jurisdictions. Taxregulations within each jurisdiction are subject to the interpretation of therelated tax laws and regulations and require significant judgment to apply.With few significant exceptions, the Company is no longer subject to U.S. federalor state and local examinations by tax authorities for the years ending before September 30,2004.

 

The Company does notexpect the total amount of unrecognized tax benefits to significantly change inthe next twelve months.

 

The Company recognizes interestaccrued and penalties related to unrecognized tax benefits in income taxexpense for all periods presented. The Company had accrued approximately$30,000 for the payment of interest and penalties, net of deferred taxbenefits, at October 1, 2007. Subsequent changes to accrued interest andpenalties have not been significant.

 

Forthe three months ended December 31, 2007, we recognized $11,814 of interest andpenalties, net of cash benefit, within income tax expense. 

 

9

----

 

 

**11.Prepaid Expenses and Other Current Assets**

 

Prepaid expenses consistof the following:

 

| ** **           | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|----------------------|------------|------------------|------------|------------------|------------|
| ** **           | ** ** | **2007**         | ** ** | **2006**         | ** ** |
| Prepaid income taxes |       | $                | 6,629,938  |             | $          | 5,017,794 |   |
| Other                |       | 1,119,454        |       | 1,191,010        |       |
|                 |       | $                | 7,749,392  |             | $          | 6,208,804 |   |

 

 

**Item 2.Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

 

**Overview**

 

We design, manufactureand sell flat panel display systems, flight information computers and advancedmonitoring systems to the Department of Defense (DOD), government agencies,commercial air transport carriers and corporate/general aviation markets.

 

Our revenues are derivedfrom the sale of our products to the retrofit market and to original equipmentmanufacturers (OEMs). Our customers include government and military entitiesand their commercial contractors, aircraft operators, aircraft modificationcenters and various OEMs. Although we occasionally sell our productsdirectly to government entities, we primarily sell our products to commercialcustomers for end use in government and military programs. Sales to defensecontractors are on commercial terms, although some of the termination and otherprovisions of government contracts are applicable to these contracts.

 

We continue to invest in and seek additional opportunities for our FlatPanel Display System product line. In October 2005, the FAA awarded theCompany a second Technical Standard Order (TSO) for our flat panel displaysystem COCKPIT/IPTM. This TSO establishes our flat panel display system asmeeting FAA requirements that have been put in place to ensure safe flight on avariety of aircraft types and, additionally, it addresses the most stringentCommercial Air Transport market requirements as provided in Title 14 of theCode of Federal Regulation, subpart 25, Commercial Air Transport. The TSOstates “It has been noted that this display system employs an integritymonitoring system that assures integrity to a catastrophic/Level A designcondition with the use of commercial graphic processors.”

 

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-767 aircraft.The STC provides B-767 operators with a low cost, rapidly implemented retrofitof their cockpit avionics with a modern pilot and copilot suite of highresolution multi-color LCD flat panel displays. Operators will benefit fromimproved dispatch reliability, logistics savings and adaptability to futurerequirements. The receipt of the STC positions the Company to pursue more than1,700 B-757 and B-767 aircraft with similar needs for Flat Panel Display Systemupgrades. The STC also provides a foundation for incorporating the product intoother airplanes as well.

 

In January 2007, theCompany in a teaming arrangement with ABX Air received another STC from the FAAon its Flat Panel Display System for use on B-757 aircraft. Similar to theprior STC awarded by the FAA, this one provides B-757 operators with the samelow cost, rapidly implemented retrofit of their cockpit avionics with a modernpilot and copilot suite of high resolution multi-color LCD flat panel displays.

 

Our cost of sales relatedto product sales is comprised of product material purchased through our supplierbase and direct in-house assembly labor and overhead costs. Many of thecomponents we use in assembling our products are standard, although certainparts are manufactured to meet our specifications. The overhead portion of costof sales is primarily comprised of salaries and benefits, building occupancy,supplies, and outside service costs related to our production, purchasing,customer service, material control and quality departments as well as warrantycosts.

 

Our cost of sales relatedto Engineering-modification and development (EMD) is comprised of engineeringlabor, consulting services and other cost associated with specific design anddevelopment projects.

 

We intend to continue toinvest in the development of new products and the enhancement of our existingproduct line and will expense research and development costs as they areincurred.

 

Our selling, general, andadministrative expenses consist of marketing and business development expenses,professional expenses, salaries and benefits for executive and administrativepersonnel, facility costs, recruiting, legal, accounting, and other generalcorporate expenses.

 

 

 

 

 

10

----

 

**Three Months Ended December 31,2007 Compared to the Three Months Ended December 31, 2006**

 

*Net sales.* Net sales increased $1.3 million, or38%, to $4.7 million for the three months ended December 31, 2007 from$3.4 million in the three months ended December 31, 2006. For the threemonths ended December 31, 2007, product sales increased $0.7 million andEMD sales increased $0.6 million from the same period in the prior year. Theincrease in product sales and EMD was primarily related to our order with EclipseAviation. The first production units for Eclipse Aviation were shipped duringthe quarter.

 

*Cost of sales.* Cost of sales increased $1.6 million or76%, to $3.7 million, or 79% of net sales in the three months ended December 31,2007 from $2.1 million, or 62 % of net sales in the three months ended December 31,2006. The overall dollar increase consists of $1.0 million in cost of salesrelated to product sales and an increase of $0.6 million related to EMD sales.The $1.0 million increase in cost related to product sales is attributable toincreased sales and additional costs associated with the first production unitsfor the Eclipse Aviation order. The increase in cost related to EMD wasprimarily related to increased EMD sales.

 

*Research and development.* Research and development expenseincreased $0.4 million or 31% to $1.7 million or 37% of net sales in the threemonths ended December 31, 2007 from $1.3 million or 38% of net sales inthe three months ended December 31, 2006.

 

The increase in researchand development expense in the quarter was mainly due to less cost beingallocated to EMD cost of sales for the period. This allocation was necessary tomatch non- recurring engineering cost with corresponding non-recurringengineering sales in the period. Overall, when you combine research anddevelopment expenses with EMD cost of sales, combined engineering, research anddevelopment related cost has increased $1.0 million for the same period in theprior year and reflects the Company’s continued commitment to productdevelopment, research and engineering.

 

*Selling, general, andadministrative.*Selling, general and administrative expenses increased $2.9 million, or 94%, to$5.9 million, or 125% of net sales in the three months ended December 31,2007 from $3.1 million or 89% of net sales in the three months ended December 31,2006. The increase in the dollar amount was primarily the result of $3.5million of legal fees in the quarter that the Company incurred in connectionwith litigation related to protecting its Intellectual Property.

 

*Interest income.* Interest income was $589,000 in thethree months ended December 31, 2007 as compared $816,000 in the threemonths ended December 31, 2006. The decrease in interest income wasprimarily the result of our reduced average cash balance in the current quarteras opposed to the same period in the prior year.

 

*Interest expense.* Interest expense was $51,000 in thethree months ended December 31, 2007 and 2006 respectively.

 

*Income tax benefit.* The income tax benefit for the threemonths ended December 31, 2007 was $1.9 million as compared to $1.1million for the three months ended December 31, 2006. The increase in theamount of tax benefit was the result of a higher loss before income tax in thethree months ended December 31, 2007 then the same period, in the prioryear.

 

The effective tax ratefor the three months ended December 31, 2007 was a benefit of 32%. Theeffective tax rate for the three months ended December 31, 2006 was abenefit of 51%. In each quarter the effective tax rate differs from thestatutory rate due to the utilization of research and experimentation taxcredits.

 

In December of 2006,an additional two-year extension of the Research and Experimentation (R&E)Tax Credit was enacted into law. This retroactive extension covered amountspaid or incurred from January 1, 2006 to December 31, 2006. Theentire impact of this retroactive extension has been recognized in the firstquarter ended December 31, 2006, as required by SFAS 109, Accounting forIncome Taxes.  For the quarter ending December 31, 2006, the overallbenefit recorded, including the impact of the R&E credit was 51% and wouldhave been 44% without this discrete item.

 

*Net loss.* As a result of the factors describedabove, our net loss in the three months ended December 31, 2007 was $4.1million, an increase of $3.0 million from the net loss of $1.1 million for thethree months ended December 31, 2006.

 

**Liquidity and Capital Resources**

 

Our main source ofliquidity has been cash flows from prior operations. We require cashprincipally to finance inventory, accounts receivable and payroll.

 

Our cash used inoperating activities was $5.2 million for the three months ended December 31,2007 as compared to $0.7 million for the three months ended December 31,2006. The increase was due primarily to higher net loss ($3.0 million),increased deferred tax benefit ($0.7 million) and increased accrued expenses($0.6 million) which were partially offset by increased accounts payable ($0.9million).

 

Our cash used ininvesting activities was $155,000 for the three months ended December 31,2007 and primarily consisted of the 

 

 

11

----

 

 

purchase of productionand laboratory test equipment. Cash used in investing activities was $27,000for the three months ended December 31, 2006 and consisted of the purchaseof production equipment.

 

Net cash flow providedfrom financing activities was $22,000 for the three months ended December 31,2007 as compared to $325,000 in the three months ended December 31, 2006.In both periods the primary source of cash was from proceeds from the exerciseof stock options.

 

The Company entered intoa $4,335,000 loan agreement dated August 1, 2000 with the Chester County,Pennsylvania Industrial Development Authority. The purpose of the loan was tofund the construction of the Company’s new office and manufacturing facility.The loan matures in 2015 and carries an interest rate set by the remarketingagent that is consistent with 30-day tax-exempt commercial paper. The loanagreement includes an optional redemption schedule that allows the Company theoption of forgoing any principal pay-down of the outstanding balance and,accordingly, the balance of the notes payable will be due in 2015

 

The loan agreementrequired the Company to maintain certain financial covenants including a ratioof liabilities to earnings before interest, taxes and depreciation andamortization (EBITDA), a fixed charge ratio and a minimum tangible net worth.As of December 31, 2006, the Company was in violation of these financialcovenants. The defaults were subsequently waived and an amendment to theagreement was entered into with the lender whereby the existing covenants weresuspended until the fiscal quarter ending on June 30, 2008.

 

In November 2007 theCompany and the lender signed an amendment to the loan agreement, which deletedexisting financial covenants and replaced them with only one restrictivecovenant that requires the Company to maintain at all times unencumbered cashand marketable securities having a market value of at least $20 million. TheCompany was in compliance with this covenant as of December 31, 2007.

 

Our future capitalrequirements depend on numerous factors, including market acceptance of ourproducts, the timing and rate of expansion of our business, acquisitions, jointventures and other factors. We have experienced increases in our expendituressince our inception consistent with growth in our operations, personnel andproduct line, and we anticipate that our expenditures will continue to increasein the foreseeable future. We believe that our cash and cash equivalents willprovide sufficient capital to fund our operations for at least the next twelvemonths. However, we may need to raise additional funds through public orprivate financings or other arrangements in order to support more rapidexpansion of our business than we now anticipate either through acquisitions ororganic growth. Further, we may need to develop and introduce new or enhancedproducts, respond to competitive pressures, invest in or acquire businesses ortechnologies or respond to unanticipated requirements or developments. Ifadditional funds are raised through the issuance of equity securities, dilutionto existing shareholders may result. If insufficient funds are available, wemay not be able to introduce new products or compete effectively in any of ourmarkets, which could hurt our business.

 

**Backlog**

 

As of December 31,2007 and 2006, our backlog was $70.0 million and $32.3 million, respectively.The period over period increase in backlog principally reflects the increase inFlat Panel Display System orders. The Flat Panel Display System component as ofDecember 31, 2007 is $61.1 million, an increase of $37.6 million over the December 31,2006 balance of $23.5 million.

 

**Critical Accounting Policies**

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities,disclosure of contingent assets and liabilities at the date of the financialstatements and the reported amount of revenues and expenses during thereporting period. The Company’s most critical accounting policies are revenuerecognition, income taxes, inventory valuation, share-based compensation andwarranty reserves.

 

*Revenuerecognition*

 

The Company recognizesrevenue under the provisions of Staff Accounting Bulletin (SAB) No. 104, “Revenue Recognition” (SAB 104).

 

The Company enters intocertain sales arrangements that include multiple deliverables as defined inEITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.”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. In general, revenues are separated between product salesand EDM sales. The allocated revenue for each deliverable is then recognizedusing appropriate revenue recognition methods.

 

The Company accounts fortransactions with software that is more than incidental to the products underSOP 97-2. “Software Revenue Recognition” and EITF Issue 03-5, “Applicability ofAICPA Statement of Position 97-2, Software Revenue Recognition, to Non-

 

 

12

----

 

 

Software Deliverables inan Arrangement Containing More-Than-Incidental Software.”  Accordingly, revenue is recognized when allof the following criteria are met: 1) there is persuasive evidence that anarrangement exists; 2) delivery has occurred or services have been rendered; 3)the seller’s price to the buyer is fixed or determinable; and 4) collectibilityis reasonably assured.

 

Sales related to certainlong-term contracts requiring development and delivery of products over severalaccounting periods are accounted for under the American Institute of CertifiedPublic Accountants (AICPA) Statement of Position (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 a percentageof completion basis using cost-to-cost methodology to measure progress towardscompletion.

 

The Company offers itscustomers extended warranties for additional fees. These warranty sales arerecorded as deferred revenue and recognized as sales on a straight-line basisover the warranty period.

 

*Incometaxes*

 

Income taxes are recordedin accordance with SFAS No. 109, “Accounting for Income Taxes.”  Provisions for federal and state income taxesare calculated on reported financial statement pre-tax income based on currenttax law. The Company recognizes deferred tax assets and liabilities fortemporary differences between the financial reporting basis and the tax basisof the Company’s assets and liabilities and expected benefits of utilizing netoperating loss carryforwards. The impact on deferred taxes of changes in taxrates and laws, if any, applied to the years during which temporary differencesare expected to be settled, are reflected in the consolidated financial statementsin the period of enactment.

 

*Inventories*

 

Inventories are writtendown for estimated obsolescence equal to the difference between the cost ofinventory and the estimated net realizable value based upon assumptions aboutfuture market conditions. If actual future demand or market conditions are lessfavorable than those projected by management, additional inventory write-downsmay be required.

 

*Share-based compensation*

 

Effective October 1,2005, the Company adopted the provisions of SFAS 123R, using the modifiedprospective approach and now accounts for share-based compensation applying thefair value method for expensing stock options. Accordingly, the adoption ofSFAS 123R’s fair value method results in compensation costs for the Company’s1998 Stock Option Plan.

 

*Warrantyreserves*

 

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. Ifthe actual cost of warranties differs from our estimated amounts, futureresults of operations could be adversely affected.

 

**Business Segments**

 

We operate in oneprincipal business segment which designs, manufactures and sells flightinformation computers, flat panel displays and advanced monitoring systems tothe Department of Defense, government agencies, commercial air transportcarriers and corporate/general aviation markets. We currently derive virtuallyall our net sales from the sale of this equipment. Almost all of the net sales,operating results and identifiable assets are in the United States.

 

**New Accounting Pronouncements**

 

In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurements*(“SFAS 157”). SFAS 157 defines fair value, establishes a framework formeasuring fair value in generally accepted accounting principles and expandsdisclosures about fair value measurements. This statement does not require anynew fair value measurements; however, the application of this Statement maychange current practice for some entities. SFAS 157 is effective for fiscalyears beginning after November 15, 2007. The Company is currentlyevaluating the impact of this pronouncement.

 

 

 

13

----

 

 

**FORWARD-LOOKINGSTATEMENTS**

 

This Form 10-Qcontains statements, which, to the extent that they are not recitations ofhistorical fact, constitute forward-looking statements within the meaning ofthe Securities Act of 1933 and the Securities Exchange Act of 1934. The words “anticipate”“believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “outlook,” “would,” “should,”“guidance,” “potential,” “continue,” “project,” “forecast” and similar expressions are intended to identifyforward-looking statements. Forward-looking statements are not guarantees offuture performance and involve risks, uncertainties and assumptions, which aredifficult to predict. Therefore, actual outcomes and results may differmaterially from what is expressed or implied by these statements.  Numerous factors, including potentially thefollowing factors, could affect the Company’s forward-looking statements andactual performance:

 
|   | · |   | market acceptance of  our COCKPIT/IPTM system or other planned products or product  enhancements;                                      |
|--------|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                   |
|   | · |   | difficulties in  developing and producing our flat panel systems, or COCKPIT/IPTM,  or other planned products or product enhancements; |
|   |   |   |                                                                                                                                   |
|   | · |   | continued market  acceptance of our air data systems products;                                                                         |
|   |   |   |                                                                                                                                   |
|   | · |   | the ability to obtain  future contracts and awards;                                                                                    |
|   |   |   |                                                                                                                                   |
|   | · |   | the availability of  government funding and customer requirements;                                                                     |
|   |   |   |                                                                                                                                   |
|   | · |   | our ability to gain  regulatory approval of our products in a timely manner;                                                           |
|   |   |   |                                                                                                                                   |
|   | · |   | delays in receiving  components from third party suppliers;                                                                            |
|   |   |   |                                                                                                                                   |
|   | · |   | the competitive  environment;                                                                                                          |
|   |   |   |                                                                                                                                   |
|   | · |   | the termination of  programs or contracts for convenience by customers;                                                                |
|   |   |   |                                                                                                                                   |
|   | · |   | failure to retain key  personnel;                                                                                                      |
|   |   |   |                                                                                                                                   |
|   | · |   | new product offerings  from competitors;                                                                                               |
|   |   |   |                                                                                                                                   |
|   | · |   | potential future  acquisitions;                                                                                                        |
|   |   |   |                                                                                                                                   |
|   | · |   | protection of  intellectual property rights;                                                                                           |
|   |   |   |                                                                                                                                   |
|   | · |   | our ability to service  the international market, and                                                                                  |
|   |   |   |                                                                                                                                   |
|   | · |   | other factors disclosed  from time to time in our filings with the Securities and Exchange Commission.                                 |

 

Readers are cautioned notto place undue reliance on these forward-looking statements, which speak onlyas of the date of this Form 10-Q. The Company does not undertake anyobligation to publicly release any revisions to these forward-lookingstatements to reflect events, circumstances or changes in expectations afterthe date of this Form 10-Q, or to reflect the occurrence of unanticipatedevents. The forward-looking statements in this document are intended to besubject to the safe harbor protection provided by Sections 27A of theSecurities Act and 21E of the Exchange Act.

 

For a discussionidentifying some important factors that could cause actual results to varymaterially from those anticipated in the forwardlooking statements, see theCompany’s Securities and Exchange Commission filings including, but not limitedto, the discussions of “Risk Factors” contained in the Company’s Annual Reporton Form 10-K for the fiscal year ended September 30, 2007.

 

Investors should also beaware that while we do, from time to time, communicate with securitiesanalysts, it is against our policy to disclose any material non-publicinformation or other confidential commercial information.  Accordingly, shareholders should not assumethat we agree with any statement or report issued by an analyst irrespective ofthe content of the statement or report. Furthermore, we have a policy against issuing or confirming financialforecasts or projections issued by others. Thus, to the extent that reports issued by securities analysts containany projections, forecasts or opinions, such reports are not the responsibilityof Innovative Solutions and Support, Inc.

 

 

 

14

----

 

 

**Item 3. Quantitative andQualitative 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-exempt commercialpaper. As the interest rates are variable, and we do not engage in hedgingactivities, a change in interest rates earned on the cash equivalents or paidon the industrial revenue bond would impact interest income and expense alongwith cash flows, but would not impact the fair market value of the related underlyinginstruments.

 

**Item 4. Controls and Procedures**

 
|   | (a)    |   | An evaluation was  performed under the supervision and with the participation of the Company’s  management, including its Chief Executive Officer, or CEO, and Chief  Financial Officer, or CFO, of the effectiveness of the Company’s disclosure  controls and procedures, as such term is defined under Rule 13a-15e  under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as  of December 31, 2007. Based on that evaluation, the Company’s management,  including the CEO and CFO, concluded that the Company’s disclosure controls  and procedures are effective to provide reasonable assurance that information  required to be disclosed by the Company in reports that it files or submits  under the Exchange Act, is recorded, processed, summarized and reported as  specified in Securities and Exchange Commission rules and forms and that  such information is accumulated and communicated to the Company’s management,  including the CEO and CFO, or persons performing similar functions, as  appropriate to allow timely decisions regarding required disclosure. |
|--------|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   | (b)    |   | There were no changes  in the Company’s internal control over financial reporting identified in  connection with the evaluation of such controls that occurred during the  Company’s most recent fiscal quarter that has materially affected, or is  reasonably likely to materially affect, the Company’s internal control over  financial reporting.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |

 

 

 

 

 

 

 

15

----

 

 

**PART II—OTHERINFORMATION**

 

**Item 1.    Legal Proceedings**

 

In the ordinary course ofbusiness, we are at times subject to various legal proceedings.  Except with respect to the fees incurred inconnection with the matters described below, we do not believe that any of the currentlegal proceedings will have a material adverse effect on our results ofoperations or financial position.  On September 13,2005 the Company filed a lawsuit in the United States District Court for theWestern District of Tennessee against J2, Inc., a company founded andjointly owned by Joseph Cesar, a former employee of the Company, and JamesZachary, a former sales consultant for the Company. The complaint alleged thatthe J2/Kollsman/Air Data Computer then being marketed by J2 and manufactured byKollsman, Inc. infringed a patent assigned to the Company.

 

On November 7, 2007the Company received a favorable jury verdict in its trade secretmisappropriation case against Kollsman, Inc. (a subsidiary of ElbitSystems Ltd.),  J2 Inc., Joseph Caesar, JamesZachary and Zachary Technologies, Inc. in the United States District Courtfor the Western District of Tennessee. The jury unanimously found that each of the defendants hadmisappropriated the Company’s air data computer technology.  The jury found that the Company had suffereddamages of just over $4.4 million in lost profits and $1.6 million indefendants’ net profits, for a total of over $6 million.  The jury also found in favor of  the Company’s claims for breach of duty andcontract, and unfair competition against J2 Inc., Joseph Caesar, James Zacharyand Zachary Technologies, Inc.

 

On December 18,2007, the court entered a temporary injunction aimed at preventing further useof the Company’s trade secret and proprietary information.  The judge presiding over the case will hearthe Company’s claims for a permanent injunction as well as punitive andexemplary damages and attorneys’ fees against Kollsman and the other defendantsin a hearing currently scheduled for March 2008**.**

 

On January 17, 2007the Company filed suit in Pennsylvania state court against StrathmanAssociates, a former software consultant for the Company, alleging thatStrathman had improperly used the Company’s trade secret and proprietaryinformation in assisting J2 and Kollsman in developing the J2/Kollsman Air DataComputer. The case is ongoing.

 

For the three monthsended December 31, 2007 and 2006 the Company has incurred approximately$3.5 million and $1.1 million, respectively, in legal fees in connection withthe two matters discussed above.

 

**Item 1A.  Risk Factors**

 

There are no materialchanges to the risk factors described under Item 1A of our Form 10-K forthe year ended September 30, 2007.

 

I**tem 2.    Unregistered Sales of Equity Securities andUse of Proceeds**

 

**          **None

 

**Item 3.    Defaults upon Senior Securities**

 

**          **None

 

**Item 4.    Submission of Matters to a Vote of SecurityHolders**

 

**          **None

 

**Item 5.    Other Information**

 

**          **None

 

**Item 6.    Exhibits**

 

(a)   Exhibits

 

        31.1         Certificationof Chief Executive Officer Pursuant to Rule 13a-14(a)

 

 

 

 

16

----

 

 

        31.2         Certificationof Chief Financial Officer Pursuant to Rule 13a-14(a)

 

        32.1         CertificationPursuant to U.S.C. Section 1350, as Adopted Pursuant to Section 906of the Sarbanes-Oxley Act of 2002

 

 

**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
| ** **                                    | **INNOVATIVE SOLUTIONS AND  SUPPORT, INC.** |
|-----------------------------------------------|---------------------------------------------|
| ** **                                    |                                        |
|                                          |                                        |
| Date:   February 6,  2008 | By:                                         | /s/ JOHN C. LONG |
|                                          |                                        | JOHN C. LONG |
|                                          |                                        | CHIEF FINANCIAL OFFICER |

 

 

 

 

 

17

----