Table of Contents

 

 

 

**UNITEDSTATES**

**SECURITIES AND 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 thequarterly period ended March 31, 2010**

 

**OR**

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

 

**[For thetransition periodfrom                           to                           ]**

 

**CommissionFile No. 0-31157**

 

**INNOVATIVE SOLUTIONS AND SUPPORT, INC.**

(Exact name of registrant as specified in its charter)

 

| **PENNSYLVANIA**                                 | ** ** | **23-2507402**       |
|--------------------------------------------------|------------|----------------------|
| (State or Other  Jurisdiction                    |       | (I.R.S. Employer     |
| of  Incorporation)                               |       | Identification  No.) |
|                                             |       |                 |
| **720  Pennsylvania Drive, Exton, Pennsylvania** | ** ** | **19341**            |
| (Address of  Principal Executive Offices)        |       | (Zip Code)           |

 

**(610)646-9800**

(Registrant’sTelephone Number, Including Area Code)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 day.  Yes x  No o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to submit and post such files). Yes o No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer or a smaller reporting company. See the definitions of “largeaccelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act.

 

| o Large accelerated filer                      |   | x Accelerated filer         |
|------------------------------------------------|--------|-----------------------------|
|                                           |   |                        |
| o Non-accelerated filer                        |   | o Smaller reporting company |
| (Do not check if  a smaller reporting company) |   |                        |

 

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

 

As of May 5, 2010,there were 16,760,759 shares of the Registrant’s Common Stock, with par valueof $.001 per share, outstanding.

 

 

 

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**INNOVATIVE SOLUTIONS AND SUPPORT, INC.**

### **FORM 10-Q March 31, 2010**

### ** **

**INDEX**

 
| ** **        | ** **                                                                                                      | **Page No.** |
|-------------------|-----------------------------------------------------------------------------------------------------------------|-------------------|
|              |                                                                                                            |              |
| **PART I.**  | **FINANCIAL INFORMATION**                                                                                       | 1                 |
|              |                                                                                                            |              |
| Item 1.           | Financial Statements (Unaudited)                                                                                | 1                 |
|              |                                                                                                            |              |
|              | Condensed  Consolidated Balance Sheets – March 31, 2010 and September 30, 2009                   | 1                 |
|              |                                                                                                            |              |
|              | Condensed  Consolidated Statements of Operations – Three and Six Months Ended March 31, 2010 and 2009 | 2                 |
|              |                                                                                                            |              |
|              | Condensed  Consolidated Statements of Cash Flows – Six Months Ended March 31, 2010 and 2009           | 3                 |
|              |                                                                                                            |              |
|              | Notes to Condensed Consolidated Financial Statements                                                            | 4 – 13       |
|              |                                                                                                            |              |
| Item 2.           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                     | 14 – 19      |
|              |                                                                                                            |              |
| Item 3.           | Quantitative  and Qualitative Disclosures about Market Risk                                                     | 20                |
|              |                                                                                                            |              |
| Item 4.           | Controls and  Procedures                                                                                        | 21                |
|              |                                                                                                            |              |
| **PART II.** | **OTHER INFORMATION**                                                                                           | 21                |
|              |                                                                                                            |              |
| Item 1.           | Legal Proceedings                                                                                               | 21                |
|              |                                                                                                            |              |
| Item 1A           | Risk Factors                                                                                                    | 21                |
|              |                                                                                                            |              |
| Item 2.           | Unregistered  Sales of Equity Securities and Use of Proceeds                                                    | 21                |
|              |                                                                                                            |              |
| Item 3.           | Defaults upon  Senior Securities                                                                                | 21                |
|              |                                                                                                            |              |
| Item 4.           | Removed and Reserved                                                                                            | 21                |
|              |                                                                                                            |              |
| Item 5.           | Other Information                                                                                               | 21                |
|              |                                                                                                            |              |
| Item 6.           | Exhibits                                                                                                        | 22                |
|              |                                                                                                            |              |
| **SIGNATURES**    |                                                                                                            | 22                |

 

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**PART I—FINANCIAL INFORMATION**

**Item 1—FinancialStatements**

 

**INNOVATIVESOLUTIONS AND SUPPORT, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

 
| ** **                                                                                                                                                                                                                       | ** ** | **March 31,** | ** ** | **September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                                                                       | ** ** | **2010**           | ** ** | **2009**               | ** ** |
| ASSETS                                                                                                                                                                                                                           |       |               |       |                   |       |
| Current Assets                                                                                                                                                                                                                   |       |               |       |                   |       |
| Cash and cash equivalents                                                                                                                                                                                                        |       | $                  | 35,654,687 |                   | $          | 35,565,694 |   |
| Accounts receivable, net                                                                                                                                                                                                         |       | 4,004,698          |       | 6,188,706              |       |
| Inventories                                                                                                                                                                                                                      |       | 5,054,422          |       | 5,306,985              |       |
| Deferred income taxes                                                                                                                                                                                                            |       | 473,000            |       | 503,993                |       |
| Prepaid expenses and other current assets                                                                                                                                                                                        |       | 1,362,383          |       | 1,227,413              |       |
|                                                                                                                                                                                                                             |       |               |       |                   |       |
| Total current assets                                                                                                                                                                                                             |       | 46,549,190         |       | 48,792,791             |       |
|                                                                                                                                                                                                                             |       |               |       |                   |       |
| Property and equipment, net                                                                                                                                                                                                      |       | 8,092,015          |       | 8,343,701              |       |
|                                                                                                                                                                                                                             |       |               |       |                   |       |
| Other assets                                                                                                                                                                                                                     |       | 260,910            |       | 399,520                |       |
|                                                                                                                                                                                                                             |       |               |       |                   |       |
| Total Assets                                                                                                                                                                                                                     |       | $                  | 54,902,115 |                   | $          | 57,536,012 |   |
|                                                                                                                                                                                                                             |       |               |       |                   |       |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                                                                                                                                                       |       |               |       |                   |       |
|                                                                                                                                                                                                                             |       |               |       |                   |       |
| Current Liabilities                                                                                                                                                                                                              |       |               |       |                   |       |
| Current portion of capitalized lease obligations                                                                                                                                                                                 |       | $                  | 9,908      |                   | $          | 9,908 |   |
| Accounts payable                                                                                                                                                                                                                 |       | 903,191            |       | 1,207,990              |       |
| Accrued expenses                                                                                                                                                                                                                 |       | 2,152,236          |       | 2,785,560              |       |
| Deferred revenue                                                                                                                                                                                                                 |       | 162,223            |       | 164,856                |       |
|                                                                                                                                                                                                                             |       |               |       |                   |       |
| Total current liabilities                                                                                                                                                                                                        |       | 3,227,558          |       | 4,168,314              |       |
|                                                                                                                                                                                                                             |       |               |       |                   |       |
| Long-term portion of capitalized lease obligations                                                                                                                                                                               |       | 21,374             |       | 26,991                 |       |
| Deferred revenue                                                                                                                                                                                                                 |       | 34,740             |       | 60,792                 |       |
| Deferred income taxes                                                                                                                                                                                                            |       | 605,203            |       | 642,651                |       |
| Other liabilities                                                                                                                                                                                                                |       | 243,600            |       | 238,522                |       |
|                                                                                                                                                                                                                             |       |               |       |                   |       |
| Total Liabilities                                                                                                                                                                                                                |       | 4,132,475          |       | 5,137,270              |       |
|                                                                                                                                                                                                                             |       |               |       |                   |       |
| Commitments and contingencies                                                                                                                                                                                                    |       | —             |       | —                 |       |
|                                                                                                                                                                                                                             |       |               |       |                   |       |
| Shareholders’ Equity                                                                                                                                                                                                        |       |               |       |                   |       |
|                                                                                                                                                                                                                             |       |               |       |                   |       |
| Preferred Stock, 10,000,000 shares authorized,  $.001 par value, of which 200,000 shares are authorized as Class A  Convertible stock. No shares issued and outstanding at March 31, 2010  and September 30, 2009 |       | —             |       | —                 |       |
|                                                                                                                                                                                                                             |       |               |       |                   |       |
| Common stock, $.001 par value: 75,000,000 shares  authorized, 18,226,469 and 18,206,839 issued at March 31, 2010 and  September 30, 2009                                                                               |       | 18,226             |       | 18,207                 |       |
|                                                                                                                                                                                                                             |       |               |       |                   |       |
| Additional paid-in capital                                                                                                                                                                                                       |       | 46,745,716         |       | 46,462,135             |       |
| Retained earnings                                                                                                                                                                                                                |       | 23,270,338         |       | 25,161,276             |       |
| Treasury stock, at cost, 1,476,000 and 1,470,510  shares at March 31, 2010 and September 30, 2009, respectively                                                                                                        |       | (19,264,640        | )          | (19,242,876            | )          |
|                                                                                                                                                                                                                             |       |               |       |                   |       |
| Total Shareholders’ Equity                                                                                                                                                                                                  |       | 50,769,640         |       | 52,398,742             |       |
|                                                                                                                                                                                                                             |       |               |       |                   |       |
| Total Liabilities and Shareholders’ Equity                                                                                                                                                                                  |       | $                  | 54,902,115 |                   | $          | 57,536,012 |   |

 

The accompanying notesare an integral part of these statements.

 

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**INNOVATIVESOLUTIONS AND SUPPORT, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

** **
| ** **                                  | ** ** | **Three Months Ending March 31,** | ** ** | **Six Months Ending March 31,** | ** ** |
|---------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                  | ** ** | **2010**                                              | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Net  sales:                                 |       |                                                  |       |                                                |       |   |   |   |   |
| Product                                     |       | $                                                     | 4,985,736  |                                                | $          | 9,365,306 |   | $ | 8,822,313 |   | $ | 18,254,424 |   |
| Engineering  - modification and development |       | 387,221                                               |       | 1,100,420                                           |       | 1,157,883 |   | 2,786,648 |   |
| Total  net sales                            |       | 5,372,957                                             |       | 10,465,726                                          |       | 9,980,196 |   | 21,041,072 |   |
|                                        |       |                                                  |       |                                                |       |   |   |   |   |
| Cost  of sales                              |       |                                                  |       |                                                |       |   |   |   |   |
| Product                                     |       | 2,816,054                                             |       | 4,915,652                                           |       | 5,181,395 |   | 9,910,746 |   |
| Engineering  - modification and development |       | 126,442                                               |       | 301,961                                             |       | 597,874 |   | 562,040 |   |
| Total  cost of sales                        |       | 2,942,496                                             |       | 5,217,613                                           |       | 5,779,269 |   | 10,472,786 |   |
|                                        |       |                                                  |       |                                                |       |   |   |   |   |
| Gross  profit                               |       | 2,430,461                                             |       | 5,248,113                                           |       | 4,200,927 |   | 10,568,286 |   |
|                                        |       |                                                  |       |                                                |       |   |   |   |   |
| Operating  expenses:                        |       |                                                  |       |                                                |       |   |   |   |   |
| Research  and development                   |       | 1,404,705                                             |       | 1,610,687                                           |       | 2,569,410 |   | 2,891,188 |   |
| Selling,  general and administrative        |       | 1,876,326                                             |       | 2,272,080                                           |       | 4,027,465 |   | 4,631,387 |   |
| Total  operating expenses                   |       | 3,281,031                                             |       | 3,882,767                                           |       | 6,596,875 |   | 7,522,575 |   |
|                                        |       |                                                  |       |                                                |       |   |   |   |   |
| Operating  income (loss)                    |       | (850,570                                              | )          | 1,365,346                                           |       | (2,395,948 | ) | 3,045,711 |   |
|                                        |       |                                                  |       |                                                |       |   |   |   |   |
| Interest  income                            |       | 27,636                                                |       | 97,227                                              |       | 50,610 |   | 298,313 |   |
| Interest  (expense)                         |       | (614                                                  | )          | (19,241                                             | )          | (1,278 | ) | (54,715 | ) |
| Other  income                               |       | —                                                |       | —                                              |       | 50,000 |   | 50,073 |   |
| Income  (loss) before income taxes          |       | (823,548                                              | )          | 1,443,332                                           |       | (2,296,616 | ) | 3,339,382 |   |
|                                        |       |                                                  |       |                                                |       |   |   |   |   |
| Income  tax expense (benefit)               |       | (77,783                                               | )          | 95,802                                              |       | (405,678 | ) | 168,466 |   |
|                                        |       |                                                  |       |                                                |       |   |   |   |   |
| Net  income (loss)                          |       | $                                                     | (745,765   | )                                                   | $          | 1,347,530 |   | $ | (1,890,938 | ) | $ | 3,170,916 |   |
|                                        |       |                                                  |       |                                                |       |   |   |   |   |
| Net  (loss) income per common share:        |       |                                                  |       |                                                |       |   |   |   |   |
| Basic                                       |       | $                                                     | (0.04      | )                                                   | $          | 0.08 |   | $ | (0.11 | ) | $ | 0.19 |   |
| Diluted                                     |       | $                                                     | (0.04      | )                                                   | $          | 0.08 |   | $ | (0.11 | ) | $ | 0.19 |   |
|                                        |       |                                                  |       |                                                |       |   |   |   |   |
| Weighted  Average Shares Outstanding:       |       |                                                  |       |                                                |       |   |   |   |   |
| Basic                                       |       | 16,752,563                                            |       | 16,718,209                                          |       | 16,749,080 |   | 16,718,209 |   |
| Diluted                                     |       | 16,752,563                                            |       | 16,718,215                                          |       | 16,749,080 |   | 16,735,645 |   |

 

The accompanying notesare an integral part of these statements.

 

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**INNOVATIVESOLUTIONS AND SUPPORT, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(unaudited)**

** **
| ** **                                                                               | ** ** | **For the Six Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                               | ** ** | **2010**                               | ** ** | **2009** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                                |       |                                   |       |   |   |
| Net  (Loss) income                                                                       |       | $                                      | (1,890,938 | ) | $ | 3,170,916 |   |
| Adjustments  to reconcile net (loss) income to net cashprovided by operating activities: |       |                                   |       |   |   |
| Depreciation  and amortization                                                           |       | 411,275                                |       | 521,097 |   |
| Deposit  forfeiture, installation kits                                                   |       | 118,660                                |       | — |   |
| Share-based  compensation expense:                                                       |       |                                   |       |   |   |
| Stock  options                                                                           |       | 186,751                                |       | 277,026 |   |
| Nonvested  stock awards                                                                  |       | 99,966                                 |       | 100,099 |   |
| Tax  benefit from share-based compensation:                                              |       |                                   |       |   |   |
| Nonvested  stock awards                                                                  |       | (3,115                                 | )          | 3,735 |   |
| Loss  on disposal of property and equipment                                              |       | 2,888                                  |       | 260 |   |
| Excess  and obsolete inventory cost                                                      |       | —                                 |       | 603,916 |   |
| (Increase)  decrease in:                                                                 |       |                                   |       |   |   |
| Accounts  receivable                                                                     |       | 2,184,008                              |       | (1,546,177 | ) |
| Inventories                                                                              |       | 252,563                                |       | 2,811,529 |   |
| Prepaid  expenses and other current assets                                               |       | 270,735                                |       | 127,708 |   |
| Other  non-current assets                                                                |       | —                                 |       | (80,534 | ) |
| Increase  (decrease) in:                                                                 |       |                                   |       |   |   |
| Accounts  Payable                                                                        |       | (304,799                               | )          | (711,683 | ) |
| Accrued  expenses                                                                        |       | (633,324                               | )          | (1,759,631 | ) |
| Income  taxes payable                                                                    |       | (400,627                               | )          | (519,521 | ) |
| Deferred  income tax                                                                     |       | (6,455                                 | )          | — |   |
| Deferred  revenue                                                                        |       | (28,685                                | )          | (236,645 | ) |
| Net  cash provided by operating activities                                               |       | 258,903                                |       | 2,762,095 |   |
|                                                                                     |       |                                   |       |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                                |       |                                   |       |   |   |
| Purchases  of property and equipment                                                     |       | (142,529                               | )          | (161,557 | ) |
| Net  cash (used in) investing activities                                                 |       | (142,529                               | )          | (161,557 | ) |
|                                                                                     |       |                                   |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                |       |                                   |       |   |   |
| Purchase  of treasury stock                                                              |       | (21,764                                | )          | (108,250 | ) |
| Repayment  of capitalized lease obligations                                              |       | (5,617                                 | )          | (5,230 | ) |
| Net  cash (used in) financing activities                                                 |       | (27,381                                | )          | (113,480 | ) |
|                                                                                     |       |                                   |       |   |   |
| Net  increase in cash and cash equivalents                                               |       | 88,993                                 |       | 2,487,058 |   |
| Cash  and cash equivalents, beginning of year                                            |       | 35,565,694                             |       | 35,031,932 |   |
|                                                                                     |       |                                   |       |   |   |
| Cash  and cash equivalents, end of period                                                |       | $                                      | 35,654,687 |   | $ | 37,518,990 |   |
|                                                                                     |       |                                   |       |   |   |
| **SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION**                                     |       |                                   |       |   |   |
| Cash  paid for interest                                                                  |       | $                                      | 1,227      |   | $ | 34,700 |   |
| Cash  paid for income tax                                                                |       | $                                      | 110,667    |   | $ | 704,486 |   |
| Cash  received from income tax refund                                                    |       | $                                      | 1,000      |   | $ | 25,115 |   |

 

The accompanyingnotes are an integral part of these statements.

 

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**InnovativeSolutions and Support Inc.**

**Notes to Condensed Consolidated FinancialStatements**

**(Unaudited)**

 

**1.****Summary of SignificantAccounting Policies**

 

***Descriptionof the Company***

 

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.

 

***Basisof Presentation***

 

The accompanyingunaudited condensed consolidated financial statements are presented pursuant tothe rules and regulations of the United States Securities and ExchangeCommission in accordance with the disclosure requirements for the quarterlyreport on Form 10-Q and therefore do not include all of the informationand footnotes required by generally accepted accounting principles for completeannual financial statements. In the opinion of Company management, theunaudited condensed consolidated financial statements reflect all adjustments(consisting of normal recurring adjustments) necessary to fairly state theresults for the interim periods presented. The condensed consolidated balancesheet as of September 30, 2009 is derived from audited financialstatements. Operating results for the three and six months ended March 31,2010 are not necessarily indicative of the results that may be expected for thefiscal year ending September 30, 2010. These unaudited condensedconsolidated financial statements should be read in conjunction with theaudited consolidated financial statements and notes of the Company included inthe Company’s Annual Report on Form 10-K for the fiscal year ended September 30,2009.

 

Our condensedconsolidated financial statements include the accounts of our wholly-ownedsubsidiaries. All intercompany balances and transactions have been eliminatedin consolidation.

 

***Use of Estimates***

 

Preparation of consolidated financial statements in conformity withaccounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect reportedamounts of assets and liabilities, and disclosure of contingent assets andliabilities, as of the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period. Estimates areused in accounting for, among other items, allowance for doubtful accounts,inventory obsolescence, product warranty cost liability, income taxes andcontingencies. Actual results could differ materially from those estimates.

 

***Cash and Cash Equivalents***

 

Highly liquid investments purchased with an original maturity of threemonths or less are classified as cash equivalents. Cash equivalents at March 31,2010 and September 30, 2009 consist of funds invested in money marketaccounts with financial institutions.

 

***Property and Equipment***

 

Property and equipment are stated at cost. Depreciation is providedusing an accelerated method over estimated useful lives of the assets (thelesser of three to seven years or over the lease term), except for the airplaneand manufacturing facility, which are depreciated using the straight-linemethod over estimated useful lives of ten years and thirty-nine years,respectively. Major additions and improvements are capitalized, whilemaintenance and repairs that do not improve or extend the life of assets arecharged to expense as incurred.

 

***Long-Lived Assets***

 

The Company assesses the impairment of long-lived assets in accordancewith Financial Accounting Standards Board (FASB) Accounting StandardsCodification (ASC) Topic 360-10, *“Property, Plant andEquipment”* (ASC Topic 360-10)*.* Thisstatement requires that long-lived assets be reviewed for impairment wheneverevents or changes in circumstances indicate the carrying amount of an asset maynot be recoverable. In addition, long-lived assets to be disposed of should bereported at the lower of the carrying amount or fair value less cost to sell.The Company considers historical performance and future estimated results inits evaluation of potential impairment and then compares the carrying amount ofthe asset to estimated future cash flows expected to result from use of theasset. If the carrying amount of the asset exceeds the estimated expectedundiscounted future cash flows, the Company measures 

 

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the amount of the impairment by comparing the carrying amount of theasset to its fair value. The estimation of fair value is generally measured bydiscounting expected future cash flows. No impairment charges were recorded during the six months ended March 31,2010 or 2009.

 

***Revenue Recognition***

 

The Company enters intosales arrangements with customers that, in general, provide for theCompany  to design, develop, manufacture  and deliver flightinformation computers, large flat-panel displays, and advanced monitoringsystems that measure and display critical flight information, including datarelative to aircraft separation, airspeed, and altitude, as well as engine andfuel data measurements.  The Company’s sales arrangements may includemultiple deliverables as defined in FASB ASC Topic 605-25, *“Multiple-ElementArrangements”* (ASC Topic 605-25), which typically include design andengineering services and the production and delivery of the flat panel displayand related components.

 

Multiple-ElementArrangements -

 

The Company identifiesall goods and/or services that are to be delivered separately under such asales arrangement and allocates revenue to each deliverable (if more than one)based on that deliverable’s fair value.  The Company then considers theappropriate recognition method for each deliverable; deliverables undermultiple-element arrangements are typically purchased engineering and designservices and product sales.  To theextent that an arrangement contains defined design and development activitiesas an identified deliverable in addition to products (resulting in amultiple-element arrangement), the Company recognizes as engineering —modification and development (“EMD”) revenue amounts earned during the designand development phase of the contract following the guidance included in FASBASC Topic 605-35, *“Construction-Type and Production-TypeContracts”*(ASC Topic 605-35).  To the extent thatmultiple-element arrangements include product sales, revenue is generallyrecognized once revenue recognition criteria for the product deliverable hasbeen met based on the provisions of FASB ASC Topic 605, *“RevenueRecognition”*(ASC Topic 605).

 

Single ElementArrangements -

 

*Products-*

 

To the extent that asingle element arrangement provides for product sales and repairs, revenue isgenerally recognized once revenue recognition criteria for the productdeliverable has been met based on the provisions of ASC Topic605.  The Company also receives orders for existing equipment andparts.  Revenue from the sale of such products is generally recognizedupon shipment to the customer.

 

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.

 

*EngineeringServices -*

 

The Company also mayenter into service arrangements to perform specified design and developmentservices related to its products.  The Company recognizes revenue fromthese arrangements as EMD revenue, following the guidance included in ASC Topic605-35. The Company considers the nature of these service arrangements(including term, size of contract and level of effort) when determining theappropriate accounting treatment for a particular contract. The Companyrecognizes the revenue from these contracts using either thepercentage-of-completion method or completed contract method of accounting.

 

The Company recordsrevenue relating to these contracts using the percentage-of-completion methodwhen the Company determines that progress toward completion is reasonable andreliably estimable and the contract is long-term in nature; the Company usesthe completed contract method for all others.

 

***Income Taxes***

 

Income taxes are recordedin accordance with FASB ASC Topic 740, *“IncomeTaxes”*(ASC Topic 740), which principally utilizes a balance sheetapproach to provide for income taxes.  Under this method, 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 loss and taxcredit 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 financialstatements in the period of enactment.  The Company files a consolidatedUnited States federal income tax return (see Note 3).

 

Effective October 1,2007 (the first day of fiscal 2008), income tax contingencies are accounted forin accordance with ASC Topic 740, which prescribes a comprehensive model forhow a company should recognize, measure, present and disclose in its financialstatements uncertain tax positions that the company has taken or expects totake on a tax return.  Significant judgment is required in 

 

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determining our provisionfor income taxes and recording the related assets and liabilities.  In thenormal course of our business, there are transactions and calculations wherethe ultimate tax determination is less than certain.  The Company and itssubsidiaries are subject to examination by Federal and State taxauthorities.  The Company regularly assesses the potential outcomes ofthese examinations and any future examinations for the current or prior yearsin determining the adequacy of the provision for income taxes.  TheCompany continually assesses the likelihood and amount of potential adjustmentsand records any necessary adjustments in the period in which the facts thatgive rise to a revision become known.  The Company has elected to recordany interest or penalties from the uncertain tax position as income taxexpense.

 

A valuation allowance isestablished when it is more likely than not that all or a portion of the netdeferred tax asset will not be realized.  The Company continues tomaintain a full valuation allowance against its net deferred tax assets, as ofthe quarter ended March 31, 2010.  In accordance with ASC Topic 740,the Company will continue to evaluate the need for a full or partial valuationallowance in future periods.

 

***Research and Development***

 

Research and development charges incurred for product design, productenhancements and future product development are expensed as incurred. Productdevelopment and design charges incurred related to a specific customeragreement that are billable are capitalized and then charged to cost of sales –EMD as the revenue related to the agreements is recognized.

 

***Comprehensive Income***

 

Pursuant to FASB ASC Topic 220, *“Comprehensive Income”*(ASC Topic 220)*,* the Company is required toclassify items of other comprehensive income by their nature in a financialstatement and display the accumulated balance of other comprehensive incomeseparately from retained earnings and additional paid-in capital in the equitysection of our condensed consolidated balance sheets.  For the six months ended March 31, 2010and 2009, comprehensive income consists of net income (loss) and there were noitems of other comprehensive income for any of the periods presented.

 

***Fair Value of Financial Instruments***

 

The Company adopted FASBASC Topic 820, *“Fair Value Measurements and Disclosures”*(ASC Topic 820) in the first quarter of fiscal 2009 for financial assets andliabilities. This standard defines fair value as the price at which an assetcould be exchanged in a current transaction between knowledgeable, willingparties. A liability’s fair value is defined as the amount that would be paidto transfer the liability to a new obligor, not the amount that would be paidto settle the liability with the creditor.

 

Assets and liabilitiesmeasured at fair value are categorized based upon the level of judgmentassociated with the inputs used to measure their fair value. Hierarchicallevels, defined by ASC Topic 820 and directly related to the amount ofsubjectivity associated with the inputs to fair valuation of these assets andliabilities, are as follows:

 

Level 1 — Unadjusted quoted prices that are availablein active markets for the identical assets or liabilities at the measurementdate.

 

Level 2 — Other observable inputs available at themeasurement date, other than quoted prices included in Level 1, either directlyor indirectly, including:

·  Quotedprices for similar assets or liabilities in active markets;

·  Quotedprices for identical or similar assets in non-active markets;

·  Inputsother than quoted prices that are observable for the asset or liability; and

·  Inputsthat are derived principally from or corroborated by other observable marketdata.

 

Level 3 — Unobservableinputs that cannot be corroborated by observable market data and reflect theuse of significant management judgment.  These values are generallydetermined using pricing models for which the assumptions utilize management’sestimates of market participant assumptions.

 

The following table setsforth by level within the fair value hierarchy the Company’s financial assetsand liabilities that were accounted for at fair value on a recurring basis asof March 31, 2010, according to the valuation techniques the Company usedto determine their fair values.

 

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| ** **                 | ** ** | **Fair Value Measurement on March 31, 2010**     | ** ** |
|----------------------------|------------|-------------------------------------------------------|------------|
| ** **                 | ** ** | **Quoted Price in**                                   | ** ** | **Significant Other** | ** ** | **Significant** | ** ** |
| ** **                 | ** ** | **Active Markets for**                                | ** ** | **Observable** | ** ** | **Unobservable** | ** ** |
| ** **                 | ** ** | **Identical Assets**                                  | ** ** | **Inputs** | ** ** | **Inputs** | ** ** |
| ** **                 | ** ** | **(Level 1)**                                         | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** |
| Assets                     |       |                                                  |       |   |   |   |   |
| Cash and cash equivalents: |       |                                                  |       |   |   |   |   |
| Money market funds         |       | $                                                     | 35,127,440 |   | $ | — |   | $ | — |   |
|                       |       |                                                  |       |   |   |   |   |
| ** **                 | ** ** | **Fair Value Measurement on September 30, 2009** | ** ** |
| ** **                 | ** ** | **Quoted Price in**                                   | ** ** | **Significant Other** | ** ** | **Significant** | ** ** |
| ** **                 | ** ** | **Active Markets for**                                | ** ** | **Observable** | ** ** | **Unobservable** | ** ** |
| ** **                 | ** ** | **Identical Assets**                                  | ** ** | **Inputs** | ** ** | **Inputs** | ** ** |
| ** **                 | ** ** | **(Level 1)**                                         | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** |
| Assets                     |       |                                                  |       |   |   |   |   |
| Cash and cash equivalents: |       |                                                  |       |   |   |   |   |
| Money market funds         |       | $                                                     | 34,793,543 |   | $ | — |   | $ | — |   |

 

***Stock-Based Compensation***

 

The Company accounts forstock-based compensation under FASB ASC Topic 505-50, *“Equity-BasedPayments to Non-Employees*(ASC Topic 505-50) and FASB ASC Topic 718,*“Stock Compensation”* (ASC Topic 718),which require the Company to measure the cost of employee services received inexchange for an award of equity instruments based on the grant-date fair valueof the award using an option pricing model. That cost is recognized over theperiod during which an employee is required to provide service in exchange forthe award.

 

***Warranty***

 

We offer warranties on some products of various lengths.At the time of shipment, we establish a reserve for costs of warranties basedon our best estimate of the amounts necessary to settle future and existingclaims using historical data on products sold as of the balance sheet date. Thelength of the warranty period, the product’s failure rates and the customer’susage affects warranty cost. If actual warranty costs differ from our estimatedamounts, future results of operations could be adversely affected.

 

***Concentrations***

 

*MajorCustomers and Products*

 

For the three monthsended March 31, 2010, three of the Company’s customers, Lockheed Martin,FedEx and American Airlines, accounted for 18%, 17% and 13% of net sales,respectively.  During the six monthsended March 31, 2010, four of the Company’s customers, Lockheed Martin,BAE Systems, FedEx and L3 Communications, accounted for 17%, 12%, 11% and 11%of net sales, respectively.

 

For the three monthsended March 31, 2009, two of the Company’s customers, American Airlinesand the United States Department of Defense accounted for 34% and 11% of netsales, respectively.  During the sixmonths ended March 31, 2009, two of the Company’s customers, AmericanAirlines and Boeing accounted for 32% and 10% of net sales, respectively.

 

*MajorSuppliers*

 

The Company, for strategic purposes such as timeliness and favorablepricing, currently buys several components from single source suppliers.Although there are a limited number of manufacturers of particular components,management believes other suppliers could provide similar components oncomparable terms.  For the three monthsended March 31, 2010 the Company’s two largest suppliers accounted for14.2% and 13.5% of the Company’s total inventory purchases, respectively.  For the six months ended March 31, 2010the Company’s four largest suppliers accounted for 22.0%, 12.0%, 10.4% and10.0% of the Company’s total inventory purchases, respectively.

 

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*Concentration of Credit Risk*

 

Financial instruments that potentially subject the Company toconcentration of credit risk consist principally of cash balances and accountsreceivable. The Company invests its excess cash where preservation of principalis the major consideration. The Company’s customer base principally consists ofcompanies within the aviation industry. The Company routinely requests advancepayments from new customers.

 

The Company has maintained a reserve for doubtful accounts in theamount of $0.2 and $0.2 million, as of March 31, 2010 and September 30,2009, respectively

 

***Recent Accounting Pronouncements***

 

In May 2009, theFASB issued ASC Topic 855 (ASC Topic 855), *Subsequent Events*which establishes general accounting for and disclosure of events that occurafter the balance sheet date but before financial statements are issued oravailable to be issued. This statement also outlines the circumstances underwhich an entity would need to record transactions occurring after the balancesheet date in the financial statements. These new disclosures identify the datethrough which the entity has evaluated subsequent events. ASC Topic 855 iseffective for interim or annual financial periods ending after June 15,2009.  In February 2010, the FASBamended its guidance removing the requirement for SEC filers to disclose thedate through which an entity has evaluated subsequent events.  The Company adopted ASC Topic 855 on April 1,2009 and the adoption had no impact on the condensed consolidated financialstatements.

 

In October 2009, theFASB issued Accounting Standards Update (ASU) No. 2009-13 (ASU 2009-13), *Multiple-Deliverable Revenue Arrangements*which updates ASCTopic 605-25, *Multiple Elements Arrangements*,of the FASB codification.  ASU 2009-13provides new guidance on how to determine if an arrangement involving multipledeliverables contains more than one unit of accounting, and if so allowscompanies to allocate arrangement considerations in a manner more consistentwith the economics of the transaction. ASU 2009-13 is effective for the Company, prospectively, for revenuearrangements entered into or materially modified in fiscal years beginning onor after June 15, 2010 (the Company’s fiscal year 2011); early applicationis permitted.  The Company is currentlyevaluating the impact of adopting ASU 2009-13 on its financial statements.

 

In October 2009, theFASB issued ASU No. 2009-14 (ASU 2009-14), *RevenueArrangements That include Software Elements* which amends ASC Topic985-605, *Software — Revenue Recognition* in regardto the scope of software guidance.  ASU2009-14 excludes software components of tangible products that functiontogether to provide the tangible product’s essential functionality.  While ASU 2009-14 does not create any newmethods of revenue recognition, it could significantly affect the Company’srecognition of revenue from period to period. ASU 2009-14 is effective for the Company, prospectively, for revenuearrangements entered into or materially modified in fiscal years beginning onor after June 15, 2010 (the Company’s fiscal year 2011); early applicationis permitted as long as the guidance from ASU 2009-13 is applied.  The Company is currently evaluating theimpact of adopting ASU 2009-14 on its financial statements.

 

In January 2010, theFASB issued ASU No. 2010-06 (ASU 2010-06), *Fair ValueMeasurements and Disclosures* which amends ASC Topic 820, adding newrequirements for disclosures for Levels 1 and 2, separate disclosures ofpurchases, sales, issuances, and settlements relating to Level 3 measurementsand clarification of existing fair value disclosures.  ASU 2010-06 is effective for interim andannual periods beginning after December 15, 2009, except for therequirement to provide Level 3 activity of purchases, sales, issuances, andsettlements on a gross basis, which will be effective for fiscal yearsbeginning after December 15, 2010 (the Company’s fiscal year 2012); earlyadoption is permitted.  The Company iscurrently evaluating the impact of adopting ASU 2009-14 on its financialstatements.

 

**2.****Detail of CertainBalance Sheet Accounts**

 

***Inventories***

 

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

 

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| ** **      | ** ** | **March 31,** | ** ** | **September 30,** | ** ** |
|-----------------|------------|--------------------|------------|------------------------|------------|
| ** **      | ** ** | **2010**           | ** ** | **2009**               | ** ** |
| Raw  materials  |       | $                  | 3,140,522  |                   | $          | 3,535,109 |   |
| Work-in-process |       | 669,811            |       | 315,179                |       |
| Finished  goods |       | 1,244,089          |       | 1,456,697              |       |
|            |       | $                  | 5,054,422  |                   | $          | 5,306,985 |   |

 

***Prepaid expenses and othercurrent assets***

 

Prepaid expenses andother current assets consist of the following:

 
| ** **                           | ** ** | **March 31,** | ** ** | **September 30,** | ** ** |
|--------------------------------------|------------|--------------------|------------|------------------------|------------|
| ** **                           | ** ** | **2010**           | ** ** | **2009**               | ** ** |
|                                 |       |               |       |                   |       |
| Revenue  recognized not yet invoiced |       | $                  | 473,220    |                   | $          | 491,417 |   |
| Prepaid  insurance                   |       | 201,685            |       | 307,477                |       |
| Deferred  engineering costs          |       | 14,014             |       | 81,957                 |       |
| Income  tax asset                    |       | 405,705            |       | —                 |       |
| Other                                |       | 267,759            |       | 346,562                |       |
|                                 |       | $                  | 1,362,383  |                   | $          | 1,227,413 |   |

 

***Property and equipment***

 

Property and equipment,net consists of the following balances:

 
| ** **                                       | ** ** | **March 31,** | ** ** | **September 30,** | ** ** |
|--------------------------------------------------|------------|--------------------|------------|------------------------|------------|
| ** **                                       | ** ** | **2010**           | ** ** | **2009**               | ** ** |
|                                             |       |               |       |                   |       |
| Computer  equipment                              |       | $                  | 2,034,077  |                   | $          | 1,986,028 |   |
| Corporate  airplane                              |       | 3,082,186          |       | 3,082,186              |       |
| Furniture  and office equipment                  |       | 1,089,298          |       | 1,074,031              |       |
| Manufacturing  facility                          |       | 5,576,466          |       | 5,558,553              |       |
| Equipment                                        |       | 4,097,202          |       | 4,037,689              |       |
| Land                                             |       | 1,021,245          |       | 1,021,245              |       |
|                                             |       | 16,900,474         |       | 16,759,732             |       |
| Less:  Accumulated depreciation and amortization |       | (8,808,459         | )          | (8,416,031             | )          |
|                                             |       | $                  | 8,092,015  |                   | $          | 8,343,701 |   |

 

Depreciation andamortization related to property and equipment was approximately $199,000 and$221,000 for the three months ended March 31, 2010 and 2009, respectively.

 

Depreciation andamortization related to property and equipment was approximately $391,000 and$438,000 for the six months ended March 31, 2010 and 2009, respectively.

 

***Other assets***

 

Other assets consist ofthe following:

 
| ** **                                                                                                                      | ** ** | **March 31,** | ** ** | **September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
| ** **                                                                                                                      | ** ** | **2010**           | ** ** | **2009**               | ** ** |
| Intangible  assets, net of accumulated amortizationof $218,090 and $198,140 at  March 31, 2010 and September 30, 2009 |       | $                  | 260,910    |                   | $          | 280,860 |   |
| Installation  kits, deposit forfeiture                                                                                          |       | —             |       | 118,660                |       |
|                                                                                                                            |       | $                  | 260,910    |                   | $          | 399,520 |   |

 

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Intangible assets consist of licensing and certification rights whichare amortized over a defined number of units. No impairment charge was recorded in the six months ended March 31,2010.

 

Total intangible amortization expense was approximately $18,950 and$40,000 for the three months ended March 31, 2010 and 2009, respectively.Total amortization expense for the six months ended March 31, 2010 and2009 was $19,950 and $83,000, respectively. Because the intangible assets arebeing amortized over a defined number of units, the future amortization expenseover the next five years cannot be determined at this time.

 

***Accruedexpenses***

 

Accrued expenses consistof the following:

 

 
| ** **                          | ** ** | **March 31,** | ** ** | **September 30,** | ** ** |
|-------------------------------------|------------|--------------------|------------|------------------------|------------|
| ** **                          | ** ** | **2010**           | ** ** | **2009**               | ** ** |
|                                |       |               |       |                   |       |
| Warranty  **(a)**                   |       | $                  | 790,684    |                   | $          | 808,544 |   |
| Salary,  benefits and payroll taxes |       | 504,330            |       | 617,224                |       |
| Reduction  in workforce / severance |       | —             |       | 166,453                |       |
| Professional  fees                  |       | 259,213            |       | 188,349                |       |
| Income  taxes payable               |       | —             |       | 112,449                |       |
| Materials  on order                 |       | 34,578             |       | 108,210                |       |
| Other                               |       | 563,431            |       | 784,331                |       |
|                                |       |               |       |                   |       |
|                                |       | $                  | 2,152,236  |                   | $          | 2,785,560 |   |

 

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(a)          The Companyprovides for the estimated cost of product warranties at the time revenue isrecognized. Warranty cost is recorded as cost of sales and the reserve balanceis recorded as an accrued expense in the financial statements. While theCompany engages in extensive product quality programs and processes, theCompany’s warranty obligation is affected by product failure rates and therelated material, labor and delivery costs incurred in correcting a productfailure. Should actual product failure rates, material or labor costs differfrom the Company’s estimates, further revisions to the estimated warrantyliability would be required.

 

Warranty cost and accrual information for the three months ended March 31,2010 is highlighted below:

 
| Warranty Accrual at December 31, 2009                      |   | $       | 779,263 |   |
|-----------------------------------------------------------------|--------|---------|---------|--------|
| Accrued expense for the three months ended  March 31, 2010 |   | 68,931  |    |
| Warranty cost for the three months ended  March 31, 2010   |   | (57,510 | )       |
| Warranty Accrual at March 31, 2010                         |   | $       | 790,684 |   |

 

Warrantycost and accrual information for the six months ended March 31, 2010 ishighlighted below:

 
| Warranty Accrual at September 30, 2009                   |   | $        | 808,544 |   |
|---------------------------------------------------------------|--------|----------|---------|--------|
| Accrued expense for the six months ended  March 31, 2010 |   | 119,071  |    |
| Warranty cost for the six months ended  March 31, 2010   |   | (136,930 | )       |
| Warranty Accrual at March 31, 2010                       |   | $        | 790,685 |   |

 

***Notespayable***

 

The Company entered into a $4,335,000 loan agreement dated August 1,2000 with the Chester County, Pennsylvania Industrial Development Authority.The purpose of the loan was to fund the construction of the Company’s newoffice and manufacturing facility. The loan was scheduled to mature in 2015 andcarried an interest rate set by the remarketing agent that was consistent with30-day tax-exempt commercial paper. The Company exercised its option to pay-downthe outstanding balance during August, 2009.

 

The interest cost related to this debt for the three months ended March 31,2010 and 2009 was $0 and $9,000, respectively. The interest cost related tothis debt for the six months ended March 31, 2010 and 2009 was $0 and$33,000 respectively. The Company was required to maintain a letter of creditin the amount of $5,000,000 covering the debt, prior to the August, 2009redemption.

 

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**3. Income Taxes**

 

The income tax benefit for the three and six months ended March 31,2010 was $78,000 and $406,000, respectively, as compared to an expense of$96,000 and $168,000, respectively, for the three and six months ended March 31,2009.  The income tax benefit for thethree and six months ended March 31, 2010 was the result of the actualpre-tax loss for both periods, as compared to the actual pre-tax income fromthe same periods in the prior year.

 

The effective tax rates for the three months ended March 31, 2010and 2009 were 9% and 7%, respectively. The effective tax rate differs from the statutory rate for the threemonths ended March 31, 2010 primarily due to a decrease in the overallforecast effective tax rate for the year from the previous quarter, inconjunction with a smaller pretax loss in the current quarter as compared tothe quarter ended December 31, 2009. The effective tax rate differs from the statutory rate for the threemonths ended March 31, 2009 due to the reversal of certain deductibletemporary differences, which were fully offset by a valuation allowance, thatwere deductible for income tax purposes in the fiscal year ended September 30,2009.

 

The effective tax rates for the six months ended March 31, 2010and 2009 were 18% and 5%, respectively. The effective tax rate differs from the statutory rate for the sixmonths ended March 31, 2010 primarily due to the forecasted utilization ofresearch and experimentation tax credit carry forwards and the forecasted netreversal of various deductible temporary differences which are fully offset bya valuation allowance, based on the forecasted level of pretax income.  The effective tax rate differs from the statutoryrate for the six months ended March 31, 2009 due to the reversal ofcertain deductible temporary differences, which were fully offset by avaluation allowance, that were deductible for income tax purposes in the fiscalyear ended September 30, 2009.

 

As of March 31, 2010, the Company recognized a $406,000 currentincome tax asset resulting from current taxable losses that can be carried backto prior years to offset federal income tax paid.  The Company maintains a full valuationallowance against its net deferred tax assets, which may not be carried back toprior taxable years, and consist primarily of deductible temporary differencesand other carryforward items.  TheCompany will continue to maintain this valuation allowance until an appropriatelevel of profitability is sustained to conclude that it is more likely than notthat a portion of these net deferred tax assets would be realized in futureperiods.  As such, improvements inpre-tax income in the future within the jurisdictions where the Companymaintains a valuation allowance may result in these tax benefits ultimatelybeing realized.  However, there is noassurance that such improvements will be achieved.

 

**4. Capital Stock**

 

At March 31, 2010,the Company’s Articles of Incorporation provides the Company authority to issue75,000,000 shares of Common Stock and 10,000,000 shares of blank checkPreferred Stock.

 

***Share-basedcompensation***

 

The Company accounts forshare-based compensation under the provisions of ASC Topic 505-50 and ASC Topic718, using the modified prospective approach and accounts for share-basedcompensation applying the fair value method for expensing stock options andnon-vested stock awards.

 

Total share-basedcompensation expense was approximately $136,000 and $183,000 for the threemonths ended March 31, 2010 and 2009, respectively. The income tax impactis recognized as a (charge) credit to additional paid-in capital in thestatement of shareholders’ equity related to share-based compensationarrangements was approximately ($1,000) and ($13,000) for the three monthsended March 31, 2010 and 2009, respectively.

 

Total share-basedcompensation expense was approximately $287,000 and $377,000 for the six monthsended March 31, 2010 and 2009, respectively. The income tax impact isrecognized as a (charge) credit to additional paid-in capital in the statementof shareholders’ equity related to share-based compensation arrangements wasapproximately ($3,000) and $4,000 for the six months ended March 31, 2010and 2009, respectively.  Compensationexpense related to share-based awards is recorded as a component of general andadministrative expense.

 

The Company maintains the1998 Stock Option Plan (the “1998 Plan”), the 2003 Restricted Stock Plan (the “RestrictedPlan”) and the 2009 Stock-Based Incentive Compensation Plan (the “2009 Plan”).  These plans were approved by the Company’sshareholders. The 1998 Plan expired on November 13, 2008.

 

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***1998Stock Option Plan***

 

The 1998 Plan allowed thegranting of incentive and nonqualified stock options to employees, officers,directors, and independent contractors and consultants. No stock options were grantedto independent contractors or consultants under this Plan.  Total compensation expense associated withawards under the 1998 plan was $86,000 and $133,000 for the three months ended March 31,2010 and 2009, respectively. Total compensation expense associated with awardsunder the 1998 plan was $187,000 and $277,000 for the six months ended March 31,2010 and 2009, respectively.

 

Incentive stock optionsgranted under the 1998 Plan have exercise prices that are at least equal to thefair value of the common stock on the grant date. Nonqualified stock optionsgranted under the 1998 Plan have exercise prices that are less than, equal toor greater than the fair value of the common stock on the date of grant. TheCompany had reserved 3,389,000 shares of Common Stock for awards under the 1998Plan.  On November 13, 2008, the1998 Plan expired and no additional shares were granted under the Plan afterthat date.

 

***RestrictedPlan***

 

Total compensationexpense under the Restricted Plan was $50,000 for both the three months ended March 31,2010 and 2009, respectively. Total compensation expense associated with theRestricted Plan was $100,000 for both the six months ended March 31, 2010and 2009, respectively. The expense relates to shares that are issued to non-employeemembers of the Board of Directors on a quarterly basis as part of theircompensation.

 

***2009Stock-Based Incentive Compensation Plan***

 

The 2009 Plan authorizes the grant of Stock Appreciation Rights (“SARs”),Restricted Stock, Options and other equity-based awards under the 2009 Plan(collectively referred to as “Awards”). Options granted under the 2009 Plan maybe either “incentive stock options” as defined in section 422 of theInternal Revenue Code (the “Code”), or nonqualified stock options, as determinedby the Compensation Committee of the Company’s Board of Directors (the “Committee”).

 

Subject to an adjustment necessary upon a stock dividend,recapitalization, forward split or reverse split, reorganization, merger,consolidation, spin-off, combination, repurchase or share exchange,extraordinary or unusual cash distribution or other similar corporatetransaction or event, the maximum number of shares of Common Stock availablefor Awards under the 2009 Plan shall be 1,200,000, all of which may be issuedpursuant to Awards of incentive stock options. In addition, the Plan provides that no more than 300,000 shares may beawarded to any employee as a performance-based Award under Section 162(m) ofthe Code.  At March 31, 2010 therewere 1,150,000 shares of Common Stock available for awards under the plan.

 

If any Award is forfeited, or if any Option terminates, expires orlapses without being exercised, shares of Common Stock subject to such Awardwill again be available for future grant. Any shares tendered by a participantin payment of the exercise price of an Option or the tax liability with respectto an Award (including, in any case, shares withheld from any such Award) willnot be available for future grant under the 2009 Plan.  If there is any change in the Company’scorporate capitalization, the Committee shall proportionately and equitablyadjust the number and kind of shares of Common Stock which may be issued inconnection with future Awards, the number and kind of shares of Common Stock coveredby Awards then outstanding under the 2009 Plan, the number and kind of sharesof Common Stock available under the 2009 Plan, the exercise or grant price ofany Award, or if deemed appropriate, make provision for a cash payment withrespect to any outstanding Award, provided that no adjustment may be made thatwould adversely affect the status of any Award that is intended to be aperformance-based Award under Section 162(m) of the Code, unlessotherwise determined by the Committee. In addition, the Committee may makeadjustments in the terms and conditions of any Awards, including anyperformance goals, in recognition of unusual or nonrecurring events affectingthe Company or any subsidiary, or in response to changes in applicable laws,regulations or accounting principles, provided that no adjustment may be madethat would adversely affect the status of any Award that is intended to be aperformance-based Award under Section 162(m) of the Code, unlessotherwise determined by the Committee.

 

At March 31, 2010,there was no recognized compensation cost related to the 2009 Plan.

 

***Stockrepurchase program***

 

On February 23, 2009, the Company’s Board of Directors approved acommon stock repurchase program to acquire up to 1,000,000 shares of theCompany’s outstanding Common Stock. Purchases of the stock were to be made fromtime to time, subject to market conditions and at prevailing market prices.There were no shares purchased under this plan during the three months ended March 31,2010, and the program was extended as outlined below on February 16, 2010.

 

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On February 16, 2010, the Company’s Board of Directors extendedthe Common Stock repurchase program to acquire up to 1,000,000 shares of theCompany’s outstanding Common Stock. Purchases of the stock were to be made from time to time, subject tomarket conditions and at prevailing market prices.  During the three months ended March 31,2010 the Company purchased 5,200 shares of common stock under the program at acost of $21,661, or an average market price of $4.17 per share.  The Company financed these purchases throughavailable cash.  The following table setsforth the purchases made under this new plan for each month of the three monthsended March 31, 2010:

 

 
| ** **         | ** ** | ** **    | ** ** | ** **     | ** ** | **Total Number of**       | ** ** | **Number of**        | ** ** |
|--------------------|------------|---------------|------------|----------------|------------|---------------------------|------------|----------------------|------------|
| ** **         | ** ** | **Total**     | ** ** | ** **     | ** ** | **Shares Purchased as**   | ** ** | **Shares that May**  | ** ** |
| ** **         | ** ** | **Number of** | ** ** | **Average**    | ** ** | **Part of Publicly** | ** ** | **Yet Be Purchased** | ** ** |
| ** **         | ** ** | **Shares**    | ** ** | **Price Paid** | ** ** | **Announced Plans or**    | ** ** | **Under the**        | ** ** |
| **Period**         | ** ** | **Purchased** | ** ** | **per Share**  | ** ** | **Programs**              | ** ** | **Program**          | ** ** |
|               |       |          |       |           |       |                      |       |                 |       |
| January 2010  |       | —        |       | —         |       | —                    |       | —               |       |
|               |       |          |       |           |       |                      |       |                 |       |
| February 2010 |       | 4,100         |       | $              | 4.16       |                      | 4,100      |                 | 995,900    |   |
|               |       |          |       |           |       |                      |       |                 |       |
| March 2010    |       | 1,100         |       | $              | 4.20       |                      | 1,100      |                 | 994,800    |   |
|               |       |          |       |           |       |                      |       |                 |       |
|               |       | 5,200         |       |           |       | 5,200                     |       |                 |       |

 

**5. Income(Loss) per Share**

 

Income (loss) per share (“EPS”)is calculated using the principles of FASB Accounting Standards Topic 260 (ASC260), *Earnings Per Share.*

 

For the three and sixmonth periods ended March 31, 2010, there were 380,000 options to purchasecommon stock outstanding excluded from the computations of diluted earnings pershare as the effect would be anti-dilutive.

 

For the three and sixmonth periods ended March 31, 2009, there were 638,000 and 438,000 optionsto purchase common stock outstanding, respectively, excluded from thecomputations of diluted earnings per share as the effect would beanti-dilutive.

 

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

 

**CAUTIONARYSTATEMENT REGARDING****FORWARD-LOOKING STATEMENTS**

 

*This report contains forward looking statementswithin the meaning of Section 21E of the Securities Exchange Act of 1934.We have based these forward looking statements largely on our currentexpectations and projections about future events and trends affecting ourbusiness. In this report, the words “believe,” “may,” “will,” “estimate,” “continue,”“anticipate,” “intend,” “forecast,” “expect,” “plan,” “should,” “is likely” andsimilar expressions, as they relate to our business or our management, areintended to identify forward looking statements, but they are not exclusivemeans of identifying them.*

 

*The forward looking statements in this report areonly predictions and actual events or results may differ materially. Inevaluating such statements, a number of risks, uncertainties and other factorscould cause our actual results, performance, financial condition, cash flows,prospects, and opportunities to differ materially from those expressed in, orimplied by, the forward looking statements. These risks, uncertainties andother factors include the following factors:*

 

·                  *the impact of general economictrends on our business;*

 

·                  *the deferral or termination ofprograms or contracts for convenience by customers;*

 

·                  *difficulties in developing andproducing our COCKPIT/IPTM system or other planned products for product enhancements;*

 

·                  *market acceptance of our flat paneldisplay systems, or COCKPIT/IPTM system or other planned products for productenhancements;*

 

·                  *our ability to gain regulatoryapproval of our products in a timely manner;*

 

·                  *failure to retain/recruit keypersonnel;*

 

·                  *continued market acceptance of ourair data systems and products;*

 

·                  *the availability of governmentfunding;*

 

·                  *delays in receiving components fromthird party suppliers;*

 

·                  *the competitive environment;*

 

·                  *the bankruptcy or insolvency of oneor more key customers;*

 

·                  *new product offerings fromcompetitors;*

 

·                  *protection of intellectual propertyrights;*

 

·                  *our ability to service theinternational market;*

 

·                  *potential future acquisitions; and*

 

·                  *other factors disclosed from time totime in our filings with the Securities and Exchange Commission.*

 

*Except as expressly required by the federalsecurities laws, we undertake no obligation to publicly update or revise anyforward looking statements, whether as a result of new information, futureevents or otherwise after the date of this report. Our results of operations inany past period should not be considered indicative of the results to beexpected for future periods. Fluctuations in operating results may also resultin fluctuations in the price of our common stock.*

 

*Readers are cautioned not toplace undue reliance on these forward-looking statements, which speak only asof the date of this Form 10-Q. The Company does not undertake anyobligation to publicly release any revisions to these forward-looking statementsto reflect events, circumstances or changes in expectations after the date ofthis Form 10-Q, or to reflect the occurrence of unanticipated events. Theforward-looking statements in this document are intended to be subject to thesafe harbor protection provided by Sections 27A of the Securities Act and 21Eof the Exchange Act. For a discussion identifying some important factors thatcould cause actual results to vary materially from those anticipated in theforward-looking statements, see the Company’s Securities and ExchangeCommission filings including, but not limited to, the discussions of “RiskFactors” contained in the Company’s Annual Report on Form 10-K for thefiscal year ended September 30, 2009.*

 

*Investorsshould also be aware that while we do, from time to time, communicate withsecurities analysts, it is against our policy to disclose any materialnon-public information or other confidential commercial information.Accordingly, shareholders should not assume that we agree with any statement orreport issued by any analyst irrespective of the content of the statement orreport. Furthermore, we have a policy against issuing or confirming financialforecasts or projections issued by others. Thus, to the extent that reportsissued by securities analysts contain any projections, forecasts or opinions,such reports are not the responsibility of*

 

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*InnovativeSolutions and Support, Inc.*

 

**Company Overview**

 

Innovative Solutions and Support, Inc. (The “Company”, “IS&S”or “we”) was founded in 1988. The Company designs, develops, manufactures andsells Flight Information Computers, Flat-Panel Display Systems, and advancedmonitoring systems that measure and display critical flight information,including data relative to aircraft separation, airspeed, and altitude, as wellas engine and fuel data measurements.

 

Our sales are derived from the sale of our products to the retrofitmarket and, to a lesser extent, original equipment manufacturers (OEMs).  Our customers include the United StatesDepartment of Defense (DoD) and their commercial contractors, aircraftoperators, aircraft modification centers and various OEMs. Although weoccasionally sell our products directly to the DoD, we primarily have sold ourproducts to commercial customers for end use in DoD programs. Sales to defensecontractors are on commercial terms, although some of the termination and otherprovisions of government contracts are applicable to these contracts.

 

Our cost of sales related to product sales is comprised of materialcomponents purchased through our supplier base and direct in-house assemblylabor and overhead costs. Many of the components we use in assembling ourproducts are standard, although certain parts are manufactured to meet ourspecifications. The overhead portion of cost of sales is primarily comprised ofsalaries and benefits, building occupancy, supplies, and outside service costsrelated to our production, purchasing, material control and qualitydepartments, and warranty costs.

 

Our cost of sales related to Engineering—modification and development(EMD) is comprised of engineering labor, consulting services, and other costassociated with specific design and development projects.

 

We intend to continue investing in the development of new products thatcomplement our current product offerings and will expense associated researchand development costs as they are incurred.

 

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

 

We sell our products toagencies of the United States and foreign governments, aircraft operators,aircraft modification centers and original equipment manufacturers.  Ourcustomers have been and may continue to be affected by the ongoing adverseeconomic conditions that currently exist both in the United States andabroad.  Such conditions may cause our customers to curtail or delay theirspending on both new and existing aircraft.  Factors that can impactgeneral economic conditions and the level of spending by our customers include,but are not limited to, general levels of consumer spending, increases infuel and energy costs, conditions in the real estate and mortgage markets,labor and healthcare costs, access to credit, consumer confidence and othermacroeconomic factors affecting spending behavior.  Additionally, spendingby government agencies may in the future be further reduced due to decliningtax revenues associated with this economic downturn.  If our customerscurtail or delay their spending or are forced to declare bankruptcy orliquidate their operations due to continuing adverse economic conditions, ourrevenues and results of operations will be adversely affected.  However, we believe that in a decliningeconomic environment a customer that may have otherwise elected to purchasenewly manufactured aircraft will instead be interested in retrofitting existingaircraft as a cost effective alternative, which should create a marketopportunity for our products.

 

**CriticalAccounting Policies and Estimates**

 

Our discussion andanalysis of our financial condition and consolidated results of operations arebased upon our condensed consolidated financial statements, which have beenprepared in accordance with generally accepted accounting principles in theUnited States. The preparation of our condensed consolidated financialstatements requires us to make estimates and assumptions that affect thereported amounts of assets, liabilities, revenues and expenses and relateddisclosure of contingent assets and liabilities. On an on-going basis, weevaluate our estimates based upon historical experience and various otherassumptions that we believe to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valuesof assets and liabilities that are not readily apparent from other sources. Ouractual results may differ from these estimates.

 

We believe that ourcritical accounting policies affect our more significant estimates andjudgments used in the preparation of our consolidated financial statements. OurAnnual Report on Form 10-K for the year ended September 30, 2009contains a discussion of these critical accounting policies. There have been nosignificant changes in our critical accounting policies since September 30,2009. See also Note 1 to our unaudited condensed consolidated financialstatements for the three and six month period ended March 31, 2010 as setforth herein.

 

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**RESULTSOF OPERATIONS FOR THE THREE AND SIX MONTHS ENDEDMARCH 31, 2010 AND 2009**

 

The following table setsforth statement of operations data expressed as a percentage of total net salesfor the periods indicated (some items may not add due to rounding):

 
| ** **                                  | ** ** | **Three Months Ending March 31,** | ** ** | **Six Months Ending March 31,** | ** ** |
|---------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                  | ** ** | **2010**                                              | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Net  sales:                                 |       |                                                  |       |                                                |       |   |   |   |   |
| Product                                     |       | 92.8                                                  | %          | 89.5                                                | %          | 88.4 | % | 86.8 | % |
| Engineering  - modification and development |       | 7.2                                                   | %          | 10.5                                                | %          | 11.6 | % | 13.2 | % |
| Total  net sales                            |       | 100.0                                                 | %          | 100.0                                               | %          | 100.0 | % | 100.0 | % |
|                                        |       |                                                  |       |                                                |       |   |   |   |   |
| Cost  of sales                              |       |                                                  |       |                                                |       |   |   |   |   |
| Product                                     |       | 52.4                                                  | %          | 47.0                                                | %          | 51.9 | % | 47.1 | % |
| Engineering  - modification and development |       | 2.4                                                   | %          | 2.9                                                 | %          | 6.0 | % | 2.7 | % |
| Total  cost of sales                        |       | 54.8                                                  | %          | 49.9                                                | %          | 57.9 | % | 49.8 | % |
|                                        |       |                                                  |       |                                                |       |   |   |   |   |
| Gross  profit                               |       | 45.2                                                  | %          | 50.1                                                | %          | 42.1 | % | 50.2 | % |
|                                        |       |                                                  |       |                                                |       |   |   |   |   |
| Operating  expenses:                        |       |                                                  |       |                                                |       |   |   |   |   |
| Research  and development                   |       | 26.1                                                  | %          | 15.4                                                | %          | 25.7 | % | 13.7 | % |
| Selling,  general and administrative        |       | 34.9                                                  | %          | 21.7                                                | %          | 40.4 | % | 22.0 | % |
| Total  operating expenses                   |       | 61.0                                                  | %          | 37.1                                                | %          | 66.1 | % | 35.8 | % |
|                                        |       |                                                  |       |                                                |       |   |   |   |   |
| Operating  income (loss)                    |       | -15.8                                                 | %          | 13.0                                                | %          | -24.0 | % | 14.5 | % |
|                                        |       |                                                  |       |                                                |       |   |   |   |   |
| Interest  income                            |       | 0.5                                                   | %          | 0.9                                                 | %          | 0.5 | % | 1.4 | % |
| Interest  (expense)                         |       | 0.0                                                   | %          | -0.2                                                | %          | 0.0 | % | -0.3 | % |
| Other  income                               |       | 0.0                                                   | %          | 0.0                                                 | %          | 0.5 | % | 0.2 | % |
| Income  (loss) before income taxes          |       | -15.3                                                 | %          | 13.8                                                | %          | -23.0 | % | 15.9 | % |
|                                        |       |                                                  |       |                                                |       |   |   |   |   |
| Income  tax expense (benefit)               |       | -1.4                                                  | %          | 0.9                                                 | %          | -4.1 | % | 0.8 | % |
|                                        |       |                                                  |       |                                                |       |   |   |   |   |
| Net  income (loss)                          |       | -13.9                                                 | %          | 12.9                                                | %          | -18.9 | % | 15.1 | % |

 

**Three Months Ended March 31,2010 Compared to the Three Months Ended March 31, 2009**

 

*Net sales.* Net sales decreased $5.1 million, or48.6%, to $5.4 million for the three months ended March 31, 2010 from$10.5 million in the three months ended March 31, 2009.  For the three months ended March 31,2010, product sales decreased $4.4 million and EMD sales decreased $0.7 millionfrom the same period in the prior year. The decrease in both product and EMD sales was primarily driven bycustomer delays in delivery schedules for backlog orders.

 

*Cost of sales.* Cost of sales decreased $2.3 million or43.6%, to $2.9 million, or 54.8% of net sales in the three months ended March 31,2010 from $5.2 million, or 49.9% of net sales in the three months ended March 31,2009.  The decrease was primarily the resultof the decrease in variable production costs during the quarter, resulting fromlower product sales, which accounted for $2.1 million of the decrease, with anadditional decrease of $0.2 million in EMD related costs.  The reduced sales volume for the three monthsended March 31, 2010 had a negative impact on gross margin as compared tothe prior year period.

 

*Research and development.* Research and development expensedecreased $0.2 million or 12.8% to $1.4 million or 26.1% of net sales in thethree months ended March 31, 2010 from $1.6 million or 15.4% of net salesin the three months ended March 31, 2009. The decrease in research and development expense in the quarter wasprimarily due to a reduction in departmental headcount.

 

*Selling, general, and administrative.* Selling, general and administrativeexpenses decreased $0.4 million, or 17.4%, to $1.9 million, or 34.9% of netsales in the three months ended March 31, 2010 from $2.3 million or 21.7%of net sales in the three months ended March 31, 2009.  The decrease in selling, general, andadministrative expense in the quarter was primarily due to continued costcontainment efforts.

 

*Interest income.* Interest income was $28,000 in the threemonths ended March 31, 2010 as compared to $97,000 in the three monthsended March 31, 2009.  The decreasein interest income was primarily the result of lower interest rates in thequarter as compared to the prior year period.

 

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*Interest expense.* Interest expense was $1,000 in the threemonths ended March 31, 2010 as compared to $19,000 in the three monthsended March 31, 2009.  The reductionwas primarily due to the redemption of the Industrial Development Bond duringAugust, 2009.

 

*Income tax expense (benefit).* The income tax benefit for the threemonths ended March 31, 2010 was $78,000 as compared to an expense of$96,000 for the three months ended March 31, 2009.  The income tax benefit for the three monthsended March 31, 2010 was the result of the actual pre-tax loss for thequarter as compared to the actual pre-tax income for the same period in theprior year.

 

The effective tax ratefor the three months ended March 31, 2010 and 2009 were 9% and 7%,respectively. The effective tax rate differs from the statutory rate for thethree months ended March 31, 2010 primarily due to the decrease in theoverall forecast effective tax rate for the year from the previous quarter, in conjunctionwith a smaller pretax loss in the current quarter as compared to the quarterended December 31, 2009.  Theeffective tax rate differs from the statutory rate for the three months ended March 31,2009 due to the reversal of certain deductible temporary differences, whichwere fully offset by a valuation allowance, that were deductible for income taxpurposes in the fiscal year ended September 30, 2009.

 

*Net (Loss) Income.* As a result of the factors described above, our net loss for the threemonths ended March 31, 2010 was ($0.7) million.  Net income for the three months ended March 31,2009 was $1.3 million.  The loss pershare of ($0.04) for the three months ended March 31, 2010 compares toincome per share of $0.08, on a fully diluted basis, for the three months endedMarch 31, 2009.

 

**Six Months Ended March 31,2010 Compared to the Six Months Ended March 31, 2009**

 

*Net sales.* Net sales decreased $11.0 million, or52.6%, to $10.0 million for the six months ended March 31, 2010 from $21.0million in the six months ended March 31, 2009. For the six months ended March 31,2010, product sales decreased $9.4 million and EMD sales decreased $1.6 millionfrom the same period in the prior year. The decrease in both product and EMD sales was primarily driven bycustomer delays in delivery schedules for backlog orders.

 

*Cost of sales.* Cost of sales decreased $4.7 million or44.8%, to $5.8 million, or 57.9% of net sales in the six months ended March 31,2010 from $10.5 million, or 49.8% of net sales in the six months ended March 31,2009.  The decrease was the result of thedecrease in variable production costs during the quarter which accounted forthe entire $4.7 million of decreased costs, as EMD related costs remained flat.  The reduced sales volume for the six monthsended March 31, 2010 had a negative impact on gross margin as compared tothe prior year period.

 

*Research and development.* Research and development expense decreased $0.3 million or 11.1% to $2.6million or 25.7% of net sales in the six months ended March 31, 2010 from$2.9 million or 13.7% of net sales in the six months ended March 31,2009.  The decrease in research anddevelopment expense in the quarter was primarily due to a reduction indepartmental headcount.

 

*Selling, general, and administrative.* Selling, general and administrativeexpenses decreased $0.6 million, or 13.0%, to $4.0 million, or 40.4% of netsales in the six months ended March 31, 2010 from $4.6 million or 22.0% ofnet sales in the six months ended March 31, 2009.  The decrease in selling, general, andadministrative expense in the quarter was primarily due to continued costcontainment efforts.

 

*Interest income.* Interest income was $51,000 in the sixmonths ended March 31, 2010 as compared to $298,000 in the six months endedMarch 31, 2009.  The decrease ininterest income was primarily the result of lower interest rates in the quarteras compared to the prior year period.

 

*Interest expense.* Interest expense was $1,000 in the sixmonths ended March 31, 2010 as compared to $55,000 in the six months endedMarch 31, 2009.  The reduction wasprimarily due to the redemption of the Industrial Development Bond duringAugust, 2009.

 

*Income tax expense.* The income tax benefit for the six months ended March 31,2010 was $406,000 as compared to an expense of $168,000 for the six monthsended March 31, 2009. The income tax benefit for the three and six monthsended March 31, 2010 was the result of the actual pre-tax loss for thequarter as compared to the actual pre-tax income from the same periods in theprior year.

 

The effective tax rates for the six months ended March 31,2010 and 2009 were 18% and 5%, respectively. The effective tax rate differs from the statutory rate for the sixmonths ended March 31, 2010 due to the forecasted utilization of researchand experimentation tax credit carryforwards, the forecasted net reversals ofvarious deductible temporary differences which are fully offset by a valuationallowance and the forecasted level of pretax income.  The effective tax rate differs from thestatutory rate for the six months ended March 31, 2009 due to the reversalof certain deductible temporary differences, which were fully offset by avaluation allowance, that were deductible for income tax purposes in the fiscalyear ended September 30, 2009.

 

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*Net (Loss) Income.* As a result of  the factorsdescribed above, our net loss for the six months ended March 31, 2010 was$(1.9) million.  Net income for the six monthsended March 31, 2009 was $3.2 million.

 

**Liquidity and Capital Resources**

 

The following tablehighlights key financial measurements of the Company:

 
| ** **                                        | ** ** | **March 31,**                   | ** ** | **September 30,** | ** ** |
|---------------------------------------------------|------------|--------------------------------------|------------|------------------------|------------|
| ** **                                        | ** ** | **2010**                             | ** ** | **2009**               | ** ** |
| Cash  and cash equivalents                        |       | $                                    | 35,654,687 |                   | $          | 35,565,694 |   |
| Accounts  receivable, net                         |       | 4,004,698                            |       | 6,188,706              |       |
| Current  assets                                   |       | 46,549,190                           |       | 48,792,791             |       |
| Current  liabilities                              |       | 3,227,558                            |       | 4,168,314              |       |
| Deferred  revenue                                 |       | 196,963                              |       | 225,648                |       |
| Total  debt and other non-current liabilities (1) |       | 880,085                              |       | 918,072                |       |
| Quick  ratio (2)                                  |       | 12.29                                |       | 10.02                  |       |
| Current  ratio (3)                                |       | 14.42                                |       | 11.71                  |       |
|                                              |       |                                 |       |                   |       |
| ** **                                        | ** ** | **Six Months Ending March 31,** | ** ** |
| ** **                                        | ** ** | **2010**                             | ** ** | **2009**               | ** ** |
| Cash  flow activites:                             |       |                                 |       |                   |       |
| Net  cash provided by operating activites         |       | $                                    | 258,903    |                   | $          | 2,762,095 |   |
| Net  cash (used in) investing activites           |       | (142,529                             | )          | (161,557               | )          |
| Net  cash (used in) financing activites           |       | (27,381                              | )          | (113,480               | )          |

 

----

(1)          Excludes deferred revenue

(2)          Calculated as: (Cash and cash equivalents and Accounts receivable, net) divided byCurrent liabilities

(3)          Calculated as: Current assets divided by Current liabilities

 

Our main source ofliquidity has been from operating cash flows generated in prior years. Werequire cash principally to finance inventory, accounts receivable and payroll.

 

***Operatingactivities***

 

Cash provided byoperating activities was $0.3 million for the six months ended March 31,2010 as compared to cash provided by operating activities of $2.8 million forthe six months ended March 31, 2009. The decrease was primarily due to anet loss of $1.9 million for the six months ended March 31, 2010 versusnet income of $3.2 million in the prior year period.  The cash provided by operating activitiesduring the six months ended March 31, 2010 was primarily due to decreasesin accounts receivable, pre-paid expenses and inventory of $2.2 million, $0.3million and $0.3 million, respectively. This was partially offset by the net loss experienced for the period, adecrease in accrued expenses and a decrease in accounts payable of $1.9million, $0.6 million and $0.3 million, respectively.

 

***Investingactivities***

 

Cash used in investingactivities was $143,000 for the six months ended March 31, 2010 and$162,000 for the six months ended March 31, 2009, which primarilyconsisted of the purchase of production and laboratory test equipment.

 

***Financingactivities***

 

Net cash used infinancing activities was $27,000 for the six months ended March 31, 2010which consisted of approximately $22,000 for the repurchase of common stock and$5,000 for the repayment of capitalized lease obligations. Net cash used in financingactivities of $113,000 for the six months ended March 31, 2009, whichconsisted of $108,000 for the repurchase of common stock, and a $5,000repayment of capitalized lease obligations.

 

The Company entered into a $4,335,000 loan agreement dated August 1,2000 with the Chester County, Pennsylvania Industrial Development Authority.The purpose of the loan was to fund construction of the Company’s new officeand manufacturing facility. 

 

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The loan was scheduled to mature in 2015 and carried an interest rateset by the remarketing agent that is consistent with 30-day tax-exemptcommercial paper. The Company exercised its option to pay-down the outstandingbalance during August, 2009.

 

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 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 March 31, 2010and September 30, 2009, our backlog was $35.0 million and $34.1 million,respectively. The $0.9 million increase in backlog was the result of $10.9million in new business orders offset by $10.0 million of recognizedrevenue.  Air Data product backlog as of March 31,2010 increased $1.1 million from September 30, 2009; while Flat PanelDisplay Systems backlog, as of March 31, 2010, decreased $0.2 million fromSeptember 30, 2009.  To the extentnew business orders do not continue to equal or exceed recognized revenue fromthe Company’s existing backlog, future operating results may be negativelyimpacted.

 

Backlog activity for thesix months ended March 31, 2010 (in thousands):

 
| **Balance at**         | ** ** | ** **     | ** ** | ** **     | ** ** | **Balance at**     | ** ** |
|------------------------|------------|----------------|------------|----------------|------------|--------------------|------------|
| **September 30,** | ** ** | **Additional** | ** ** | **Recognized** | ** ** | **March 31,** | ** ** |
| **2009**               | ** ** | **Bookings**   | ** ** | **in Revenue** | ** ** | **2010**           | ** ** |
|                   |       |           |       |           |       |               |       |
| $                      | 34,142     |           | $          | 10,876         |       | $                  | 9,980      |   | $ | 35,038 |   |
|                        |            |                |            |                |            |                    |            |  |  |  |  |

 

 

Backlog activity for thethree months ended March 31, 2010 (in thousands):

 
| **Balance at**        | ** **   | ** **     | ** ** | ** **          | ** ** | **Balance at**     | ** ** |
|-----------------------|--------------|----------------|------------|---------------------|------------|--------------------|------------|
| **December 31,** | ** **   | **Additional** | ** ** | **Recognized**      | ** ** | **March 31,** | ** ** |
| **2009**              | ** **   | **Bookings**   | ** ** | **in Revenue** | ** ** | **2010**           | ** ** |
|                  |         |           |       |                |       |               |       |
| $                     |  34,321 |           | $          | 6,090               |       | $                  | 5,373      |   | $ | 35,038 |   |
|                       |              |                |            |                     |            |                    |            |  |  |  |  |

 

**Off-BalanceSheet Arrangements**

 

We do not participate intransactions that generate relationships with unconsolidated entities orfinancial partnerships, such as special purpose entities (“SPEs”) or variableinterest entities (“VIEs”), which would have been established for the purposeof facilitating off-balance sheet arrangements or other limited purposes. As ofMarch 31, 2010 and September 30, 2009, we were not involved with anyunconsolidated SPEs or VIEs.

 

**Item 3.Quantitative and Qualitative Disclosures About Market Risk**

 

The Company’s operationsare exposed to market risks primarily as a result of changes in interest rates.The Company does not use derivative financial instruments for speculative ortrading purposes. The Company’s exposure to market risk for changes in interestrates relates to its cash equivalents. The Company’s cash equivalents consistof funds invested in money market accounts, which bear interest at a variablerate.  As the interest rates arevariable, and we do not engage in hedging activities, a change in interest ratesearned on the cash equivalents would impact interest income and cash flows, butwould not impact the fair market value of the related underlyinginstruments.  Assuming that the balancesduring the three and six months ending March 31, 2010 were to remainconstant and no actions were taken to alter the existing interest ratesensitivity, a hypothetical 1% increase or decrease in our variable interestrates would have affected interest income by approximately $90,000 and$183,000, respectively, with a resulting impact on cash flows of approximately$90,000 and $183,000 for the three and six months ended March 31, 2010,respectively.

 

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**Item 4.Controls and Procedures**

 

(a)          An evaluation was performed under thesupervision and with the participation of the Company’s management, includingits Chief Executive Officer, or CEO, and Chief Financial Officer, or CFO, ofthe effectiveness of the Company’s disclosure controls and procedures, as suchterm is defined under Rule 13a-15e under the Securities Exchange Act of1934, as amended (the “Exchange Act”) as of March 31, 2010. Based on thatevaluation, the Company’s management, including the CEO and CFO, concluded thatthe Company’s disclosure controls and procedures are effective to providereasonable assurance that information required to be disclosed by the Companyin reports that it files or submits under the Exchange Act, is recorded,processed, summarized and reported as specified in Securities and ExchangeCommission rules and forms and that such information is accumulated andcommunicated to the Company’s management, including the CEO and CFO, or personsperforming similar functions, as appropriate to allow timely decisionsregarding required disclosure.

 

(b)         There were no changes in the Company’sinternal control over financial reporting identified in connection with theevaluation of such controls that occurred during the Company’s most recent fiscalquarter that has materially affected, or is reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

 

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**PART II—OTHER INFORMATION**

 

**Item 1.    Legal Proceedings**

 

In the ordinary course ofbusiness, we are at times subject to various legal proceedings and claims. Wedo not believe any such matters that are currently pending will have a materialadverse effect on our results of operations or financial position.

 

On January 17, 2007the Company filed suit in the Court of Common Pleas for Delaware County,Pennsylvania against Strathman Associates, a former software consultant for IS&S,alleging that Strathman had improperly used IS&S trade secret andproprietary information in assisting J2 and Kollsman in developing theJ2/Kollsman Air Data Computer. The case is ongoing.

 

**Item1A.  Risk Factors**

 

There are no materialchanges to the risk factors described under Item 1A of our Form 10-K forthe year ended September 30, 2009.

 

I**tem 2.   UnregisteredSales of Equity Securities and Use of Proceeds**

 

***Stockrepurchase program***

 

On February 23, 2009, the Company’s Board of Directors approved a CommonStock repurchase program to acquire up to 1,000,000 shares of the Company’soutstanding Common Stock. Purchases of the stock were to be made from time totime, subject to market conditions and at prevailing market prices. There wereno shares purchased under this plan during the three months ended March 31,2010. The program was scheduled to expire on February 21, 2010; on February 16,2010 the Company’s Board of Directors approved the extension of this program.

 

On February 16, 2010, the Company’s Board of Directors extendedthe Common Stock repurchase program to acquire up to 1,000,000 shares of theCompany’s outstanding Common Stock. Purchases of the stock were to be made from time to time, subject tomarket conditions and at prevailing market prices.  During the three months ended March 31,2010 the Company purchased 5,200 shares of common stock under the program at acost of $21,661, or an average market price of $4.17 per share.  The Company financed these purchases throughavailable cash.  The following table setsforth the purchases made under this new plan for each month of the three monthsended March 31, 2010:

 
| ** **         | ** ** | ** **         | ** ** | ** **          | ** ** | **Total Number of**     | ** ** | **Number of**             | ** ** |
|--------------------|------------|--------------------|------------|---------------------|------------|-----------------------------------|------------|--------------------------------|------------|
| ** **         | ** ** | **Total**          | ** ** | ** **          | ** ** | **Shares Purchased as** | ** ** | **Shares that May**  | ** ** |
| ** **         | ** ** | **Number of** | ** ** | **Average**         | ** ** | **Part of Publicly**    | ** ** | **Yet Be Purchased** | ** ** |
| ** **         | ** ** | **Shares**         | ** ** | **Price Paid** | ** ** | **Announced Plans or**  | ** ** | **Under the**             | ** ** |
| **Period**         | ** ** | **Purchased**      | ** ** | **per Share**       | ** ** | **Programs**                      | ** ** | **Program**                    | ** ** |
|               |       |               |       |                |       |                              |       |                           |       |
| January 2010  |       | —             |       | —              |       | —                            |       | —                         |       |
|               |       |               |       |                |       |                              |       |                           |       |
| February 2010 |       | 4,100              |       | $                   | 4.16       |                              | 4,100      |                           | 995,900    |   |
|               |       |               |       |                |       |                              |       |                           |       |
| March 2010    |       | 1,100              |       | $                   | 4.20       |                              | 1,100      |                           | 994,800    |   |
|               |       |               |       |                |       |                              |       |                           |       |
|               |       | 5,200              |       |                |       | 5,200                             |       |                           |       |

 

**Item3.  Defaults upon Senior Securities**

 

None

 

**Item 4.**

 

Removed and reserved

 

**Item5.  Other Information**

 

None

 

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**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

 

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*   Filed herewith

 

†   Furnished herewith

 

**SIGNATURE**

 

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: May 05, 2010 |   | By:                                         | /s/ JOHN C. LONG |
|                    |   |                                        | JOHN C. LONG |
|                    |   |                                        | CHIEF FINANCIAL OFFICER |

 

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