**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

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

 

**For thequarterly period ended December 31, 2005**

 

**OR**

 

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

 

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

 

**Commission File No. 0-31157**

 

**INNOVATIVE SOLUTIONS AND SUPPORT, INC.**

(Exact name of registrant as specified in itscharter)

 
| **PENNSYLVANIA**                                           | ** ** | **23-2507402**      |
|------------------------------------------------------------|------------|---------------------|
| (State or other jurisdiction                               |       | (IRS Employer       |
| of incorporation)                                          |       | Identification No.) |
|                                                       |       |                |
| **720 Pennsylvania Drive, Exton, Pennsylvania**            | ** ** | **19341**           |
| (Address of principal executive offices)                   |       | (Zip Code)          |
|                                                       |       |                |
| **(610) 646-9800**                                         |
| (Registrant’s telephone number, including  area code) |

 

Indicateby check mark whether registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

Yesý     Noo

 

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

 

o Large accelerated filer       ýAccelerated filer     o Non-accelerated filer

 

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

 

Yeso            No ý

 

Asof February 2, 2006, there were 18,062,807 shares of the Registrant’sCommon Stock, with par value of $.001 per share, outstanding.

 

 

----

 

**INNOVATIVE SOLUTIONS & SUPPORT, INC.**

### **FORM 10-Q December 31, 2005**

 

**INDEX**

 
|              |                                                                                             | **Page No.** |
|-------------------|--------------------------------------------------------------------------------------------------|-------------------|
|              |                                                                                             |              |
| **PART I.**  | **FINANCIAL INFORMATION**                                                                        | —            |
|              |                                                                                             |              |
| Item 1.           | Financial Statements (Unaudited)                                                                 |              |
|              |                                                                                             |              |
|              | Condensed Consolidated  Balance Sheets – September 30, 2005 and December 31, 2005 | 3                 |
|              |                                                                                             |              |
|              | Condensed Consolidated  Statements of Operations –                                          |              |
|              | Three Months Ended December 31,  2004 and 2005                                              | 4                 |
|              |                                                                                             |              |
|              | Condensed Consolidated Statements  of Cash Flows –                                          |              |
|              | Three Months Ended December 31,  2004 and 2005                                              | 5                 |
|              |                                                                                             |              |
|              | Notes to Condensed Consolidated  Financial Statements                                            | 6 – 9        |
|              |                                                                                             |              |
| Item 1A           | Risk Factors                                                                                     | 9                 |
|              |                                                                                             |              |
| Item 2.           | Managements Discussion and  Analysis of Financial Controls and Results of Operations             | 9 – 14       |
|              |                                                                                             |              |
| Item 3.           | Quantitative and Qualitative  Disclosures about Market Risk                                      | 14                |
|              |                                                                                             |              |
| Item 4.           | Controls and Procedures                                                                          | 14                |
|              |                                                                                             |              |
| **PART II.** | **OTHER INFORMATION**                                                                            |              |
|              |                                                                                             |              |
| Item 1.           | Legal Proceedings                                                                                | 15                |
|              |                                                                                             |              |
| Item 2.           | Unregistered Sales of Equity  Securities and use of Proceeds                                     | 15                |
|              |                                                                                             |              |
| Item 3.           | Defaults upon Senior  Securities                                                                 | 15                |
|              |                                                                                             |              |
| Item 4.           | Submission of Matters to a  Vote of Security Holders                                             | 15                |
|              |                                                                                             |              |
| Item 5.           | Other Information                                                                                | 15                |
|              |                                                                                             |              |
| Item 6.           | Exhibits                                                                                         | 15                |
|              |                                                                                             |              |
| **SIGNATURES**    |                                                                                             |              |

 

2

----

 

**PART I–FINANCIAL INFORMATION**

**Item 1–Financial Statements**

**INNOVATIVE SOLUTIONS AND SUPPORT, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEET**

**(unaudited)**

 
| ** **                                                                                                                                                                                                                          | ** ** | **As of  September 30, 2005** | ** **  | **As of  December 31, 2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------|-------------|-----------------------------------|------------|
| **ASSETS**                                                                                                                                                                                                                          | ** ** | ** **                         | ** **  | ** **                        | ** ** |
| Current Assets:                                                                                                                                                                                                                     |       |                               |        |                              |       |
| Cash and cash equivalents                                                                                                                                                                                                           |       | $                                  | 83,172,582  |                              | $          | 82,631,890 |   |
| Accounts receivable, less allowance for  doubtful accounts of $100,000 at September 30, 2005 and December 31,  2005                                                                                                       |       | 5,479,936                          |        | 5,316,834                         |       |
| Inventories                                                                                                                                                                                                                         |       | 3,911,626                          |        | 3,648,493                         |       |
| Deferred income taxes                                                                                                                                                                                                               |       | 956,070                            |        | 701,102                           |       |
| Prepaid expenses and other current assets                                                                                                                                                                                           |       | 4,028,498                          |        | 4,314,267                         |       |
|                                                                                                                                                                                                                                |       |                               |        |                              |       |
| Total current assets                                                                                                                                                                                                                |       | 97,548,712                         |        | 96,612,586                        |       |
|                                                                                                                                                                                                                                |       |                               |        |                              |       |
| Property and Equipment:                                                                                                                                                                                                             |       |                               |        |                              |       |
| Computers and test equipment                                                                                                                                                                                                        |       | 4,278,748                          |        | 4,369,434                         |       |
| Corporate airplane                                                                                                                                                                                                                  |       | 2,998,161                          |        | 2,998,161                         |       |
| Furniture and office equipment                                                                                                                                                                                                      |       | 734,038                            |        | 734,038                           |       |
| Manufacturing facility                                                                                                                                                                                                              |       | 5,420,741                          |        | 5,420,741                         |       |
| Land                                                                                                                                                                                                                                |       | 1,021,245                          |        | 1,021,245                         |       |
|                                                                                                                                                                                                                                |       | 14,452,933                         |        | 14,543,619                        |       |
| Less- Accumulated depreciation and  amortization                                                                                                                                                                                    |       | (5,091,881                         | )           | (5,281,210                        | )          |
|                                                                                                                                                                                                                                |       |                               |        |                              |       |
| Net property and equipment                                                                                                                                                                                                          |       | 9,361,052                          |        | 9,262,409                         |       |
|                                                                                                                                                                                                                                |       |                               |        |                              |       |
| Deposits and other assets                                                                                                                                                                                                           |       | 125,114                            |        | 518,114                           |       |
|                                                                                                                                                                                                                                |       |                               |        |                              |       |
| Total assets                                                                                                                                                                                                                        |       | $                                  | 107,034,878 |                              | $          | 106,393,109 |   |
|                                                                                                                                                                                                                                |       |                               |        |                              |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                                                                                       |       |                               |        |                              |       |
|                                                                                                                                                                                                                                |       |                               |        |                              |       |
| CURRENT LIABILITIES:                                                                                                                                                                                                                |       |                               |        |                              |       |
| Current portion of notes payable                                                                                                                                                                                                    |       | $                                  | 100,000     |                              | $          | 100,000 |   |
| Current portion of capitalized lease  obligations                                                                                                                                                                                   |       | 7,257                              |        | 7,257                             |       |
| Accounts payable                                                                                                                                                                                                                    |       | 305,516                            |        | 337,265                           |       |
| Accrued expenses                                                                                                                                                                                                                    |       | 3,503,814                          |        | 2,561,927                         |       |
| Deferred revenue                                                                                                                                                                                                                    |       | 176,650                            |        | 209,611                           |       |
|                                                                                                                                                                                                                                |       |                               |        |                              |       |
| Total current liabilities                                                                                                                                                                                                           |       | 4,093,237                          |        | 3,216,060                         |       |
|                                                                                                                                                                                                                                |       |                               |        |                              |       |
| Note payable                                                                                                                                                                                                                        |       | 4,235,000                          |        | 4,235,000                         |       |
| Long-term portion of capitalized lease  obligations                                                                                                                                                                                 |       | 13,113                             |        | 10,537                            |       |
| Deferred revenue                                                                                                                                                                                                                    |       | 191,463                            |        | 173,845                           |       |
| Deferred income taxes                                                                                                                                                                                                               |       | 635,967                            |        | 581,307                           |       |
| Commitments and contingencies                                                                                                                                                                                                       |       | —                             |        | —                            |       |
|                                                                                                                                                                                                                                |       |                               |        |                              |       |
| Shareholders’ Equity:                                                                                                                                                                                                          |       |                               |        |                              |       |
| Preferred stock, 10,000,000 shares  authorized, $.001par value, of which 200,000 shares are authorized as Class A  Convertible stock. No shares issued and outstanding at September 30,  2005 and December 31, 2005. |       | —                             |        | —                            |       |
|                                                                                                                                                                                                                                |       |                               |        |                              |       |
| Common stock, $.001 par value: 75,000,000  shares authorized, 18,047,425 and 18,058,471 shares issued and outstanding at  September 30, 2005 and December 31, 2005                                                        |       | 18,047                             |        | 18,058                            |       |
| Additional paid-in capital                                                                                                                                                                                                          |       | 41,926,318                         |        | 42,230,444                        |       |
| Retained earnings                                                                                                                                                                                                                   |       | 55,921,733                         |        | 55,927,858                        |       |
|                                                                                                                                                                                                                                |       |                               |        |                              |       |
| Total shareholders’ equity                                                                                                                                                                                                     |       | 97,866,098                         |        | 98,176,360                        |       |
|                                                                                                                                                                                                                                |       |                               |        |                              |       |
| Total liabilities and shareholders’ equity                                                                                                                                                                                     |       | $                                  | 107,034,878 |                              | $          | 106,393,109 |   |

 

The accompanying notes are an integral part of these statements.

 

3

----

 

**INNOVATIVE SOLUTIONS AND SUPPORT, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(unaudited)**

 
| ** **                           | ** ** | **Three Months  Ended  December 31,  2004** | ** ** | **Three Months  Ended  December 31,  2005** | ** ** |
|--------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| Net sales                            |       | $                                                | 18,978,804 |                                             | $          | 5,405,387 |   |
| Cost of sales                        |       | 6,182,143                                        |       | 2,702,018                                        |       |
| Gross profit                         |       | 12,796,661                                       |       | 2,703,369                                        |       |
| Operating expenses:                  |       |                                             |       |                                             |       |
| Research and development             |       | 1,271,531                                        |       | 1,535,001                                        |       |
| Selling, general and administrative  |       | 2,028,467                                        |       | 1,896,836                                        |       |
|                                 |       | 3,299,998                                        |       | 3,431,837                                        |       |
| Operating income (loss)              |       | 9,496,663                                        |       | (728,468                                         | )          |
| Interest income                      |       | 283,250                                          |       | 781,445                                          |       |
| Interest expense                     |       | (39,738                                          | )          | (43,512                                          | )          |
| Income before income taxes           |       | 9,740,175                                        |       | 9,465                                            |       |
| Income taxes                         |       | 3,547,372                                        |       | 3,340                                            |       |
| Net income                           |       | $                                                | 6,192,803  |                                             | $          | 6,125 |   |
| Net Income Per Common Share:         |       |                                             |       |                                             |       |
| Basic                                |       | $                                                | 0.35       |                                             | $          | 0.00 |   |
| Diluted                              |       | $                                                | 0.34       |                                             | $          | 0.00 |   |
|                                 |       |                                             |       |                                             |       |
| Weighted Average Shares Outstanding: |       |                                             |       |                                             |       |
| Basic                                |       | 17,752,707                                       |       | 18,055,243                                       |       |
| Diluted                              |       | 18,270,413                                       |       | 18,272,423                                       |       |

 

The accompanying notes are an integral part of these statements.

 

4

----

 

**INNOVATIVE SOLUTIONS AND SUPPORT, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(unaudited)**

 
| ** **                                                                                   | ** ** | **For the Three  Months Ended  December 31,  2004** | ** ** | **For the Three  Months Ended  December 31,  2005** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                        |       |                                                     |       |                                                     |       |
| Net income                                                                                   |       | $                                                        | 6,192,803  |                                                     | $          | 6,125 |   |
| Adjustments to reconcile net income to net  cash provided by (used in) operating activities: |       |                                                     |       |                                                     |       |
| Depreciation and amortization                                                                |       | 182,235                                                  |       | 201,838                                                  |       |
| Stock-based compensation expense                                                             |       | —                                                   |       | 174,009                                                  |       |
| Compensation expense for stock issued to  directors                                          |       | 57,990                                                   |       | 60,048                                                   |       |
| Loss on Disposal of Fixed Assets                                                             |       | —                                                   |       | 156                                                      |       |
| Excess and obsolete inventory expense                                                        |       | (6,017                                                   | )          | 85,129                                                   |       |
| Deferred income taxes                                                                        |       | —                                                   |       | 200,308                                                  |       |
| Tax benefit from exercise of stock options                                                   |       | 116,741                                                  |       | 21,378                                                   |       |
| Excess tax benefits from share-based  payment arrangements                                   |       | —                                                   |       | (8,689                                                   | )          |
| (Increase) decrease in:                                                                      |       |                                                     |       |                                                     |       |
| Accounts receivable                                                                          |       | (193,064                                                 | )          | 163,102                                                  |       |
| Inventories                                                                                  |       | (346,097                                                 | )          | 178,004                                                  |       |
| Prepaid expenses and other current assets                                                    |       | 84,628                                                   |       | (285,769                                                 | )          |
| Increase (decrease) in:                                                                      |       |                                                     |       |                                                     |       |
| Accounts payable                                                                             |       | (348,443                                                 | )          | 31,749                                                   |       |
| Accrued expenses                                                                             |       | 1,705,926                                                |       | (1,088,554                                               | )          |
| Deferred revenue                                                                             |       | (19,909                                                  | )          | 15,343                                                   |       |
| Net cash provided by (used in) operating  activities                                         |       | 7,426,793                                                |       | (245,823                                                 | )          |
|                                                                                         |       |                                                     |       |                                                     |       |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                        |       |                                                     |       |                                                     |       |
| Purchases of property and equipment                                                          |       | (111,122                                                 | )          | (96,351                                                  | )          |
| Purchases of other assets                                                                    |       | —                                                   |       | (253,333                                                 | )          |
| Net cash used in investing activities                                                        |       | (111,122                                                 | )          | (349,684                                                 | )          |
|                                                                                         |       |                                                     |       |                                                     |       |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                        |       |                                                     |       |                                                     |       |
| Proceeds from exercise of stock options                                                      |       | 157,848                                                  |       | 48,702                                                   |       |
| Repayment of capitalized lease obligation                                                    |       | —                                                   |       | (2,576                                                   | )          |
| Excess tax benefits from share-based  payment arrangements                                   |       | —                                                   |       | 8,689                                                    |       |
| Net cash provided by financing activities                                                    |       | 157,848                                                  |       | 54,815                                                   |       |
|                                                                                         |       |                                                     |       |                                                     |       |
| Net increase (decrease) in cash and cash  equivalents                                        |       | $                                                        | 7,473,519  |                                                     | $          | (540,692 | ) |
|                                                                                         |       |                                                     |       |                                                     |       |
| Cash and cash equivalents, beginning of year                                                 |       | $                                                        | 65,867,167 |                                                     | $          | 83,172,582 |   |
|                                                                                         |       |                                                     |       |                                                     |       |
| Cash and cash equivalents, end of period                                                     |       | $                                                        | 73,340,686 |                                                     | $          | 82,631,890 |   |
|                                                                                         |       |                                                     |       |                                                     |       |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW  INFORMATION:                                           |       |                                                     |       |                                                     |       |
| Cash paid for interest                                                                       |       | $                                                        | 19,257     |                                                     | $          | 31,101 |   |
| Cash paid for income taxes                                                                   |       | $                                                        | 998,500    |                                                     | $          | 435,000 |   |

 

The accompanying notes are an integral part of these statements.

 

5

----

 

**Innovative Solutions & Support Inc.**

**Notes to Condensed Consolidated FinancialStatements**

 

**1.Basis of Presentation:**

 

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

 

Thebalance sheet as of December 31, 2005, the statement of operations for thethree months ended December 31, 2004 and 2005 and the statements of cashflows for the three months ended December 31, 2004 and 2005 have beenprepared by the Company without audit. In the opinion of management, alladjustments, consisting of normal and recurring adjustments, necessary topresent fairly the financial position, results of operations and cash flows at December 31,2005 and for all periods presented have been made.

 

Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with accounting principles generally accepted in theUnited States of America have been condensed or omitted. It is suggested thatthese financial statements be read in conjunction with the financial statementsand notes thereto included in the Company’s Form 10K for the year ended September 30,2005 as filed with the Securities and Exchange Commission. The results ofoperations for the three months ended December 31, 2005 are notnecessarily indicative of the operating results for the full year.

 

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

 

**2. Netincome per Share**

 

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

 

Areconciliation of weighted average shares outstanding appears below:

 
| ** **                                | ** ** | **Three Months  Ended  December 31, 2004** | ** ** | **Three Months  Ended  December 31, 2005** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| Weighted average number of shares-basic   |       | 17,752,707                                      |       | 18,055,243                                      |       |
| Effect of dilutive securities:            |       |                                            |       |                                            |       |
| Employee stock options                    |       | 517,706                                         |       | 217,180                                         |       |
|                                      |       |                                            |       |                                            |       |
| Weighted average number of shares-diluted |       | 18,270,413                                      |       | 18,272,423                                      |       |

 

Forthe three-month periods ended December 31, 2005 and 2004, there were 206,000and 12,000 options outstanding that were excluded from the computation ofdiluted earnings per share as the effect would be antidilutive.

 

**3.Concentrations**

 

Forthe three months ended December 31, 2005, three customers accounted for 28%,10% and 9% of net sales or 47% on a combined basis.  For the three months ended December 31,2004, three customers accounted for 16%, 15%, and 12% of net sales or 43% on acombined basis.

 

6

----

 

**4.Inventories**

 

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

 
| ** **      | ** ** | **September 30,  2005** | ** ** | **December 31,  2005** | ** ** |
|-----------------|------------|------------------------------|------------|-----------------------------|------------|
| Raw materials   |       | $                            | 1,696,050  |                        | $          | 1,879,145 |   |
| Work-in-process |       | 1,151,828                    |       | 1,050,878                   |       |
| Finished goods  |       | 1,063,748                    |       | 718,470                     |       |
|            |       | $                            | 3,911,626  |                        | $          | 3,648,493 |   |

 

**5.Warranty**

 

The Company provides for the estimated cost of product warrantiesat the time revenue is recognized. Warranty cost is recorded as cost of salesand the reserve balance recorded as an accrued expense in the financialstatements. While the Company engages in extensive product quality programs andprocesses, the Company’s warranty obligation is affected by product failurerates and the related material, labor and delivery costs incurred in correctinga product failure. Should actual product failure rates, material or labor costsdiffer from the Company’s estimates, further revisions to the estimatedwarranty liability would be required.

Warranty cost and accrual information for the three months endedDecember 31, 2005 is highlighted below:

 
| Warranty accrual at September 30, 2005                  |   | $       | 770,845 |   |
|--------------------------------------------------------------|--------|---------|---------|--------|
| Accrued expense for the quarter ended December 31, 2005 |   | 17,297  |    |
| Warranty costs for the quarter ended December 31. 2005  |   | (47,166 | )       |
|                                                         |   |    |    |
| Warranty accrual at December 31, 2005                   |   | $       | 740,976 |   |

 

**6.Stock Options**

 

TheCompany’s 1998 Stock Option Plan (the “Plan”) provides for the granting ofincentive and nonqualified stock options to employees, officers, directors andindependent contractors and consultants. Through December 31, 2005, nostock options have been granted to independent contractors or consultants underthis plan.

 

Incentivestock options granted under the Plan have exercise prices that must be at leastequal to the fair value of the common stock on the date of grant. Nonqualifiedstock options granted under the Plan have exercise prices that may be lessthan, equal to or greater than the fair value of the common stock on the dateof grant. The Company has reserved 3,389,025 shares of Common Stock for awardsunder the Plan. As of December 31, 2005 there were 1,703,518 remaining andavailable for grant.

 

OnDecember 16, 2004, the FASB finalized SFAS No. 123(R) Share-BasedPayment (SFAS 123(R)). SFAS123(R) amends SFAS 123 and supersedes APB25. SFAS123(R) requires that the cost of share-based payment transactions (includingthose with employees and non-employee directors’) be recognized in thefinancial statements. SFAS 123(R) applies to all share-based paymenttransactions in which an entity acquires goods or services by issuing (oroffering to issue) its shares, share options, or other equity instruments(except for those held by an Employee Stock Option Plan (ESOP)) or by incurringliabilities (1) in amounts based (even in part) on the price of the entity’sshares or other equity instruments, or (2) that require (or may require)settlement by the issuance of an entity’s shares or other equity instruments.This statement was effective as of the first annual reporting period beginningafter June 15, 2005, or the Company’s period ending December 31, 2005.

 

EffectiveOctober 1, 2005 the Company adopted the provisions of SFAS 123(R), usingthe modified prospective approach and now accounts for share-based compensationapplying the fair value method for expensing stock options. Accordingly, theadoption of SFAS 123R’s fair value method resulted in compensation costs forthe Company’s 1998 Stock Option Plan. The compensation cost that has beencharged against income as a result of adoption of SFAS 123R for the plan was$174,009 for the three month period ended December 31, 2005. The totalincome tax benefit recognized in the statement of operations for share-basedcompensation arrangements was $61,425 for the three month period ended December 31,2005.

 

7

----

 

Share-basedcompensation costs prior to October 1, 2005 were recognized using theintrinsic value method in accordance with Accounting Principles Board Opinion (“APB”)No. 25, “Accounting for Stock Issued to Employees.” For disclosurepurposes, pro forma net income and net income per share data were provided inaccordance with SFAS No. 123, “Accounting for Stock-Based Compensation,”as if the fair value method had been applied. Under SFAS No. 123,compensation cost related to stock options granted to employees was computed basedon the fair value of the stock option at the date of grant using theBlack-Scholes option pricing model. Prior to the adoption of SFAS 123(R) hadcompensation costs been determined based on the fair market value of the stockoptions, consistent with the provisions of SFAS 123, the Company’s net incomeand earnings per share for the three months ended December 31, 2004 wouldhave been as follows:

 
| ** **                          | ** ** | **Three Months Ended  December 31, 2004** | ** ** | **Three Months Ended  December 31, 2005** | ** ** |
|-------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|
| Net income as reported              |       | $                                              | 6,192,803  |                                           | $          | 6,125 |   |
|                                |       |                                           |       |                                           |       |
| Add back fair market value expense: |       |                                           |       | 112,584                                        |       |
| Employee stock options (1)          |       |                                           |       |                                           |       |
|                                |       |                                           |       |                                           |       |
| Deduct fair market value expense:   |       |                                           |       |                                           |       |
| Employee stock options (2)          |       | (183,411                                       | )          | (112,584                                       | )          |
|                                |       |                                           |       |                                           |       |
| Pro forma net income                |       | $                                              | 6,009,392  |                                           | $          | 6,125 |   |
|                                |       |                                           |       |                                           |       |
| Basic EPS:                          |       |                                           |       |                                           |       |
| As reported                         |       | $                                              | 0.35       |                                           | $          | 0.00 |   |
| Pro forma                           |       | $                                              | 0.34       |                                           | $          | 0.00 |   |
|                                |       |                                           |       |                                           |       |
| Diluted EPS:                        |       |                                           |       |                                           |       |
| As reported                         |       | $                                              | 0.34       |                                           | $          | 0.00 |   |
| Pro forma                           |       | $                                              | 0.33       |                                           | $          | 0.00 |   |

 

----

(1)     Amount representscompensation expense determined under the fair market value method included inreported net income, net of related tax effect.

 

(2)     Amounts representcompensation expense if it had been determined under the fair market valuebased method, net of related tax effect.

 

Thefair value of each option grant is estimated on the date of grant using theBlack-Scholes option pricing model and the following weighted –averageassumptions:

 
| ** **                               | ** ** | **Three Months  Ended  December 31, 2004** | ** ** | **Three Months  Ended  December 31, 2005** | ** ** |
|------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| Expected lives (years)                   |       | 8.9                                             |       | 9.3                                             |       |
| Weighted average risk-free interest rate |       | 1.6                                             | %          | 1.8                                             | %          |
| Expected volatility                      |       | 66.8                                            | %          | 65.8                                            | %          |
| Expected dividend rate                   |       | —                                          | %          | —                                          | %          |

 

**NewAccounting Pronouncements**

 

InMay 2005, the Financial Accounting Standards Board (FASB) issued Statementof Financial Accounting Standard (SFAS) No. 154, “Accounting Changes andError Corrections – a replacement of APB Opinion No. 20 and FASB StatementNo. 3”.   SFAS No. 154 requiresretrospective application to prior periods’ financial statements of changes inaccounting principle, unless it is impracticable to determine either theperiod-specific effects or the cumulative effect of the change.  SFAS No. 154 also requires thatretrospective application of a change in accounting principle be limited to thedirect effects of the change.  Indirecteffects of a change in accounting

 

8

----

 

principle,such as a change in nondiscretionary profit-sharing payments resulting from anaccounting change, should be recognized in the period of the accountingchange.  SFAS No. 154 also requiresthat a change in depreciation, amortization, or depletion method forlong-lived, non-financial assets be accounted for as a change in accountingestimate effected by a change in accounting principle.  SFAS No. 154 is effective for accountingchanges and corrections of errors made in fiscal years beginning after December 15,2005.  Early adoption is permitted foraccounting changes and corrections of errors made in fiscal years beginningafter the date this Statement is issued. The Company will adopt the provisions of SFAS No. 154 as applicablebeginning in fiscal 2007.

 

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

 

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

 

**Item 1A.  Risk Factors**

 

Thereare no material changes to the risk factors described under Item 1A of our Form 10-Kfor the year ended September 30, 2005.

 

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

 

**Overview**

 

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

 

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

 

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

 

Wecontinue to invest in and seek additional opportunities for our Flat PanelDisplay product line. In October 2005, the FAA awarded the Company asecond Technical Standard Order (TSO) for the flat panel display or COCKPIT/IP®.This TSO establishes our flat panel display system as meeting FAA requirementsthat have been put in place to ensure safe flight on a variety of aircrafttypes and, additionally, it addresses the most stringent Commercial AirTransport market requirements as provided in Title 14 of the Code of FederalRegulation, subpart 25, Commercial Air Transport. The TSO states “It has beennoted that this display system employs an integrity monitoring system thatassures integrity to a catastrophic/Level A design condition with the use ofcommercial graphic processors’.

 

InOctober 2005, the Company in a teaming arrangement with ABX Air, receivedFAA Supplemental Type Certification (STC) of its Flat Panel Display System foruse on B-767 aircraft. The STC provides B-767 operators with a low cost,rapidly implemented retrofit of their cockpit avionics with a modern pilot andcopilot suite of high resolution multi-color LCD flat panel displays. Operatorswill benefit from improved dispatch reliability, logistics savings andadaptability to future requirements. The receipt of the STC positions theCompany to pursue more than 1,700 B-757 and B-767 aircraft with similar needsfor Flat Panel Display System upgrades. The STC also provides a foundation forincorporating the product into other airplanes as well.

 

9

----

 

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

 

Weintend to continue investing in the development of new products and theenhancement of our existing product line. We expense research and developmentcosts related to future product development as they are incurred.

 

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

 

**ThreeMonths Ended December 31, 2005 Compared to the Three Months Ended December 31,2004**

 

*Netsales.* Net sales decreased$13.6 million, or 71.6%, to $5.4 million for the three months ended December 31,2005 from $19.0 million in the three months ended December 31, 2004. This decreasein net sales was mainly due to a decrease in demand for our RVSM system. Salesfor the three months ended December 31, 2004 reflected an industry wideresponse to a Federal Aviation Administration (FAA) mandate that required theinstallation of RVSM equipment on aircraft flying between 29,000 and 41,000 by January 20,2005. The peak demand for the RVSM system declined after this date.

 

*Cost ofsales.* Cost of sales decreased$3.5 million or 56.3%, to $2.7 million, or 50% of net sales in the three monthsended December 31, 2005 from $6.2 million, or 33 % of net sales in thethree months ended December 31, 2004. The absolute dollar decrease in costof sales was related to our decrease in net sales. As a percentage, the increasewas the result of fixed operating costs not being absorbed over lower net salesin the current period.

 

*Researchand development.*Research and development expenses increased $0.3 million or 21% to $1.5 millionor 28% of net sales in the three months ended December 31, 2005 from $1.3million or 7% of net sales in the three months ended December 31, 2004.  The increase in dollar spending reflects oursustained new product development effort. The percent increase was mostly dueto lower sales in the period.

 

*Selling,general, and administrative.* Selling, general, and administrative expenses decreased $0.1 million,or 7.0%, to $1.9 million, or 35% of net sales in the three months ended December 31,2005 from $2.0 million or 11% of net sales in the three months ended December 31,2004. The decrease in the dollar amount was primarily the result of lowercommissions. The increase as a percent of net sales was the result of lower netsales in the period.

 

*Interestincome.* Interestincome was $781,000 in the three months ended December 31, 2005 ascompared to interest income of $283,000 in the three months ended December 31,2004. The increase in interest income in the three months ended December 31,2005 was primarily the result of higher interest rates in the current periodand an increase in our cash balance over the prior period.

 

*Interestexpense.* Interestexpense was $44,000 in the three months ended December 31, 2005 ascompared to interest expense of $39,000 in the three months ended December 31,2004. The increase in interest expense in the three months ended December 31,2005 was primarily the result of higher interest rates in the period.

 

*Incometax expense.* Incometax expense for the three months ended December 31, 2005 was $3,000. Theincome tax expense for the three months ending December 31, 2004 was $3.5million. The decrease in tax expense was primarily due to lower income in theperiod. The effective tax rate in the December 31, 2005 quarter was 35.3%.In the December 31, 2004 quarter the effective tax rate was 36.4%. In eachquarter, the effective tax rate differs from the statutory rate due to theutilization of research and development tax credits.

 

*Netincome.* As a resultof the factors described above, our net income in the three months ended December 31,2005 decreased $6.2 million, or approximately 100%, to $6,125 or 0.1% of netsales, from $6.2 million or 33% of net sales in the three months ended December 31,2004.

 

**Liquidityand Capital Resources**

 

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

 

10

----

 

Ourcash flow from operating activities was a negative $246,000 for the three monthsended December 31, 2005 as compared to a positive $7.4 million for the threemonths ended December 31, 2004. The decrease was due primarily to lowernet income ($6.2 million) and reduced accrued expenses ($2.8 million) whichwere partially offset by reduced inventories ($0.5 million) and an increase inaccounts payable ($0.4 million).

 

Ourcash used in investing activities was $350,000 for the three months ended December 31,2005. This primarily consisted of spending for product certification, productionequipment and laboratory test equipment. Cash used in investing activities was$111,000 for the three months ended December 31, 2004 and primarilyconsisted of production equipment, laboratory test equipment, computerequipment and office furniture.

 

Netcash flow from financing activities was $55,000, for the three months ended December 31,2005 as compared to $158,000 in the three months ended December 31, 2004.In both periods the primary source of cash was from proceeds from the exerciseof stock options.

 

Ourfuture capital requirements depend on numerous factors, including marketacceptance of our products, the timing and rate of expansion of our business,acquisitions, joint ventures and other factors. We have experienced increasesin our expenditures since our inception consistent with growth in ouroperations, personnel and product line, and we anticipate that our expenditureswill continue to increase in the foreseeable future. We believe that our cashand cash equivalents will provide sufficient capital to fund our operations forat least the next twelve months. However, we may need to raise additional fundsthrough public or private financings or other arrangements in order to supportmore rapid expansion of our business than we now anticipate either throughacquisitions or organic growth. Further, we may need to develop and introducenew or enhanced products, respond to competitive pressures, invest in oracquire businesses or technologies or respond to unanticipated requirements ordevelopments. If additional funds are raised through the issuance of equitysecurities, dilution to existing shareholders may result. If insufficient fundsare available, we may not be able to introduce new products or competeeffectively in any of our markets, which could hurt our business.

 

**Backlog**

 

As of December 31, 2005 and 2004, our backlogwas $18.2 million and $36.2 million, respectively. The period over perioddecline in backlog principally reflects the passing of peak demand for RVSMrelated Air data products.

 

Sequentially,our 1st quarter backlog grew by $5.3 million or 41% when compared tothe prior quarter ( the 4th quarter of fiscal 2005). The flat panelsystem component of backlog was $5.9 million in the 4th quarter offiscal 2005 and increased to $12.1 million in the 1st quarter offiscal 2006, representing an increase of $6.2 million or 105%.

 

**CriticalAccounting Policies**

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities, disclosure of contingent assets and liabilities at the date of thefinancial statements and the reported amount of revenues and expenses during thereporting period. The Company’s most critical accounting policies are revenuerecognition, income taxes, allowance for doubtful accounts, inventory valuation,share-based compensation and warranty reserves.

 

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

 

Salesrelated to certain long-term contracts requiring development and delivery ofproducts over several years are accounted for under the American Institute ofCertified Public Accountants (AICPA) Statement of Position (SOP) 81-1, *Accounting for Performance of Construction-Type and CertainProduction-Type Contracts.*We consider the nature of these contractsas well as the types of products and services provided when determining theappropriate accounting treatment for a particular contract. Certain long-termcontracts are recorded on a percentage of completion basis using cost-to-costmethodology to measure progress towards completion.

 

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

 

TheCompany enters into certain sales arrangements that include multipledeliverables as defined in Emerging Issues Task Force (EITF) Issue No. 00-21,*Accounting for Revenue Arrangements with MultipleDeliverables*. Effective July 1, 2003, the Company identifiesall goods and/or services that are to be delivered separately under a salesarrangement and allocates revenue to each deliverable based on fair value thatis established with the customer during contract negotiations. In general,revenues are separated

 

11

----

 

betweenproduct sales and non-recurring engineering services. The allocated revenue foreach deliverable is then recognized using appropriate revenue recognitionmethods. Effective for transactions entered into after October 1, 2003,the Company accounts for transactions with software and non-software componentsunder EITF Issue 03-5, “Applicability of AICPA Statement of Position 97-2,Software Revenue Recognition, to Non-Software Deliverables in an ArrangementContaining More-Than-Incidental Software.”

 

Incometaxes are recorded in accordance with SFAS No. 109, Accounting for IncomeTaxes. Provisions for federal and state income taxes are calculated on reportedfinancial statement pre-tax income based on current tax law. The Companyrecognizes deferred tax assets and liabilities for temporary differencesbetween the financial reporting basis and the tax basis of the Company’s assetsand liabilities and expected benefits of utilizing net operating losscarryforwards. The impact on deferred taxes of changes in tax rates and laws,if any, applied to the years during which temporary differences are expected tobe settled, are reflected in the consolidated financial statements in theperiod of enactment.

 

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

 

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

 

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

 

EffectiveOctober 1, 2005 the Company adopted the provisions of SFAS 123R, using themodified prospective approach and now accounts for share-based compensationapplying the fair value method for expensing stock options. Accordingly, theadoption of SFAS 123R’s fair value method results in compensation costs for theCompany’s 1998 Stock Option Plan.

 

**BusinessSegments**

 

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

 

**NewAccounting Pronouncements**

 

InMay 2005, the Financial Accounting Standards Board (FASB) issued Statementof Financial Accounting Standard (SFAS) No. 154, “Accounting Changes andError Corrections – a replacement of APB Opinion No. 20 and FASB StatementNo. 3”.   SFAS No. 154 requiresretrospective application to prior periods’ financial statements of changes inaccounting principle, unless it is impracticable to determine either theperiod-specific effects or the cumulative effect of the change.  SFAS No. 154 also requires thatretrospective application of a change in accounting principle be limited to thedirect effects of the change.  Indirecteffects of a change in accounting principle, such as a change in nondiscretionaryprofit-sharing payments resulting from an accounting change, should berecognized in the period of the accounting change.  SFAS No. 154 also requires that a changein depreciation, amortization, or depletion method for long-lived,non-financial assets be accounted for as a change in accounting estimateeffected by a change in accounting principle. SFAS No. 154 is effective for accounting changes and corrections oferrors made in fiscal years beginning after December 15, 2005.  Early adoption is permitted for accountingchanges and corrections of errors made in fiscal years beginning after the datethis Statement is issued.  The Companywill adopt the provisions of SFAS No. 154 as applicable beginning infiscal 2007.

 

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

 

12

----

 

financialposition or results of operations.

 

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

 

**FORWARD-LOOKING STATEMENTS**

 

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

 

•                  continued market acceptance of our air datasystems products;

 

•                  the ability to obtain future contracts and awards;

 

•                  the availability of government funding andcustomer requirements;

 

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

 

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

 

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

 

•                  delays in receiving components from thirdparty suppliers;

 

•                  the competitive environment;

 

•                  the termination of programs or contracts forconvenience by customers;

 

•                  failure to retain key personnel;

 

•                  new product offerings from competitors;

 

•                  potential future acquisitions;

 

•                  protection of intellectual property rights;

 

•                  our ability to service the internationalmarket, and

 

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

 

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

 

Fora discussion identifying some important factors that could cause actual resultsto vary materially from those anticipated in the forwardlooking statements, seethe Company’s Securities and Exchange Commission filings including, but notlimited to, the

 

13

----

 

discussionsof “Risk Factors” contained in the Company’s Annual Report on Form 10-Kfor the fiscal year ended September 30, 2005.

 

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

 

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

 

**Item 4.Controls and Procedures**

 

(a)          Anevaluation was performed under the supervision and with the participation ofthe Company’s management, including its Chief Executive Officer, or CEO, andChief Financial Officer, or CFO, of the effectiveness of the Company’sdisclosure controls and procedures, as such term is defined under Rule 13a-15eunder the Securities Exchange Act of 1934, as amended (the “Exchange Act”) asof December 31, 2005. Based on that evaluation, the Company’s management,including the CEO and CFO, concluded that the Company’s disclosure controls andprocedures are effective to provide reasonable assurance that informationrequired to be disclosed by the Company in reports that it files or submitsunder the Exchange Act, is recorded, processed, summarized and reported asspecified in Securities and Exchange Commission rules and forms.

 

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

 

14

----

 

**PART II–OTHER INFORMATION**

 

**Item 1.****          ****Legal Proceedings**

 

Inthe ordinary course of our business, we are at times subject to various legalproceedings. We do not believe that any current legal proceedings will have amaterial adverse effect on our results of operations or financial position.

 

I**tem 2.****          ****Unregistered Sales of EquitySecurities and Use of Proceeds**

 

None

 

**Item 3.****          ****Defaults upon Senior Securities**

 

None

 

**Item 4.****          ****Submission of Matters to a Voteof Security Holders**

 

Nomatters were submitted to a vote of our shareholders during the three monthsended December 31, 2005.

 

**Item 5.****          ****Other Information**

 

None

 

**Item 6. Exhibits**

 
| (a)    | Exhibits |
|--------|----------|
|   |     |   |
|   | 31.1     |   | Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) |
|   |     |   |   |
|   | 31.2     |   | Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) |
|   |     |   |   |
|   | 32.1     |   | Certification Pursuant to U.S.C. Section 1350, as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

15

----

 

**SIGNATURES**

 

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

 

 
|                         | **INNOVATIVE  SOLUTIONS AND SUPPORT, INC.** |
|------------------------------|---------------------------------------------|
|                         |                                        |   |
|                         |                                        |   |
| Date:  February 3, 2006 | By:                                         | /s/  JAMES J. REILLY |   |
|                         |                                        | **James  J. Reilly Chief Financial Officer** |

 

16

----