**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

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

 

**For the quarterly period ended June 30,2005**

 

**OR**

 

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

 

**[For the transition period from                     to                           ]**

 

**Commission File No. 0-31157**

 

**INNOVATIVE SOLUTIONS AND SUPPORT, INC.**

(Exact name of registrant as specified in itscharter)

 
| **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) |

 

Indicate by check mark whether registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.Yes  **ý**     No  **o**

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act). Yes  **ý**    No  **o**

 

As of July 29, 2005, there were 18,038,825 shares of theRegistrant’s Common Stock, with par value of $.001 per share, outstanding.

 

 

----

 

**INNOVATIVE SOLUTIONS & SUPPORT, INC.**

### **FORM 10-Q JUNE 30, 2005**

###  

**INDEX**

 
| ** **        | ** **                                                                                                              | **Page No.** |
|-------------------|-------------------------------------------------------------------------------------------------------------------------|--------------|
| **PART I.**  | **FINANCIAL INFORMATION**                                                                                               |         |
|              |                                                                                                                    |         |
| Item 1.           | FINANCIAL  STATEMENTS (UNAUDITED)                                                                                       |         |
|              |                                                                                                                    |
|              | Condensed  Consolidated Balance Sheets – September 30, 2004 and June 30, 2005                            | 3            |
|              |                                                                                                                    |         |
|              | Condensed  Consolidated Statements of Operations –  Three Months and Nine Months Ended June 30, 2004 and 2005 | 4            |
|              |                                                                                                                    |         |
|              | Condensed  Consolidated Statements of Cash Flows –  Nine Months Ended June 30, 2004 and 2005                  | 5            |
|              |                                                                                                                    |         |
|              | Notes  to Condensed Consolidated Financial Statements                                                                   | 6            |
|              |                                                                                                                    |         |
| Item  2.          | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                             | 9            |
|              |                                                                                                                    |         |
| Item  3.          | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                             | 14           |
|              |                                                                                                                    |         |
| Item 4.           | CONTROLS  AND PROCEDURES                                                                                                | 14           |
|              |                                                                                                                    |         |
| **PART II.** | **OTHER  INFORMATION**                                                                                                  |         |
|              |                                                                                                                    |         |
| Item 1.           | LEGAL PROCEEDINGS                                                                                                       | 15           |
|              |                                                                                                                    |         |
| Item 2.           | UNREGISTERED SALES OF EQUITY SECURITIES AND  USE OF PROCEEDS                                                            | 15           |
|              |                                                                                                                    |         |
| Item 3.           | DEFAULTS UPON SENIOR SECURITIES                                                                                         | 15           |
|              |                                                                                                                    |         |
| Item 4.           | SUBMISSION OF MATTERS TO A VOTE OF SECURITY  HOLDERS                                                                    | 15           |
|              |                                                                                                                    |         |
| Item 5.           | OTHER INFORMATION                                                                                                       | 15           |
|              |                                                                                                                    |         |
| Item 6.           | EXHIBITS                                                                                                                | 15           |
|              |                                                                                                                    |
| **SIGNATURES**    |                                                                                                                    |
|                   |                                                                                                                         |              |  |

 

2

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**PART I–FINANCIAL INFORMATION**

**Item1–Financial Statements**

**INNOVATIVE SOLUTIONS AND SUPPORT, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEET**

**(unaudited)**

 
| ** **                                                                                                                                                                                                      | ** ** | **As of  September 30,  2004** | ** ** | **As of  June 30,  2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|--------------------------------|------------|
| **ASSETS**                                                                                                                                                                                                      | ** ** | ** **                          | ** ** | ** **                     | ** ** |
| Current Assets:                                                                                                                                                                                                 |       |                                |       |                           |       |
| Cash and cash equivalents                                                                                                                                                                                       |       | $                                   | 65,867,167 |                           | $          | 83,219,709 |   |
| Accounts receivable, less allowance for  doubtful accounts of $100,000 at September 30, 2004 and June 30,  2005                                                                                       |       | 5,003,100                           |       | 7,510,876                      |       |
| Inventories                                                                                                                                                                                                     |       | 5,191,628                           |       | 3,660,592                      |       |
| Deferred income taxes                                                                                                                                                                                           |       | 984,111                             |       | 984,111                        |       |
| Prepaid expenses                                                                                                                                                                                                |       | 665,276                             |       | 1,344,642                      |       |
|                                                                                                                                                                                                            |       |                                |       |                           |       |
| Total current assets                                                                                                                                                                                            |       | 77,711,282                          |       | 96,719,930                     |       |
|                                                                                                                                                                                                            |       |                                |       |                           |       |
| Property and Equipment:                                                                                                                                                                                         |       |                                |       |                           |       |
| Computers and test equipment                                                                                                                                                                                    |       | 3,933,326                           |       | 4,085,695                      |       |
| Corporate airplane                                                                                                                                                                                              |       | 2,998,161                           |       | 2,998,161                      |       |
| Furniture and office equipment                                                                                                                                                                                  |       | 622,364                             |       | 717,461                        |       |
| Manufacturing facility                                                                                                                                                                                          |       | 5,414,986                           |       | 5,420,741                      |       |
| Land                                                                                                                                                                                                            |       | 1,021,245                           |       | 1,021,245                      |       |
|                                                                                                                                                                                                            |       | 13,990,082                          |       | 14,243,303                     |       |
| Less - Accumulated depreciation and  amortization                                                                                                                                                               |       | (4,369,851                          | )          | (4,864,727                     | )          |
|                                                                                                                                                                                                            |       |                                |       |                           |       |
| Net property and equipment                                                                                                                                                                                      |       | 9,620,231                           |       | 9,378,576                      |       |
|                                                                                                                                                                                                            |       |                                |       |                           |       |
| Deposits and other assets                                                                                                                                                                                       |       | 137,114                             |       | 128,114                        |       |
|                                                                                                                                                                                                            |       |                                |       |                           |       |
| Total assets                                                                                                                                                                                                    |       | $                                   | 87,468,627 |                           | $          | 106,226,620 |   |
|                                                                                                                                                                                                            |       |                                |       |                           |       |
| **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                           |       | 409,418                        |       |
| Accrued expenses                                                                                                                                                                                                |       | 4,754,641                           |       | 3,683,789                      |       |
| Deferred revenue                                                                                                                                                                                                |       | 526,023                             |       | 735,463                        |       |
|                                                                                                                                                                                                            |       |                                |       |                           |       |
| Total current liabilities                                                                                                                                                                                       |       | 7,084,168                           |       | 4,935,927                      |       |
|                                                                                                                                                                                                            |       |                                |       |                           |       |
| Note payable                                                                                                                                                                                                    |       | 4,235,000                           |       | 4,235,000                      |       |
| Long-term portion of capitalized lease  obligations                                                                                                                                                             |       | 20,681                              |       | 15,035                         |       |
| Deferred revenue                                                                                                                                                                                                |       | 261,934                             |       | 209,081                        |       |
| Deferred income taxes                                                                                                                                                                                           |       | 411,857                             |       | 411,857                        |       |
| Commitments and contingencies                                                                                                                                                                                   |       | —                              |       | —                         |       |
|                                                                                                                                                                                                            |       |                                |       |                           |       |
| Shareholders’ Equity:                                                                                                                                                                                      |       |                                |       |                           |       |
| Preferred stock, 10,000,000 shares  authorized-Class A Convertible stock, $.001 par value; 200,000 shares  authorized, no shares issued and outstanding at September 30, 2004 and June 30,  2005 |       | —                              |       | —                         |       |
|                                                                                                                                                                                                            |       |                                |       |                           |       |
| Common stock, $.001 par value: 75,000,000  shares authorized, 20,272,995 and 18,027,368 shares issued and outstanding at  September 30, 2004 and June 30, 2005                                        |       | 20,273                              |       | 18,027                         |       |
|                                                                                                                                                                                                            |       |                                |       |                           |       |
| Additional paid-in capital                                                                                                                                                                                      |       | 48,705,531                          |       | 41,699,407                     |       |
| Retained earnings                                                                                                                                                                                               |       | 37,342,940                          |       | 54,702,286                     |       |
| Treasury stock, at cost, 2,535,039 and 0  shares at                                                                                                                                                             |       |                                |       |                           |       |
| September 30, 2004 and June 30,  2005                                                                                                                                                                 |       | (10,613,757                         | )          | —                         |       |
|                                                                                                                                                                                                            |       |                                |       |                           |       |
| Total shareholders’ equity                                                                                                                                                                                 |       | 75,454,987                          |       | 96,419,720                     |       |
|                                                                                                                                                                                                            |       |                                |       |                           |       |
| Total liabilities and shareholders’ equity                                                                                                                                                                 |       | $                                   | 87,468,627 |                           | $          | 106,226,620 |   |

 

The accompanying notes are an integral part of these statements.

 

3

----

 

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

 
| ** **                           | ** ** | **Three Months  Ended  June 30,  2004** | ** ** | **Three Months  Ended  June 30,  2005** | ** ** | **Nine Months  Ended  June 30,  2004** | ** ** | **Nine Months  Ended  June 30,  2005** | ** ** |
|--------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| Net sales                            |       | $                                            | 12,269,653 |                                         | $          | 17,101,620                                  |       | $                                           | 31,688,276 |   | $ | 55,081,445 |   |
| Cost of sales                        |       | 4,056,372                                    |       | 5,846,912                                    |       | 11,200,624                                  |       | 17,806,327                                  |       |
| Gross profit                         |       | 8,213,281                                    |       | 11,254,708                                   |       | 20,487,652                                  |       | 37,275,118                                  |       |
| Operating expenses:                  |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Research and development             |       | 1,363,143                                    |       | 1,501,475                                    |       | 3,861,311                                   |       | 4,321,474                                   |       |
| Selling, general and administrative  |       | 2,090,357                                    |       | 2,489,287                                    |       | 5,600,461                                   |       | 6,821,682                                   |       |
|                                 |       | 3,453,500                                    |       | 3,990,762                                    |       | 9,461,772                                   |       | 11,143,156                                  |       |
| Operating income                     |       | 4,759,781                                    |       | 7,263,946                                    |       | 11,025,880                                  |       | 26,131,962                                  |       |
| Interest income                      |       | (116,110                                     | )          | (543,857                                     | )          | (345,985                                    | )          | (1,255,431                                  | )          |
| Interest expense                     |       | 31,197                                       |       | 48,796                                       |       | 94,201                                      |       | 127,930                                     |       |
| Income before income taxes           |       | 4,844,694                                    |       | 7,759,007                                    |       | 11,277,664                                  |       | 27,259,463                                  |       |
| Income taxes                         |       | 1,559,086                                    |       | 2,860,294                                    |       | 3,810,625                                   |       | 9,894,108                                   |       |
| Net income                           |       | $                                            | 3,285,608  |                                         | $          | 4,898,713                                   |       | $                                           | 7,467,039  |   | $ | 17,365,355 |   |
| Net Income Per Common Share:         |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Basic                                |       | $                                            | 0.19       |                                         | $          | 0.27                                        |       | $                                           | 0.43       |   | $ | 0.97 |   |
| Diluted                              |       | $                                            | 0.18       |                                         | $          | 0.27                                        |       | $                                           | 0.42       |   | $ | 0.95 |   |
|                                 |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Weighted Average Shares Outstanding: |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Basic                                |       | 17,499,959                                   |       | 17,909,270                                   |       | 17,296,491                                  |       | 17,814,504                                  |       |
| Diluted                              |       | 17,941,119                                   |       | 18,360,921                                   |       | 17,801,727                                  |       | 18,314,568                                  |       |

 

The accompanying notes are an integral part of these statements.

 

4

----

 

**INNOVATIVE SOLUTIONS AND SUPPORT,INC.CONDENSED CONSOLIDATED STATEMENTS OFCASH FLOWS(unaudited)**

 
| ** **                                                                                         | ** ** | **For the Nine  Months Ended  June 30,  2004** | ** ** | **For the Nine  Months Ended  June 30,  2005** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|------------|
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                              |       |                                                |       |                                                |       |
| Net income                                                                                         |       | $                                                   | 7,467,039  |                                                | $          | 17,365,355 |   |
| Adjustments to reconcile net income to net  cash provided  by (used in) operating activities: |       |                                                |       |                                                |       |
| Depreciation and amortization                                                                      |       | 520,665                                             |       | 565,876                                             |       |
| Loss (Gain) on Disposal of Fixed Assets                                                            |       | 1,037                                               |       | (14,000                                             | )          |
| Excess and obsolete inventory expense                                                              |       | 62,998                                              |       | 52,340                                              |       |
| Compensation expense for stock issued to  directors                                                |       | 182,766                                             |       | 145,525                                             |       |
| Tax benefit from exercise of stock options                                                         |       | 175,982                                             |       | 1,628,562                                           |       |
| (Increase) decrease in:                                                                            |       |                                                |       |                                                |       |
| Accounts receivable                                                                                |       | 1,963,871                                           |       | (2,493,776                                          | )          |
| Inventories                                                                                        |       | (1,919,997                                          | )          | 1,478,696                                           |       |
| Prepaid expenses and other                                                                         |       | 305,045                                             |       | (679,366                                            | )          |
| Increase (decrease) in:                                                                            |       |                                                |       |                                                |       |
| Accounts payable                                                                                   |       | 201,486                                             |       | (1,286,829                                          | )          |
| Accrued expenses                                                                                   |       | 116,164                                             |       | (989,931                                            | )          |
| Deferred revenue                                                                                   |       | 2,290                                               |       | 156,587                                             |       |
| Net cash provided by operating activities                                                          |       | $                                                   | 9,079,346  |                                                | $          | 15,929,039 |   |
|                                                                                               |       |                                                |       |                                                |       |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                              |       |                                                |       |                                                |       |
| Purchases of property and equipment                                                                |       | (560,105                                            | )          | (315,221                                            | )          |
| Net cash used in investing activities                                                              |       | $                                                   | (560,105   | )                                                   | $          | (315,221 | ) |
|                                                                                               |       |                                                |       |                                                |       |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                              |       |                                                |       |                                                |       |
| Proceeds from exercise of stock options                                                            |       | 674,330                                             |       | 1,744,370                                           |       |
| Proceeds from exercise of warrants                                                                 |       | 614,598                                             |       |                                                |       |
| Capital lease obligations                                                                          |       | 39,119                                              |       |                                                |       |
| Repayments of capital lease obligations                                                            |       | (9,338                                              | )          | (5,646                                              | )          |
| Net cash provided by financing activities                                                          |       | 1,318,709                                           |       | 1,738,724                                           |       |
|                                                                                               |       |                                                |       |                                                |       |
| Net increase in cash and cash equivalents                                                          |       | $                                                   | 9,837,950  |                                                | $          | 17,352,542 |   |
|                                                                                               |       |                                                |       |                                                |       |
| Cash and cash equivalents, beginning of  year                                                      |       | $                                                   | 48,789,744 |                                                | $          | 65,867,167 |   |
|                                                                                               |       |                                                |       |                                                |       |
| Cash and cash equivalents, end of period                                                           |       | $                                                   | 58,627,694 |                                                | $          | 83,219,709 |   |

 

The accompanying notes are an integral part of these statements.

 

5

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**InnovativeSolutions & Support Inc.Notes to Condensed Consolidated FinancialStatements**

 

**1.Basis of Presentation:**

 

InnovativeSolutions and Support, Inc. (the “Company”) was incorporated inPennsylvania on February 12, 1988. The Company’s primary business is thedesign, manufacture and sale of flight information computers, flat paneldisplays and advanced monitoring systems for the military, government,commercial air transport and corporate aviation markets.

 

Thebalance sheet as of June 30, 2005, the statement of operations for thethree months and nine months ended June 30, 2004 and 2005 and thestatements of cash flows for the nine months ended June 30, 2004 and 2005have been prepared by the Company without audit. In the opinion of management,all adjustments, consisting of normal and recurring adjustments, necessary topresent fairly the financial position, results of operations and cash flows at June 30,2005 and for all periods presented have been made.

 

Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with accounting principles generally accepted in theUnited States of America have been condensed or omitted. It is suggested thatthese financial statements be read in conjunction with the financial statementsand notes thereto included in the Company’s Form 10K for the year ended September 30,2004 as filed with the Securities and Exchange Commission. The results ofoperations for the three months and nine months ended June 30, 2005 arenot necessarily indicative of the operating results for the full year.

 

OnJune 13, 2005, the Company’s Board of Directors approved a three-for-twosplit of the Company’s common stock.  Thestock split was effected in the form of a fifty percent (50%) stock dividendthat was paid on July 7, 2005 to shareholders of record on June 23,2005.  The issued and outstanding commonstock and all share and per share amounts have been retroactively restated inthis report to give effect to this three-for-two stock split.

 

**2. Netincome per Share**

 

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

 

Areconciliation of weighted average shares outstanding appears below:

 
| ** **                                | ** ** | **Three Months  Ended  June 30, 2004** | ** ** | **Three Months  Ended  June 30, 2005** | ** ** | **Nine Months  Ended  June 30, 2004** | ** ** | **Nine Months  Ended  June 30, 2005** | ** ** |
|-------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| Weighted average number of shares-basic   |       | 17,499,959                                  |       | 17,909,270                                  |       | 17,296,491                                 |       | 17,814,504                                 |       |
| Effect of dilutive securities:            |       |                                        |       |                                        |       |                                       |       |                                       |       |
| Employee stock options                    |       | 441,160                                     |       | 451,651                                     |       | 358,522                                    |       | 500,064                                    |       |
| Warrants                                  |       | 0                                           |       | 0                                           |       | 146,714                                    |       | 0                                          |       |
| Weighted average number of shares-diluted |       | 17,941,119                                  |       | 18,360,921                                  |       | 17,801,727                                 |       | 18,314,568                                 |       |

 

Forthe three month periods ended June 30, 2005 and 2004, there were -0- and1,846 options outstanding that were excluded from the computation of dilutedearnings per share as the effect would have been antidilutive.  For the nine month periods ended June 30,2005 and 2004, there were 16,841 and 7,153 options outstanding that wereexcluded from the computation of diluted earnings per share as the effect wouldhave been antidilutive.

 

**3.Concentrations**

 

Forthe three months ended June 30, 2005, three customers accounted for 19%,15%, and 11% of net sales or 45% on a combined basis.  For the three months ended June 30,2004, three customers accounted for 17%, 11%, and 10% of net sales or 38% on acombined basis.  For the nine monthsended June 30, 2005, three customers accounted for 12%, 11% and 10% of netsales or 33% on a combined basis.  Forthe nine months ended June 30, 2004, four customers accounted for 13%, 13%,10% and 10% of net sales or 46% on a combined basis.

 

6

----

 

**4.Inventories**

 

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

 
| ** **      | ** ** | **September 30,  2004** | ** ** | **June 30,  2005** | ** ** |
|-----------------|------------|------------------------------|------------|-------------------------|------------|
| Raw materials   |       | $                            | 1,928,005  |                    | $          | 2,016,387 |   |
| Work-in-process |       | 2,573,932                    |       | 1,102,657               |       |
| Finished goods  |       | 689,691                      |       | 541,548                 |       |
|            |       | $                            | 5,191,628  |                    | $          | 3,660,592 |   |

 

**5.Warranty**

 

TheCompany provides for the estimated cost of product warranties at the timerevenue is recognized. Warranty cost is recorded as cost of sales in thefinancial statements. While the Company engages in extensive product qualityprograms and processes, the Company’s warranty obligation is affected byproduct failure rates and the related material, labor and delivery costsincurred in correcting a product failure. Should actual product failure rates,material or labor costs differ from the Company’s estimates, further revisionsto the estimated warranty liability would be required.

 

Warranty cost and accrual information for thethree months ended June 30, 2005 is highlighted below:

 
| Warranty accrual at March 31, 2005                  |   | $       | 790,751 |   |
|----------------------------------------------------------|--------|---------|---------|--------|
| Accrued expense for the quarter ended June 30, 2005 |   | 46,183  |    |
| Warranty costs for the quarter ended June 30, 2005  |   | (45,459 | )       |
| Warranty accrual at June 30, 2005                   |   | $       | 791,475 |   |

 

Warranty cost and accrual information for thenine months ended June 30, 2005 is highlighted below:

 
| Warranty accrual at September 30, 2004                  |   | $        | 757,476 |   |
|--------------------------------------------------------------|--------|----------|---------|--------|
| Accrued expense for the nine months ended June 30, 2005 |   | 160,793  |    |
| Warranty costs for the nine months ended June 30, 2005  |   | (126,794 | )       |
| Warranty accrual at June 30, 2005                       |   | $        | 791,475 |   |

 

**6.Stock Options**

 

TheCompany’s 1998 Stock Option Plan (the “Plan”) provides for the granting ofincentive and nonqualified stock options to employees, officers, directors andindependent contractors and consultants.

 

Incentivestock options granted under the Plan must be at least equal to the fair valueof the common stock on the date of grant. Nonqualified stock options grantedunder the Plan may be less than, equal to or greater than the fair value of thecommon stock on the date of grant. The Company has reserved 3,389,025 shares ofCommon Stock for awards under the Plan (after giving effect to the Company’sthree-for-two stock split).

 

Stock-basedemployee compensation is recognized using the intrinsic value method inaccordance with Accounting Principles Board Opinion (“APB”) No. 25, “Accountingfor Stock Issued to Employees.” For disclosure purposes, pro forma net incomeand net income per share data are provided in accordance with SFAS No. 123,“Accounting for Stock-Based Compensation,” as if the fair value method had beenapplied. Under SFAS No. 123, compensation cost related to stock optionsgranted to employees is computed based on the fair value of the stock option atthe date of grant using the Black-Scholes option pricing model. Had the Companyrecognized compensation cost for its stock option plans consistent with theprovisions of SFAS No. 123, the Company’s pro forma net income for thethree-month and nine-month periods ended June 30, 2004 and 2005 would havebeen as follows:

 

7

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| ** **                                                                                                                                        | ** ** | **Three Months  Ended  June 30,  2004** | ** ** | **Three Months  Ended  June 30,  2005** | ** ** | **Nine Months  Ended  June 30,  2004** | ** ** | **Nine Months  Ended  June 30,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| Net Income:                                                                                                                                       |       |                                         |       |                                         |       |                                        |       |                                        |       |
| As reported                                                                                                                                       |       | $                                            | 3,285,608  |                                         | $          | 4,898,713                                   |       | $                                           | 7,467,039  |   | $ | 17,365,355 |   |
| Deduct: Total stock based employee  compensation expense determined under the fair value based method for all  awards, net of related tax effects |       | $                                            | (194,088   | )                                            | $          | (201,483                                    | )          | $                                           | (568,524   | ) | $ | (607,881 | ) |
|                                                                                                                                              |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Pro forma                                                                                                                                         |       | $                                            | 3,091,520  |                                         | $          | 4,697,230                                   |       | $                                           | 6,898,515  |   | $ | 16,757,474 |   |
|                                                                                                                                              |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Basic EPS:                                                                                                                                        |       |                                         |       |                                         |       |                                        |       |                                        |       |
| As reported                                                                                                                                       |       | $                                            | 0.19       |                                         | $          | 0.27                                        |       | $                                           | 0.43       |   | $ | 0.97 |   |
| Pro forma                                                                                                                                         |       | $                                            | 0.18       |                                         | $          | 0.26                                        |       | $                                           | 0.40       |   | $ | 0.94 |   |
|                                                                                                                                              |       |                                         |       |                                         |       |                                        |       |                                        |       |
| Diluted EPS:                                                                                                                                      |       |                                         |       |                                         |       |                                        |       |                                        |       |
| As reported                                                                                                                                       |       | $                                            | 0.18       |                                         | $          | 0.27                                        |       | $                                           | 0.42       |   | $ | 0.95 |   |
| Pro forma                                                                                                                                         |       | $                                            | 0.17       |                                         | $          | 0.26                                        |       | $                                           | 0.39       |   | $ | 0.91 |   |

 

**NewAccounting Pronouncements**

 

InMay 2005, the Financial Accounting Standards Board (FASB) issued Statementof Financial Accounting Standard (SFAS) No. 154, “Accounting Changes andError Corrections – a replacement of APB Opinion No. 20 and FASB StatementNo. 3”.   SFAS No. 154 requiresretrospective application to prior periods’ financial statements of changes inaccounting principle, unless it is impracticable to determine either theperiod-specific effects or the cumulative effect of the change.  SFAS No. 154 also requires thatretrospective application of a change in accounting principle be limited to thedirect effects of 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. 154 also requires that a changein depreciation, amortization, or depletion method for long-lived, nonfinancialassets be accounted for as a change in accounting estimate effected by a changein accounting principle.  SFAS No. 154is effective for accounting changes and corrections of errors made in fiscalyears 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 isissued.  The Company will adopt theprovisions of SFAS No. 154 as applicable beginning in fiscal 2007.

 

InDecember 2004, The FASB issued SFAS No. 123(R), “Share Based Payment”.Statement No. 123(R) requires all entities to recognize compensationexpense in an amount equal to the fair value of share based payments granted toemployees. This statement is effective for the first fiscal year beginningafter June 15, 2005. The Company will adopt Statement No. 123(R)beginning with the first quarter of fiscal 2006. Adoption of the statement willrequire the Company to record compensation expense relating to the issuance ofemployee stock options. Currently, the Company follows APB No. 25 whichdoes not require the recognition of compensation expense relating to theissuance of stock options so long as the quoted market price of the Company’sstock at the date of grant is less than or equal to the amount an employee mustpay to acquire the stock.  The Company iscurrently evaluating the impact the adoption of this statement will have on itsconsolidated financial position or results of operations.

 

InDecember 2004, the FASB issued FASB Staff Position (FSP) FAS 109-1, “Applicationof FASB Statement No. 109, Accounting for Income Taxes, to the TaxDeduction on Qualified Production Activities Provided by the American JobsCreation Act of 2004”. This FSP provides guidance on the application ofStatement 109 to the provisions within the American Jobs Creation Act of 2005(the Act), which provides tax relief to U.S. domestic manufacturers. The FSPstates that a manufacturer’s deduction provided for under the Act should beaccounted for as a special deduction in accordance with Statement 109 and notas a tax rate reduction. The FSP also reminds preparers that the specialdeduction should be considered by an enterprise in (a) measuring deferredtaxes when the enterprise is subjected to graduated tax rates, and (b) assessingwhether a valuation allowance is necessary as required by Statement 109. Thisstatement is effective immediately. The Company has adopted this statement andit did not have a material impact on the Company’s financial position orresults of operations.

 

InNovember 2004, the Financial Accounting Standards Board (FASB) issuedStatement of Financial Accounting Standards (SFAS) 151, “Inventory Costs”. ThisStatement amends the guidance in ARB No. 43, Chapter 4 “Inventory Pricing”,to clarify the accounting for abnormal amounts of idle facility expense,freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43,Chapter 4 previously stated that “... under some circumstances, items such asidle facility expense, excessive spoilage, double freight, and rehandling costsmay be so abnormal

 

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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 of operations.

 

**Item 2. Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

**Overview**

 

Wedesign, manufacture and sell flight information computers, flat panel displaysand advanced monitoring systems to the Department of Defense (DOD), governmentagencies, commercial air transport carriers and corporate/general aviationmarkets.

 

Ourrevenues are derived from the sale of our products to the retrofit market and,to a lesser extent, original equipment manufacturers (OEMs). Our customersinclude government and military entities and their commercial contractors,aircraft operators, aircraft modification centers and various OEMs. Althoughwe occasionally sell our products directly to government entities, we primarilysell our products to commercial customers for end use in government andmilitary programs.

 

Sincefiscal 1997, the majority of our revenues have come from the sale of ReducedVertical Separation Minimum (RVSM) compliant air data systems.

 

Wecontinue to invest in and seek additional opportunities for our Flat PanelDisplay product line. The Company’s Flat Panel Display received certificationfrom the Federal Aviation Administration (FAA) in the form of a TechnicalStandard Order (TSO) on July 2, 2004. To date, we have been selected by the U.S. Navy for Flat Panelapplications on their Landing Craft Air Cushion (LCAC) platforms. The Navyprogram has multi-year requirements that we believe will provide a solid basefor future awards. Further, we were selected by Boeing to provide Flat Panelsfor the Boeing 767 tanker program. While Boeing’s contract with the US AirForce was recently cancelled, the program is expected to be recompeted in thefuture. In the near term, the Company will continue to provide Boeing with FlatPanels for installation on 767 tanker planes that will be sold to foreigncustomers. In addition, Lockheed Martin selected us to provide Flat Panel Systemsfor the retrofit of C-130 airplanes. Boeing has also recently selected our FlatPanel System for installation on The Royal Netherlands Air Force KC-10 cockpitupdate program. The Company has also recently teamed with ABX Air, Inc. inan agreement to upgrade B-767 cockpits with Flat Panel Display Systems. Thisagreement will provide B-767-200/300 operators with a single point of contact forboth low cost and rapidly implemented retrofit systems.

 

Our“cost of sales” is comprised of material components purchased through oursupplier base and direct in-house assembly labor and overhead costs. Many ofthe components 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.

 

Wecontinue to invest in the development of new products and the enhancement ofour existing product line. We expense research and development costs related tofuture product development as they are incurred.

 

Ourselling, general, and administrative expenses consist of marketing and businessdevelopment expenses, professional expenses, salaries and benefits forexecutive and administrative personnel, facility costs, recruiting, legal,accounting, and other general corporate expenses.

 

**ThreeMonths Ended June 30, 2005 Compared to the Three Months Ended June 30,2004**

 

*Netsales.* Net salesincreased $4.8 million, or 39%, to $17.1 million for the three months ended June 30,2005 from $12.3 million in the three months ended June 30, 2004. Thisincrease in net sales was mainly due to increased RVSM system deliveries toboth the commercial air transportation and general aviation market segments.The increase in net sales reflects an industry wide response to a FederalAviation Administration (FAA) mandate. Essentially, the mandate requires RVSMequipment installations on aircraft flying between 29,000 and 41,000 feet by January 20,2005. The Company’s equipment provides RVSM compliance. Equipment deliveriesrelated to the FAA’s mandate continue as both air transport and generalaviation industry segments meet the new FAA mandate.

 

*Cost ofsales.* Cost of salesincreased $1.8 million or 44%, to $5.8 million, or 34% of net sales in thethree months ended June 30, 2005 from $4.1 million, or 33% of net sales inthe three months ended June 30, 2004. The increase in cost of sales was primarilyrelated to our increase in net sales.

 

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*Researchand development.*Research and development expenses increased $0.1 million or 10% to $1.5 millionor 9% of net sales in the three months ended June 30, 2005 from $1.4million or 11% of net sales in the three months ended June 30, 2004.  The decrease as a percent to sales was due tothe increase in net sales in the current period.

 

*Selling,general, and administrative.* Selling, general, and administrative expenses increased $0.4 million,or 19%, to $2.5 million, or 15% of net sales in the three months ended June 30,2005 from $2.1 million or 17% of net sales in the three months ended June 30,2004. The increase in the dollar amount was primarily the result of highercommissions, compensation and corporate governance expenses. The decrease as apercent of net sales was the result of higher net sales in the period.

 

*Interestincome.* Interestincome was $544,000 in the three months ended June 30, 2005 as compared tointerest income of $116,000 in the three months ended June 30, 2004. Theincrease in interest income in the three months ended June 30, 2005 wasprimarily the result of higher interest rates in the current period and anincrease in our cash balance over the prior period.

 

*Interestexpense.* Interestexpense was $49,000 in the three months ended June 30, 2005 as compared tointerest expense of $31,000 in the three months ended June 30, 2004. Theincrease in interest expense in the three months ended June 30, 2005 wasprimarily the result of higher interest rates in the period.

 

*Incometax expense.* Incometax expense for the three months ended June 30, 2005 was $2.9 million. Theincome tax expense for the three months ending June 30, 2004 was $1.6million. The increase in tax expense was primarily due to higher income in theperiod. The effective tax rate in the June 30, 2005 quarter was 36.9%. Inthe June 30, 2004 quarter the effective tax rate was 32%. In each quarter,the effective tax rate differs from the statutory rate due to the utilizationof research and development tax credits. Although the credits utilized in eachperiod were similar, the effective tax rate was lower in 2004 due to lowerpre-tax income in the period ended June 30, 2004.

 

*Netincome.* As a resultof the factors described above, our net income in the three months ended June 30,2005 increased $1.6 million or 49%, to $4.9 million, or 29% of net sales, from$3.3 million or 27% of net sales in the three months ended June 30, 2004.

 

**NineMonths Ended June 30, 2005 Compared to the Nine Months Ended June 30,2004**

 

*Netsales*. Net salesincreased $23.4 million, or 74%, to $55.1 million for the nine months ended June 30,2005 from $31.7 million in the nine months ended June 30, 2004. Thisincrease in net sales was mainly due to increased RVSM system deliveries toboth the commercial air transportation and general aviation market segments.The increase in net sales reflects an industry wide response to a FederalAviation Administration (FAA) mandate. Essentially, the mandate requires RVSMequipment installations on aircraft flying between 29,000 and 41,000 feet by January 20,2005. The Company’s equipment provides RVSM compliance. Equipment deliveriesrelated to the FAA’s mandate continue as both air transport and generalaviation industry segments meet the new FAA mandate.

 

*Cost ofsales.* Cost of salesincreased $6.6 million or 59 %, to $17.8 million, or 32% of net sales in thenine months ended June 30, 2005 from $11.2 million, or 35% of net sales inthe nine months ended June 30, 2004. The absolute dollar increase in costof sales was related to our increase in net sales. As a percentage, thedecrease was primarily the result of fixed operating costs being absorbed overhigher net sales in the current period.

 

*Researchand development.*Research and development expenses increased $0.5 million or 12% to $4.3 millionor 8% of net sales in the nine months ended June 30, 2005 from $3.9million or 12% of net sales in the nine months ended June 30, 2004. Theincrease in spending was due to additional program development work while thedecrease, as a percent to sales, was due to the increase in net sales in thecurrent period.

 

*Selling,general, and administrative.* Selling, general, and administrative expenses increased $1.2 million,or 22%, to $6.8 million, or 12% of net sales in the nine months ended June 30,2005 from $5.6 million or 18% of net sales in the nine months ended June 30,2004. The increase in the dollar amount was primarily the result of highercommissions, compensation and corporate governance expenses. As a percentage,the decrease was primarily the result of higher net sales in the currentperiod.

 

*Interestincome.* Interestincome was $1.3 million in the nine months ended June 30, 2005 as comparedto interest income of $0.3 million in the nine months ended June 30, 2004.The increase in interest income in the nine months ended June 30, 2005 wasprimarily the result of higher interest rates in the current period and anincrease in our cash balance over the prior period.

 

*Interestexpense.* Interest expensewas $128,000 in the nine months ended June 30, 2005 as compared tointerest expense of $94,000 in the nine months ended June 30, 2004. Theincrease in interest expense in the nine months ended June 30, 2005 wasprimarily the result of higher interest rates in the period.

 

*Incometax expense.* Incometax expense for the nine months ended June 30, 2005 was $9.9 million. Theincome tax expense for the nine months ending June 30, 2004 was $3.8million. The increase in tax expense was primarily due to higher income in theperiod. The effective tax rate in

 

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thenine months ended June 30, 2005 was 36.3%. In the nine months ended June 30,2004, the effective tax rate was 33.8%. In each period, the effective tax ratediffers from the statutory rate due to the utilization of research anddevelopment tax credits. Although the credits utilized in each period weresimilar, the effective tax rate was lower in 2004 due to lower pre-tax incomein the period ended June 30, 2004.

 

*Netincome.* As a resultof the factors described above, our net income in the nine months ended June 30,2005 increased $9.9 million or 133%, to $17.4 million, or 32% of net sales,from $7.5 million or 24% of net sales in the nine months ended June 30,2004.

 

**Liquidityand Capital Resources**

 

Ourmain sources of liquidity have been cash flows from operations. We require cashprincipally to finance inventory, accounts receivable and payroll.

 

Ourcash flow provided from operating activities was $15.9 million for the ninemonths ended June 30, 2005 as compared to $9.1 million for the nine monthsended June 30, 2004. The increase was due to higher net income that waspartially offset by an increase in accounts receivable and a decrease inaccounts payable in the period.

 

Ourcash used in investing activities was $315,000 for the nine months ended June 30,2005 and primarily consisted of production equipment, laboratory testequipment, computer equipment and office furniture. Cash used in investing activitieswas $560,000 for the nine months ended June 30, 2004 and primarilyconsisted of production equipment, laboratory test equipment, computerequipment and office furniture.

 

Netcash flow from financing activities was $1.7 million for the nine months ended June 30,2005 as compared to $1.3 million in the nine months ended June 30, 2004.In the nine month period ended June 30, 2005, the in-flow of cash was theresult of proceeds from the exercise of stock options. In the period ended June 30,2004, the in-flow was the result of the exercise of both stock options andwarrants. All remaining warrants were exercised during the fiscal year ended September 30,2004.

 

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 expenditureswill continue to increase in the foreseeable future. We believe that our cashand cash equivalents will provide sufficient capital to fund our operations forat least the next twelve months. However, we may need to raise additional fundsthrough public or private financings or other arrangements in order to supportmore rapid expansion of our business than we now anticipate either throughacquisitions or organic growth. Further, we may need to develop and introducenew or enhanced products, respond to competitive pressures, invest in oracquire businesses or technologies or respond to unanticipated requirements ordevelopments. If additional funds are raised through the issuance of equitysecurities, dilution to existing shareholders may result. If insufficient fundsare available, we may not be able to introduce new products or competeeffectively in any of our markets, which could hurt our business.

 

**Backlog**

 

AtJune 30, 2005 our backlog was $13.7 million. At June 30, 2004 ourbacklog was $27.9 million. Our backlog consists solely of orders that webelieve to be firm. In the case of contracts with government entities, ordersare only included in backlog to the extent funding has been obtained for suchorders.

 

**CriticalAccounting Policies**

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and 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, allowance for doubtful accounts, inventory valuationand warranty reserves.

 

TheCompany recognizes sales for products when the following revenue recognitioncriteria are met: persuasive evidence of an arrangement exists, productdelivery and acceptance has occurred, pricing is fixed or determinable, andcollection is reasonably assured. The Company recognizes sales upon shipment ofproducts to customers.

 

Salesrelated to certain long-term contracts requiring development and delivery ofproducts over several years are accounted for under the American Institute ofCertified Public Accountants (AICPA) Statement of Position (SOP) 81-1, *Accounting for Performance of Construction-*

 

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*Typeand Certain Production-Type Contracts.*We consider the nature of these contracts aswell as the types of products and services provided when determining theappropriate accounting treatment for a particular contract. Certain long-termcontracts are recorded on a percentage of completion basis using cost-to-costmethodology to measure progress towards completion.

 

TheCompany offers its customers extended warranties for additional fees. Thesewarranty sales are recorded as deferred revenue and recognized as sales on astraight-line basis over the warranty period.

 

TheCompany enters into certain sales arrangements that include multipledeliverables as defined in Emerging 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 with the customer during contract negotiations. In general,revenues are separated between product sales and non-recurring engineeringservices. The allocated revenue for each deliverable is then recognized usingappropriate revenue recognition methods. Effective for transactions enteredinto after October 1, 2003, the Company accounts for transactions withsoftware and non-software components under EITF Issue 03-5, “Applicability ofAICPA Statement of Position 97-2, Software Revenue Recognition, to Non-SoftwareDeliverables in an Arrangement Containing More-Than-Incidental Software.”

 

Incometaxes are recorded in accordance with SFAS No. 109, Accounting for IncomeTaxes. Provisions for federal and state income taxes are calculated on reportedfinancial statement pre-tax income based on current tax law. The Companyrecognizes deferred tax assets and liabilities for temporary differencesbetween the financial reporting basis and the tax basis of the Company’s assetsand liabilities 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.

 

Wemaintain an allowance for doubtful accounts for estimated losses resulting fromthe inability of our customers to make required payments. These allowances aredetermined by analyzing historical data and trends. If actual losses aregreater than estimated amounts or if the financial condition of our customerswere to deteriorate, resulting in an impairment of their ability to makepayments, future results from operations could be adversely affected.

 

Inventoriesare written down for estimated obsolescence equal to the difference between thecost of inventory and the estimated net realizable value based upon assumptionsabout future market conditions. If actual future demand or market conditionsare less favorable than those projected by management, additional inventory write-downsmay be required.

 

Weoffer warranties on some products of various lengths. At the time of shipment,we establish a reserve for the estimated cost of warranties based on our bestestimate of the amounts necessary to settle future and existing claims usinghistorical data on products sold as of the balance sheet date. The length ofthe warranty period, the product’s failure rates and the customer’s usageaffects warranty cost. If the actual cost of warranties differs from ourestimated amounts, future results of operations could be adversely affected.

 

**BusinessSegments**

 

Weoperate in one principal business segment which designs, manufactures and sellsflight information computers, flat panel displays and advanced monitoringsystems to the Department of Defense, government agencies, commercial airtransport carriers and corporate/general aviation markets. We currently derivevirtually all our net sales from the sale of this equipment. Almost all of thenet sales, operating results and identifiable assets are in the United States.

 

**NewAccounting Pronouncements**

 

InMay 2005, the Financial Accounting Standards Board (FASB) issued Statementof Financial Accounting Standard (SFAS) No. 154, “Accounting Changes andError Corrections – a replacement of APB Opinion No. 20 and FASB StatementNo. 3”.   SFAS No. 154 requiresretrospective application to prior periods’ financial statements of changes inaccounting principle, unless it is impracticable to determine either theperiod-specific effects or the cumulative effect of the change.  SFAS No. 154 also requires thatretrospective application of a change in accounting principle be limited to thedirect effects of the change.  Indirecteffects of a change in accounting principle, such as a change in nondiscretionaryprofit-sharing payments resulting from an accounting change, should berecognized in the period of the accounting change.  SFAS No. 154 also requires that a changein depreciation, amortization, or depletion method for long-lived, nonfinancialassets be accounted for as a change in accounting estimate effected by a changein accounting principle.  SFAS No. 154is effective for accounting changes and corrections of errors made in fiscalyears 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 isissued.  The Company will adopt theprovisions of SFAS No. 154 as applicable beginning in fiscal 2007.

 

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InDecember 2004, The FASB issued SFAS No. 123(R), “Share Based Payment”.Statement No. 123(R) requires all entities to recognize compensationexpense in an amount equal to the fair value of share based payments granted toemployees. This statement is effective for the first fiscal year beginningafter June 15, 2005. The Company will adopt Statement No. 123(R)beginning with the first quarter of fiscal 2006. Adoption of the statement willrequire the Company to record compensation expense relating to the issuance ofemployee stock options. Currently, the Company follows APB No. 25 whichdoes not require the recognition of compensation expense relating to theissuance of stock options so long as the quoted market price of the Company’sstock at the date of grant is less than or equal to the amount an employee mustpay to acquire the stock.  The Company iscurrently evaluating the impact the adoption of this statement will have on itsconsolidated financial position or results of operations.

 

InDecember 2004, the FASB issued FASB Staff Position (FSP) FAS 109-1, “Applicationof FASB Statement No. 109, Accounting for Income Taxes, to the TaxDeduction on Qualified Production Activities Provided by the American JobsCreation Act of 2004”. This FSP provides guidance on the application ofStatement 109 to the provisions within the American Jobs Creation Act of 2005(the Act), which provides tax relief to U.S. domestic manufacturers. The FSPstates that a manufacturer’s deduction provided for under the Act should beaccounted for as a special deduction in accordance with Statement 109 and notas a tax rate reduction. The FSP also reminds preparers that the specialdeduction should be considered by an enterprise in (a) measuring deferredtaxes when the enterprise is subjected to graduated tax rates, and (b) assessingwhether a valuation allowance is necessary as required by Statement 109. Thisstatement is effective immediately.  TheCompany has adopted this statement and it did not have a material impact on theCompany’s financial position or results of operations.

 

InNovember 2004, the Financial Accounting Standards Board (FASB) issuedStatement of Financial Accounting Standards (SFAS) 151, “Inventory Costs”. ThisStatement amends the guidance in ARB No. 43, Chapter 4 “Inventory Pricing”,to clarify the accounting for abnormal amounts of idle facility expense,freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43,Chapter 4 previously stated that “... under some circumstances, items such asidle facility expense, excessive spoilage, double freight, and rehandling costsmay be so abnormal as to require treatment as current period charges...”. ThisStatement requires that those items be recognized as current-period chargesregardless of whether they meet the criterion of “so abnormal”. In addition,this Statement requires that allocation of fixed production overheads to thecosts of conversion be based on the normal capacity of the productionfacilities. This statement is effective for inventory costs incurred duringfiscal years beginning after June 15, 2005. The Company does not expectthe adoption of this statement will have a material impact on its consolidatedfinancial position or results of operations.

 

**FORWARD-LOOKING STATEMENTS**

 

ThisForm 10-Q contains statements, which, to the extent that they are notrecitations of historical fact, constitute forward-looking statements withinthe meaning of the Securities Act of 1933 and the Securities Exchange Act of1934. The words “believe,” “estimate,” “anticipate,” “project,” “intend,” “expect,”“plan,” “outlook,” “forecast” and similar expressions are intended to identifyforward-looking statements. Numerous factors, including potentially thefollowing factors, could affect the Company’s forward-looking statements andactual performance:

 

•                  continued market acceptance of our air datasystems products;

 

•                  the ability to obtain or the timing ofobtaining future government awards;

 

•                  the availability of government funding andcustomer requirements;

 

•                  difficulties in developing and producing ourflat panel display systems (CIP) or other planned products or productenhancements;

 

•                  market acceptance of our CIP system or otherplanned products or product enhancements;

 

•                  our ability to gain regulatory approval ofour products in a timely manner;

 

•                  delays in receiving components from thirdparty suppliers;

 

•                  the competitive environment;

 

•                  the timing and customer acceptance of productdeliveries and launches;

 

•                  the termination of programs or contracts forconvenience by customers;

 

•                  failure to retain key personnel;

 

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•                  new product offerings from competitors;

 

•                  potential future acquisitions;

 

•                  protection of intellectual property rights;

 

•                  our ability to service the internationalmarket, and

 

•                  other factors disclosed from time to time inour filings with the Securities and Exchange Commission.

 

Readersare cautioned not to place undue reliance on these forward-looking statements,which speak only as of the date of this Form 10-Q. The Company does notundertake any obligation to publicly release any revisions to theseforward-looking statements to reflect events, circumstances or changes inexpectations after the date of this Form 10-Q, or to reflect theoccurrence of unanticipated events. The forward-looking statements in thisdocument are intended to be subject to the safe harbor protection provided bySections 27A of the Securities Act and 21E of the Exchange Act.

 

Fora discussion identifying some important factors that could cause actual resultsto vary materially from those anticipated in the forwardlooking statements, seethe Company’s Securities and Exchange Commission filings including, but notlimited to, the discussions of “Risk Factors” contained in the Company’s AnnualReport on Form 10-K for the fiscal year ended September 30, 2004.

 

**Item 3. Quantitative andQualitative Disclosures About Market Risk**

 

TheCompany’s operations are exposed to market risks primarily as a result ofchanges in interest rates. The Company does not use derivative financialinstruments for speculative or trading purposes. The Company’s exposure tomarket risk for changes in interest rates relates to its cash equivalents andan industrial revenue bond. The Company’s cash equivalents consist of fundsinvested in money market accounts, which bear interest at a variable rate,while the industrial revenue bond carries an interest rate that is consistentwith 30-day, tax-exempt commercial paper. As the interest rates are variable,and we do not engage in hedging activities, a change in interest rates earnedon the cash equivalents or paid on the industrial revenue bond would impactinterest income and expense along with cash flows, but would not impact thefair market value of the related underlying instruments.

 

**Item 4. Controls andProcedures**

 

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-15eunder the Securities Exchange Act of 1934, as amended (the “Exchange Act”) asof June 30, 2005. Based on that evaluation, the Company’s management,including the CEO and CFO, concluded that the Company’s disclosure controls andprocedures provide reasonable assurance that information required to bedisclosed by the Company in reports that it files or submits under the ExchangeAct, is recorded, processed, summarized and reported as specified in Securitiesand Exchange Commission rules and forms. There were no significant changesin the Company’s internal control over financial reporting that occurred duringthe Company’s most recent fiscal quarter that has materially affected, or isreasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

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**PART II–OTHER INFORMATION**

 

**Item 1.****          ****LEGAL PROCEEDINGS**

None

 

**Item 2.****          ****UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

None

 

**Item 3.****          ****DEFAULTS UPON SENIOR SECURITIES**

None

 

**Item 4.****          ****SUBMISSION OF MATTERS TO A VOTEOF SECURITY HOLDERS**

None

 

**Item 5.****          ****OTHER INFORMATION**

None

 

**Item 6.****          ****EXHIBITS**

 

(a)          Exhibits

 

31.1                           Certification of Chief Executive OfficerPursuant to Rule 13a-14(a)

 

31.2                           Certification of Chief Financial OfficerPursuant 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

 

 

**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
| ** **                | **INNOVATIVE  SOLUTIONS AND SUPPORT, INC.** |
|---------------------------|---------------------------------------------|
| ** **                | ** **                                  |
|                      |                                        |   |
| Date:  July 29, 2005 | By:                                         | /s/  JAMES J. REILLY |   |
| ** **                | ** **                                  | **James  J. Reilly Chief Financial Officer** |

 

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