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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549



FORM 10-K


ý

 

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

For the fiscal year ended September 30, 20082010

OR

o

 

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

For the transition period from                                    to                                     .

Commission File No. 0-31157



INNOVATIVE SOLUTIONS AND SUPPORT, INC.
(Exact name of registrant as specified in its charter)

Pennsylvania
(State or other jurisdiction of incorporation)
 23-2507402
(IRS Employer Identification No.)

720 Pennsylvania Drive, Exton, Pennsylvania
(Address of principal executive offices)

 

19341
(Zip Code)

(610) 646-9800

(Registrant's telephone number, including area code)

          Securities registered pursuant to Section 12(b) of the Act:

Title of each class: Name of each exchange on which registered
Common Stock par value $.001 per share The NASDAQ Stock Market, LLC

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

          Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o    No ý

          Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act Yes o    No ý

          Note: Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or Sectionsection 15(d) of the Exchange Act from their obligations under those sections.

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

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

          Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

          Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer," "non-accelerated filer," and "smaller reporting company," in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o Accelerated filer ý Non-accelerated filer o
(Do not check if a
smaller reporting company)
 Smaller reporting companyReporting Company o

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

          The aggregate market value of the Registrant's common stock held by non-affiliates of the Registrant as of March 31, 20082010 (the last business day of the registrant's most recently completed second quarter) was approximately $136.0$80.1 million. Shares of common stock held by each executive officer and director and by each person who owns 10% or more of our outstanding common stock have been excluded since such persons may be deemed affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

          As of December 5, 2008,04, 2010, there were 16,734,14916,770,415 outstanding shares of the Registrant's Common Stock


Documents Incorporated by Reference

          Portions of the Registrant's Proxy Statement for the 20092011 Annual Meeting of Shareholders to be filed prior to January 28, 20092010 are incorporated by reference into Part III of this Report. Such Proxy Statement, except for the parts therein which have been specifically incorporated by reference, shall not be deemed "filed" for the purposes of this Report on Form 10-K.


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INNOVATIVE SOLUTIONS AND SUPPORT, INC.

20082010 Annual Report on Form 10-K

Table of Contents

 
  
 Page

 

Part I

 

Item 1.

 

Business

 3

Item 1A.

 

Risk Factors

 1213

Item 1B.

 

Unresolved Staff Comments

 1718

Item 2.

 

Properties

 1718

Item 3.

 

Legal Proceedings

 1718

Item 4.

 

Submission of Matters to a Vote of Security HoldersRemoved and Reserved

 18

 

Part II

  

Item 5.

 

Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Repurchases of Equity Securities

 19

Item 6.

 

Selected Financial Data

 2021

Item 7.

 

Management's Discussion and Analysis of Financial Condition and Results of Operations

 22

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

 3032

Item 8.

 

Financial Statements and Supplementary Data

 3032

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 5261

Item 9A.

 

Controls and Procedures

 5261

 

Part III

 

Item 10.

 

Directors, Executive Officers and Corporate Governance

 5565

Item 11.

 

Executive Compensation

 5565

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 5565

Item 13.

 

Certain Relationships and Related Transactions and Director Independence

 5666

Item 14.

 

Principal Accounting Fees and Services

 5666

 

Part IV

 

Item 15.

 

Exhibits, Financial Statement Schedules

 5666

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FORWARD LOOKING STATEMENTS

        This report contains forward looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. We have based these forward looking statements largely on our current expectations and projections about future events and trends affecting our business. In this report, the words "believe," "may," "will," "estimate," "continue," "anticipate," "intend," "forecast," "expect," "plan," "should," "is likely" and similar expressions, as they relate to our business or our management, are intended to identify forward looking statements, but they are not exclusive means of identifying them.

        The forward looking statements in this report are only predictions and actual events or results may differ materially. In evaluating such statements, a number of risks, uncertainties and other factors could cause our actual results, performance, financial condition, cash flows, prospects and opportunities to differ materially from those expressed in, or implied by, the forward-looking statements. These risks, uncertainties and other factors include those set forth in Item 1A (Risk Factors) of this Annual Report on Form 10-K and the following factors:

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

        Investors should also be aware that while we do, from time to time, communicate with securities analysts, it is against our policy to disclose any material non-public information or other confidential commercial information. Accordingly, shareholders should not assume that we agree with any statement or report issued by any analyst irrespective of the content of the statement or report. Furthermore, we have a policy against issuing or confirming financial forecasts or projections issued by others. Thus, to the extent that reports issued by securities analysts contain any projections, forecasts or opinions, such reports arenot the responsibility of Innovative Solutions and Support, Inc.


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PART I

Item 1.    Business

Overview

        Innovative Solutions and Support, Inc. (the "Company," "IS&S" or "We""we") was founded in 1988. The Company designs, manufactures and sells Flat Panel Display Systems, Flight Information Computers and advanced monitoring systems to the Department of Defense (DoD), government agencies, defense contractors, commercial air transport carriers, original equipment manufacturers (OEMs), and the corporate/general aviation markets. The Company is increasingly positioning itself as a system integrator; this capability provides the Company with the potential to generate more substantive orders over a broader product base. The Company has demonstrated thean ability to incorporate added functionality such as electronic flight bags, charting and mapping systems into its Flat Panel Display Systems'System product line. Our strategy as both a manufacturer and integrator is to leverage the latest technologies developed for the personal computer and telecommunications industries into advanced, cost-effective solutions for both the aviation industry and DoD. We believe this approach, combined with our industry experience, enables us to develop high-quality products and systems, substantially reduce product time to market and achieve cost advantages over the products offered by our competitors.

        For several years the Company has been working with advances in technology that have the potential to provide pilots increasing amounts of information that will enhance both the safety and efficiency of flying. These advances have come together in the Company's COCKPIT/IP™ (Cockpit Information Portal or CIP) or Flat Panel Display System product line that incorporates proprietary technology, low cost, reduced power consumption, decreased weight and weight as well as diverseincreased functionality. The Company's Flat Panel Display System product line is suited to address market demand that we believe will be driven by regulatory mandates, new technologies and aging equipment on airplanes that have been in service for up to fifty years. We believe the transition to Flat Panel Display Systems as part of airplane retrofit requirements continues. This shift in regulatory and technological environment is underway.illustrated by the dramatic increase in the number of Wide Area Augmentation System (WAAS) approach qualified airports. Aircraft equipped with our Flat Panel Display System product line will be qualified to land at such airports, which we believe will further increase the demand for our products.

        In fiscal 2010, IS&S announced it received FAA certification for its Class 3 Electronic Charts and XM Satellite Weather upgrade to the AVIO NG integrated cockpit system of the Eclipse Aerospace, Inc. (EAI) EA500 Very Light Jet. IS&S commenced sales to EAI of the upgrade for installation on existing aircraft. IS&S introduced and began sales of increased functionality for its COCKPIT/IP™ Flat Panel Display System for application on the B757/B767 platform. The company also received additional Transport Canada Supplement Type Certificate (STC) certification for the B757 to further address the needs of that market.

        In fiscal 2009, IS&S announced it began delivering a new product to the U.S. military: high resolution, 20 inch diagonal displays. These displays are used in the rear of the aircraft by tactical mission officers. The Company also initiated shipments of the Flat Panel Display System being marketed by Cessna as the "AdViz" cockpit upgrade solution for legacy Citation 500/501, 550/551, S550 and 560 aircraft. "AdViz" provides access to navigational aids such as XM Weather, navigation charts, remote radio tuning, and enhanced video all while improving reliability and reducing weight. IS&S received an amended Supplement Type Certificate (STC) on the PC-12 Flat Panel Display System for the WAAS program with Lateral and Vertical Precision Performance with a fully coupled auto-pilot. The company also received a Supplemental Type Certificate (STC) for RVSM Compliance of its PC-12 Flat Panel Display System in fiscal 2009.

        In fiscal 2008, IS&S announced an addition to its Cockpit/IP™COCKPITt/IPTM Flat Panel Display System product line: the IS&S Vantage COCKPIT/IP™ Flat Panel Display System, an open architecture flat


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panel cockpit display system capable of interfacing with most third party avionics. The Vantage system can be retrofitted into a variety of airframes. The Company launched a Wide Area Augmentation System (WAAS) program with Lateral and Vertical Precision Performance with a fully coupled auto-pilot for its PC-12 COCKPIT/IP™ Flat Panel Display System. WAAS capability allows PC-12 operators to fly precision approaches at smaller airports. This capability is also available on other aircraft platforms as well.platforms. IS&S received amended Supplemental Type Certificates (STC) for the Boeing 757, 757/767 platform from the FAAFederal Aviation Administration (FAA) adding increased functionality to the Cockpit/IPCOCKPIT/IP™ Flat Panel Display System. The Company increased the volume of work it is conducting for Homeland Security's Pilatus PC-12 and Lockheed Martin C-130 fleets.

        Fiscal 2007 saw the COCKPIT/IP™ or Flat Panel Display System product line gain significant recognition and acceptance in the industry with the Federal Aviation Administration (FAA) issuing two additional Flat Panel Display System STC's; one for Boeing 757 aircraft and one for the Pilatus PC-12 with E-Chart Capability. Also in fiscal 2007 we entered into four strategic agreements with four different internationally recognized customers. Early in 2007 the Cessna Aircraft Company entered into an agreement with us to provide Flat Panel Display Systems on legacy Cessna Citation aircraft. Later in the year the Company announced that Eclipse Aviation entered into a five year OEM agreement to provide Flat Panel Display Systems for their Eclipse 500 VLJ (Very Light Jet) aircraft. Under this agreement the Company will be the exclusive provider of Flat Panel Display Systems to Eclipse. Eclipse Aviation filed a voluntary petition for relief under Chapter 11 of the U.S. Bankruptcy Code on November 25, 2008. The Company established inventory and accounts receivable reserves in September 30, 2008 as more fully discussed in Item 7 of this report. In the third quarter American


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Airlines awarded the Company an order to retrofit its entire fleet of Boeing 757 and 767 aircraft with the Company's Flat Panel Display Systems. The Company's fourth major agreement was recorded in September as a premier international cargo carrier entered an agreement with the Company to retrofit their fleet of Boeing 757 aircraft with Flat Panel Display Systems.

        In fiscal 2006 the Flat Panel Display System product line expanded in terms of both FAA certifications and additional customer orders. The FAA awarded the Company two new Technical Standard Orders (TSO) and two new STC's for 15" and 10" Flat Panel Display System installations on Pilatus PC-12 airplanes. The Company also received orders from two Pilatus distributors for 15" installations. Further, Kalitta Air placed an order with the Company for Flat Panel Engine Instrument Display Systems (FP/EIDS) for B-747 retrofit applications. FAA certification relating to this display application is in process. Also, Marshalls of Cambridge, who in fiscal 2005 chose us as their common core avionics upgrade, placed their first order with us in fiscal 2006. Their initial award was for C-130 retrofits.

Our Industry

        A wide range of information, including airspeed and altitude, is critical for proper and safe operation of aircraft. With advances in technology, new types of information to assist pilots, such as satellite based weather and ground terrain maps, are becoming available for display in cockpits. We believe aircraft cockpits will increasingly become information centers, capable of delivering additional information that is either mandated by regulation or demanded by pilots to assist in the safe and efficient operation of aircraft.

        There are three general types of flight data: aircraft heading and altitude information, flight critical aircraft control data aircraftand navigation data. Aircraft heading and altitude data and navigation data. Flight critical aircraft control information such as air data includes aircraft speed, altitude and rates of ascent and descent. Aircraft heading and altitudeFlight critical aircraft control information includes engine data such as fuel and oil quantity and other engine measurements, and navigationmeasurements. Navigation data includes radio position, flight management, Global Positioning System (GPS) and alternative source information,information; which is information not originating on the aircraft, including weather depiction maps, GPS navigation and surface terrain maps. Air data calculations are based primarily on air pressure measurements derived from sensors on the aircraft. Engine data are determined by measuring various indices such as temperature, volume, revolutions per minute (RPM) and pressure within an aircraft's engines and other mechanical equipment. AlternativeGPS and alternative source information is typically derived from satellites or equipment located on land and fed by satellite or radio signals to the aircraft. Pilots can then display this information in the cockpit for reference and enhanced position awareness.

        Traditionally, flight data and other cockpit information were displayed on a series of separate analog dials.instruments. In the early 1980s, digital displays using cathode ray tubesCathode Ray Tubes (CRT) began to replace some individual analog displays.instruments. The industry has now begun to developoffers high resolution color flat panel displayspanels using active matrix liquid crystal displaysActive Matrix Liquid Crystal Displays (AMLCD) to replace traditional analog instruments or digitalCRT displays. We expect that the ability to display more information in a space-efficientspace efficient and customized platform will become increasingly important if additional information, such as weather depiction maps, traffic information and surface terrain maps, become mandated by regulation or demanded by pilots. Accordingly, we believe flat panel displays, which can integrate and display a "suite" of information, will increasingly replace individual displaysinstruments and CRTs as the method for delivering and ordering information displayed in cockpits.

        Equipment data, such as engine and fuel related information, were traditionally displayed on conventional solid-state displays.analog instruments. Engine and fuel displaysinstruments provide information on engine activity, including oil and hydraulic pressures and temperature. This instrumentation includes individual and multiple displaysThese instruments are clustered throughout an aircraft's cockpit. Engine and fuel displaysinstruments tend to be replaced more frequently than other displaysinstruments due to increased obsolescence problems and normal wear-and-tear. As information displayed by this instrumentation is vital for safe and efficient flight,


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aircraft operators continue to purchase individual conventional engine and fuel displaysinstruments to replace older or non-functioning displays.instruments. Increasingly, operators are beginning to replacereplacing their individual instrumentsinstrument clusters with integrated COCKPIT/IP™ Flat Panel Display Systems.


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        As the skies and airports are becoming more crowded, the aviation industry and regulators are concentrating on new technologies, procedures and regulations that allow more aircraft to operate in the skies and on the ground safely, efficiently and with less impact on the environment. These new technologies and procedures, such as traffic avoidance, ground awareness, increased precision of navigation and vertical position, runway incursion prevention and increased digital communication, will require innovation and intuitive methods to display situational awareness information for the pilots. The Company believes that flat panel displays are the best method to handle these and future requirements.

Strategy

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


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        Pursuant to SFAS No. 130, "Reporting Comprehensive Income," the Company would beis required to classify items of other comprehensive income by their nature in a financial statement and display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. Comprehensiveour condensed consolidated balance sheets. For fiscal 2010 and 2009, comprehensive income consists of net income and there were no items of other comprehensive income for any of the periods presented.

        The estimatedCompany adopted FASB ASC Topic 820, "Fair Value Measurements and Disclosures" (ASC Topic 820) in the first quarter of fiscal 2009 for financial assets and liabilities. This standard defines fair value amounts presentedas the price at which an asset could be exchanged in these consolidated financial statements were determineda current transaction between knowledgeable, willing parties. A liability's fair value is defined as the amount that would be paid to transfer the liability to a new obligor, not the amount that would be paid to settle the liability with the creditor.

        Assets and liabilities measured at fair value are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels, defined by ASC Topic 820 and directly related to the Company using available market information and appropriate methodologies. The Company's financial instruments consist primarilyamount of cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities and debt instruments. The carrying valuessubjectivity associated with the inputs to fair valuation of these assets and liabilities, are considered toas follows:


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INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

3. Summary of Significant Accounting Policies: (Continued)

        The following table sets forth by level within the fair values basedvalue hierarchy the Company's financial assets and liabilities that were accounted for at fair value on pertinent information available to managementa recurring basis as of September 30, 20082010 and 2007.2009, according to the valuation techniques the Company used to determine their fair values.

 
 Fair Value Measurement on June 30, 2010 
 
 Quoted Price in
Active Markets for
Identical Assets
 Significant Other
Observable
Inputs
 Significant
Unobservable
Inputs
 
 
 (Level 1) (Level 2) (Level 3) 

Assets

          
 

Cash and cash equivalents:

          
  

Money market funds

 $36,903,024 $ $ 


 
 Fair Value Measurement on September 30, 2009 
 
 Quoted Price in
Active Markets for
Identical Assets
 Significant Other
Observable
Inputs
 Significant
Unobservable
Inputs
 
 
 (Level 1) (Level 2) (Level 3) 

Assets

          
 

Cash and cash equivalents:

          
  

Money market funds

 $34,793,543 $ $ 

        We accountThe Company accounts for stock-based compensation under SFAS No. 123 (revised 2004),FASB ASC Topic 505-50, "Share-Based PaymentEquity-Based Payments to Non-Employees" (SFAS 123(R)). SFAS 123(R)(ASC Topic 505-50) and ASC Topic 718, "Stock Compensation" (ASC Topic 718), which requires usthe Company to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award using an option pricing model. That cost is recognized over the period during which an employee is required to provide service in exchange for the award.

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

        In October 2009, the FASB issued ASU 2009-13, which updates ASC Topic 605-25, of the FASB codification. ASU 2009-13 provides new guidance on how to determine if an arrangement involving multiple deliverables contains more than one unit of accounting, and if so allows companies to allocate


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INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

3. Summary Ofof Significant Accounting Policies: (Continued)

        In December 2007,October 2009, the FASB issued SFASASU 2009-14 which amends ASC Topic 985-605,Software—Revenue Recognition (ASC Topic 985-605) in regard to the scope of software guidance. ASU 2009-14 excludes software components of tangible products that function together to provide the tangible product's essential functionality. While ASU 2009-14 does not create any new methods of revenue recognition, it could significantly affect the Company's recognition of revenue from period to period. In accordance with ASU 2009-14 the Company has chosen to adopt this guidance retrospectively for fiscal 2010 and determined that it had no impact on the Company's financial condition or operating results, as the Company did not previously have arrangements and/or sales that were included within the scope of ASC Topic 985-605. Additionally the Company has assessed any potential impact the new accounting guidance would have had on all prior periods being presented and determined that it would have had no impact on any of the Company's prior financial statements or operating results. The Company is required to adopt, and has adopted the amendment in 2009-14 using the transitional method.

        In January 2010, the FASB issued Accounting Standards Update No. 141R, "Business Combinations" (SFAS 141R)2010-06 (ASU 2010-06),Fair Value Measurements and Disclosures which replaces SFAS No. 141, "Business Combinations." SFAS 141R, among other things, establishes principles andamends ASC Topic 820, adding new requirements for how an acquirer entity recognizesdisclosures for Levels 1 and measures in its financial statements the identifiable assets acquired, the liabilities assumed2, separate disclosures of purchases, sales, issuances, and any controlling interests in the acquired entity; recognizessettlements relating to Level 3 measurements and measures the goodwill acquired in the business combination or a gain from a bargain purchase;clarification of existing fair value disclosures. ASU 2010-06 is effective for interim and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. Costs of the acquisition will be recognized separately from the business combination. SFAS 141R applies prospectively, except for taxes, to business combinations for which the acquisition date is on or after theannual periods beginning of the first annual reporting period on or after December 15, 2008.

        In September 2006,2009 (the Company's fiscal year 2011), except for the FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS 157"). SFAS 157 defines fair value, establishesrequirement to provide Level 3 activity of purchases, sales, issuances, and settlements on a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This statement does not require any new fair value measurements; however, the application of this Statement may change current practice for some entities. SFAS 157 isgross basis, which will be effective for fiscal years beginning after NovemberDecember 15, 2007.2010 (the Company's fiscal year 2012); early adoption is permitted. The Company is currently evaluating the impact of this pronouncement.adopting ASU 2010-06 on its financial statements.

        In April 2010, the FASB issued Accounting Standards Update No. 2010-17 (ASU 2010-17),Revenue Recognition—Milestone Method which amends ASC Topic 605,Revenue Recognition, providing a consistent framework for applying the milestone method, thus adding clarity in practice on its application. The objective of ASU 2010-17 is to provide guidance on defining a milestone and determining when to apply the milestone method of revenue recognition to research and development transactions. ASU 2010-17 is effective for the Company, prospectively, for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010 (the Company's fiscal year 2011); early adoption is permitted. The Company is currently evaluating the impact of adopting ASU 2010-17 on its financial statements.


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INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

4. Net Income (Loss) Per Share:

        Net income (loss) per share is calculated pursuant to SFAS No. 128, "EarningsASC Topic 260Earnings per Share" (SFAS 128)share. Basic earnings per share EPS(EPS) excludes potentially dilutive securities and is computed by dividing net income by the weighted-averageweighted average number of Common shares outstanding for the period. Diluted EPS is computed assuming the conversion or exercise of all dilutive securities such as preferredemployee stock optionsoptions.

        In fiscal 2010 there was a difference of 26,358 shares between basic weighted average shares outstanding and warrants.

diluted weighted average shares outstanding used in the computation of diluted EPS. In fiscal 2009 there was a difference of 15,121 shares between basic weighted average shares outstanding and diluted weighted average shares outstanding used in the computation of diluted EPS. There is no difference between basic weighted average shares outstanding and diluted weighted-averageweighted average shares outstanding used to compute diluted EPS for fiscal years 2008, 2007 and 2006 becausedue to the Company is inexperiencing a net loss position.loss.

        The number of incremental shares from the assumed exercise of stock options is calculated by using the treasury stock method. For the fiscal years endedAs of September 30, 2008, 20072010 and 2006,2009, there were 750,608, 572,959491,200 and 701,854606,549 options to purchase common stock outstanding, respectively, thatrespectively. For fiscal year 2010, 240,770 options to purchase common stock were excluded from the computation of diluted earnings per share, as the effect would be anti-dilutive. For fiscal year 2009, 425,949 options to purchase common stock were excluded from the computation of diluted earnings per share, as the effect would be anti-dilutive.

5. Prepaid Expensesexpenses and Other Current Assets:other current assets:

        Prepaid expenses and other current assets consist of the following:

 
 September 30, 
 
 2008 2007 

Prepaid income taxes

 $ $5,017,794 

Other

  1,406,260  1,191,010 
      

 $1,406,260 $6,208,804 
      

 
 September 30,
2010
 September 30,
2009
 

Revenue recognized not yet invoiced

 $420,429 $491,417 

Prepaid insurance

  298,308  307,477 

Deferred engineering costs

  48,237  81,957 

Income tax refund receivable

  29,066   

Other

  186,728  346,562 
      

 $982,768 $1,227,413 
      

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INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

6. Property and equipment:

        Property and equipment, net consists of the following balances:

 
 September 30,
2010
 September 30,
2009
 

Computer equipment

 $1,968,365 $1,986,028 

Corporate airplane

  3,082,186  3,082,186 

Furniture and office equipment

  1,077,698  1,074,031 

Manufacturing facility

  5,576,466  5,558,553 

Equipment

  4,070,171  4,037,689 

Land

  1,021,245  1,021,245 
      

  16,796,131  16,759,732 
 

Less: Accumulated depreciation and amortization

  (9,034,593) (8,416,031)
      

 $7,761,538 $8,343,701 
      

        Depreciation and amortization related to property and equipment was approximately $0.8 million, $0.9 million and $1.0 million for fiscal 2010, 2009 and 2008, respectively.

7. Other Assets:assets:

        Other assets consist of the following:

 
 September 30, 
 
 2008 2007 

Intangible assets, net of accumulated amortization of $89,950 and $36,000 at September 30, 2008 and 2007

 $289,050 $2,820,500 

Other

  216,790  187,710 
      

 $505,840 $3,008,210 
      

 
 September 30,
2010
 September 30,
2009
 

Intangible assets, net of accumulated amortization of $257,850 and $198,140 at September 30, 2010 and September 30, 2009

 $221,150 $280,860 

Installation kits, deposit forfeiture

    118,660 
      

 $221,150 $399,520 
      

        Intangible assets consist of licensing and certification rights which are amortized over a defined number of units. During theThe Company had non-cash purchases of other assets of $0, $100,000 and $0 in 2010, 2009 and 2008, respectively. No impairment charge was recorded in fiscal year ended September 30, 2008, the2010 or 2009. The Company recorded an asset impairment charge of $2.5 million the full carrying value of previouslyin 2008 related to acquired engineering software whichthat was determined to offer no future cash flow generation and is no longer part of the Company's product offering and will generate no future cash flows. No impairment charge was recorded in fiscal year 2007.offerings.

        Total intangible amortization expense was $68,450approximately $0.1 million, $0.2 million and $14,400$0.1 million for the fiscal years ended September 30,2010, 2009 and 2008, and 2007, respectively. Because the intangible assets are being amortized over a defined number of units, the future amortization expense over the next five years cannot be determined at this time.


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INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

8. Accrued Expenses:expenses:

        Accrued expenses consist of the following:

 
 September 30, 
 
 2008 2007 

Salary, benefits and payroll taxes

 $904,904 $603,565 

Warranty

  736,815  592,524 

Income taxes payable

  798,801  959,227 

Professional fees

  474,730  1,515,630 

Reduction in workforce / Severance

  904,163   

Materials on order

  467,759  137,245 

Other

  843,291  862,641 
      

 $5,130,463 $4,670,832 
      

During the fiscal year ended

 
 September 30,
2010
 September 30,
2009
 

Warranty

 $933,270 $808,544 

Salary, benefits and payroll taxes

  552,646  617,224 

Reduction in workforce / severance(a)

    166,453 

Professional fees

  303,139  188,349 

Income taxes payable

    112,449 

Materials on order

  18,772  108,210 

Other

  777,233  784,331 
      

 $2,585,060 $2,785,560 
      

(a)
The amount included in Reduction in work force/severance as of September 30, 2008,2009 is severance related to the Company incurred $904,163 in severance and other costs associated with the reduction in workforce and the September termination of itsformer Chief Executive Officer.

Officer which is payable under the terms of the Release Agreement dated November 10, 2008.

8.9. Warranty:

        The Company provides for the estimated cost of product warranties at the time revenue is recognized. Warranty cost is recorded as cost of sales and the reserve balance recorded as an accrued expense in the financial statements. While the Company engages in extensive product quality programs and processes, the Company's warranty obligation is affected by product failure rates and the related material, labor and delivery costs incurred in correcting a product failure. Should actual product failure rates, material or labor costs differ from Companythe Company's estimates, further revisions to the estimated warranty liability would be required.


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8. Warranty: (Continued)

        Warranty cost and accrual information for the fiscal years ended September 30, 20082010 and 2007:2009:

 
 2008 2007 

Warranty accrual at October 1,

 $592,524 $617,116 

Accrued expense for the fiscal year ended September 30

  317,968  210,555 

Warranty costs for the fiscal year ended September 30

  (173,677) (235,147)
      

Warranty accrual at September 30

 $736,815 $592,524 
      

 
 2010 2009 

Warranty Accrual as of October 1,

  808,544  736,815 

Accrued expense for fiscal year

  410,551  353,726 

Warranty cost incurred for fiscal year

  (285,825) (281,997)
      

Warranty accrual as of September 30,

  933,270  808,544 
      

9.10. Income Taxes:

        The Company accounts        Income taxes are recorded in accordance with ASC Topic 740 "Income Taxes", which utilizes a balance sheet approach to provide for income taxes under SFAS No. 109, which generally provides thattaxes. Under this method, the Company recognizes deferred tax assets and liabilities be recognized for temporary differences between the financial reporting basis and the tax basis of the Company's assets, and liabilities and expected benefits of utilizing net operating loss (NOL) carry forwards.and tax credit carry-forwards. The impact on deferred taxes of changes in tax rates and laws, if any, applied to the years during which temporary differences are expected to be settled, are reflected in the consolidated financial statements in the period of enactment.


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INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

10. Income Taxes: (Continued)

        ComponentsThe components of income taxes are as follows:

 
 For the Fiscal Year Ended September 30, 
 
 2008 2007 2006 

Current provision (benefit):

          
 

Federal

 $236,170 $(4,463,302)$(1,943,991)
 

State

  (30,708) 3,377   
        

  205,462  (4,459,925) (1,943,991)
        

Deferred provision (benefit):

          
 

Federal

  883,439  (639,263) (158,789)
 

State

  420,238  4,166  (445,820)
        

  1,303,677  (635,097) (604,609)
        

 $1,509,139 $(5,095,022)$(2,548,600)
        

 
 For the Fiscal Year Ended September 30, 
 
 2010 2009 2008 

Current provision (benefit):

          
 

Federal

 $(33,770)$134,560 $236,170 
 

State

  (64,243) (38,362) (30,708)
        

Total current provision (benefit)

  (98,013) 96,198  205,462 
        

Deferred provision (benefit):

          
 

Federal

      883,439 
 

State

  (11,081) 138,658  420,238 
        

Total deferred provision (benefit)

  (11,081) 138,658  1,303,677 
        

Total current and deferred provision (benefit)

 
$

(109,094

)

$

234,856
 
$

1,509,139
 
        

        Following is a reconciliation of the statutory federal rate to the Company's effective income tax rate:

 
 For the Fiscal Year Ended September 30, 
 
 2008 2007 2006 

Federal statutory tax rate

  34.0% 34.0% 35.0%

State income taxes, net of federal benefit

  7.3% 0.0% 5.3%

Research and development tax credits

  1.8% 5.1% 0.5%

Increase in valuation allowance

  (74.5)%    

Additional benefit from federal amended and carryback

  6.3%    

Other

  1.5% (2.6)% 6.1%
        

  (23.6)% 36.5% 46.9%
        

 
 For the Fiscal Year Ended
September 30,
 
 
 2010 2009 2008 

Federal statutory tax rate

  34.0% 34.0% 34.0%

State income taxes, net of federal benefit

  13.8% (0.1)% 7.3%

Research and development tax credits

  (20.7)% (13.1)% 1.8%

Valuation allowance

  (38.7)% (14.1)% (74.5)%

Additional benefit from federal amended and carryback claims

  0.0% 0.0% 6.3%

Other

  (5.5)% (2.2)% 1.5%
        
 

Effective income tax rate

  (17.1)% 4.5% (23.6)%
        

        In October 2008, the Emergency Economic Stabilization Act of 2008 an extension of the Research and Experimentation ("R&E") tax credit was enacted, into law. This retroactive extension is for amounts paid or incurred afterwhich retroactively reinstated and extended the Federal Research & Development (R&D) Tax Credit from January 1, 2008 to December 31, 2007.


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9. Income Taxes: (Continued)


2009. The entire impact of this retroactive extension will bewas recognized in the first quarter of the fiscal year ending September 30, 2009 as required by SFAS 109.ASC Topic 740; accordingly the Company's effective income tax rate for that year reflected the benefit of the R&D credit generated over the period January 1, 2008 through September 30, 2009. Due to the lapse of the federal R&D credit on December 31, 2009, the Company has recorded the impact of the R&D credit for only the first quarter in the fiscal year ended September 30, 2010.


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INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

10. Income Taxes: (Continued)

        The deferred tax effect of temporary differences giving rise to the Company's deferred tax assets and liabilities consists of the components below.

 
 September 30, 
 
 2008 2007 
 
 Current Non Current Current Non Current 

Deferred tax assets:

             
 

Deferred revenue

 $77,920 $ $45,504 $ 
 

Reserves and accruals

  3,172,061  237,460  657,250  198,456 
 

Research and development credit

  184,837     462,267    
 

Software

     596,469     
 

NOL carryforwards—state

    1,050,052    824,573 
 

Stock options

    687,353    362,894 
 

Other

    55,131     
          

  3,434,818  2,626,465  1,165,021  1,385,923 
 

Less: Valuation allowance

  (3,002,107) (2,295,589) (246,325) (293,032)
          

Deferred tax asset

  432,711  330,876  918,696  1,092,891 
          

Deferred tax liabilities:

             
 

Depreciation

    (745,512)   (764,831)
 

Other

  (18,075)   (18,801)  
          

Deferred tax liability

  (18,075) (745,512) (18,801) (764,831)
          

Net deferred tax asset (liability)

 $414,636 $(414,636)$899,895 $328,060 
          

 
 As of September 30, 
 
 2010 2009 
 
 Current Non Current Current Non Current 

Deferred tax assets:

             
 

Deferred revenue

 $18,180 $3,031 $19,265 $21,981 
 

Reserves and accruals

  1,609,142  256,645  1,740,317  277,324 
 

Research and development credit

  655,214  208,384  582,329  142,027 
 

Software

      298,297   
 

NOL carryforwards—state

    1,189,643    1,146,081 
 

Stock options

    628,640    865,445 
 

Other

    11,437    40,138 
          

  2,282,536  2,297,780  2,640,208  2,492,996 
 

Less: Valuation allowance

  (1,760,184) (2,291,087) (2,136,215) (2,425,047)
          

Total deferred tax assets

  522,352  6,693  503,993  67,949 
          

Deferred tax liabilities:

             
 

Depreciation

    (656,622)   (710,600)
          

Total deferred tax liabilities

    (656,622)   (710,600)
          

Net deferred tax asset (liability)

 
$

522,352
 
$

(649,929

)

$

503,993
 
$

(642,651

)
          

        During the fiscal year ended September 30, 20072010, the Company generated a federal net operating loss (NOL) of approximately $14.2 million.$155,000. The Company plans to carry back this NOL was carried-back to a previous tax years and the Company receivedyear, such that a refund receivable of previously paid federal income tax of approximately $5.1 million during the quarter ended March 31, 2008.$29,000 has been recorded. As of September 30, 2008,2010, the Company hadhas state net operating losses of $17.8$20.2 million, which begin to expire in varying amounts beginning inafter fiscal year ending September 30, 2026. In addition, the Company has federal research and development tax credit carryforwards of approximately $214,049,$655,000, which begin to expire in varying amounts beginning 2027.after fiscal year ending September 30, 2028, and state research and development tax credit carryforwards of $208,000 (net of federal impact), which begin to expire in varying amounts after fiscal year ending September 30, 2023.

        The Company's financial statements contain certain deferred tax assets which have arisen primarily as a result of tax benefits associated with the loss before income tax incurred during the twelve months ended September 30, 2008, as well asCompany evaluates deferred income taxes on a quarterly basis to determine if valuation allowances are required by considering available evidence, including historical and projected taxable income and tax assets resulting from temporary differences in prior tax years. SFAS 109planning strategies that are both prudent and feasible. ASC Topic 740 requires the consideration of a valuation allowance to reflect the likelihood of realization of deferred tax assets. Significant management judgment is required in determining any valuation allowance recorded against net deferred tax assets. The Company considered all available positive and negative evidence, including significant operating losses incurred in 2006 and 2007, continued operating losses in 2008, uncertainty as to the extent and timing of profitability in future periods, and ongoing tax planning strategies. Based on the weight of available evidence at that time, the Company recorded a full valuation allowance against net deferred tax assets during the quarter ended March 31, 2008. ThereAs of September 30, 2010, the Company considered all available positive and negative evidence, including the cumulative operating loss related to the fiscal years ended September 30, 2008, 2009, and 2010, and the uncertainty as to the extent and timing of profitability in future periods.


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INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

10. Income Taxes: (Continued)

As a result of this analysis, there were no significant changes in management's judgment during the quarteryear ended September 30, 20082010, and the Company continues to carry a full valuation allowance against its net deferred tax assets.


Table The valuation allowance decreased by $510,000 and $736,000 for the year ended September 30, 2010 and 2009, respectively, due primarily to net reversals of Contents

9. Income Taxes: (Continued)deductible temporary differences.

        If realization of deferred tax assets in the future is considered more likely than not, a reduction to the valuation allowance related to deferred tax assets would increase net income in the period such determination is made. The amount of deferred tax assets considered realizable is based on significant estimates, and it is possible that changes in these estimates could materially affect the financial condition and results of operations. The Company's effective tax rate may vary from period to period based on changes in estimated taxable income or loss; changes to the valuation allowance; changes to federal or state tax laws; and as a result of acquisitions.acquisitions and changes in UTP's, if any.

        The        In accordance with ASC Topic 740, the Company adopted the provisions of FASB Interpretation 48,"Accountingrelated to accounting for Uncertainty in Income Taxes" (FIN 48),uncertain income tax positions on October 1, 2007. Previously,The $587,000 cumulative effect of adoption was recorded as an increase to retained earnings in the first quarter of the fiscal year ended September 30, 2008.

        Following is a reconciliation of beginning and ending balances of total amounts of gross unrecognized tax benefits:

 
 For the Fiscal Year Ended
September 30,
 
 
 2010 2009 2008 

Balance at beginning of year

 $474,000 $324,000 $435,000 

Unrecognized tax benefits related to prior years

      (125,000)

Unrecognized tax benefits related to current year

  34,000  191,000  72,000 

Settlements

       

Decrease in unrecognized tax benefits due to the lapse of applicable statute of limitations

  (83,000) (41,000) (58,000)
        

Balance at end of year

 $425,000 $474,000 $324,000 
        

        The total liabilities associated with the unrecognized tax benefits that, if recognized, would impact the Company's effective tax rate were $425,000, $474,000 and $324,000 at September 30, 2010, 2009 and 2008, respectively. It is not anticipated that unrecognized tax benefits taken regarding previously filed returns will change significantly over the next twelve months.

        The Company's policy is to recognize interest accrued and, if applicable, penalties related to unrecognized tax benefits in income tax expense for all periods presented. The Company accountedhas accrued approximately $8,000 and $19,000 for the payment of interest, net of tax contingencies in accordance with SFAS No. 5,"Accountingbenefits, at September 30, 2010 and 2009, respectively. There is no accrual recorded for Contingencies". Atpenalties.

        For the adoption date of October 1, 2007, the Company applied FIN 48 to all tax positions for which the statute of limitations remained open. As a result of implementation of FIN 48,fiscal year ended September 30, 2010, 2009 and 2008, the Company recognized a decreasebenefit of approximately $587,000 in the liability for unrecognized$10,000, $2,000 and $6,000, respectively, of interest (net of federal impact) within income tax benefits, which was accounted for as an increase to the October 1, 2007 balance of retained earnings.

        The amount of unrecognized tax benefits as of October 1, 2007 was approximately $435,000, all of which, if ultimately recognized, would reduce the Company's annual effective tax rate.expense.

        The Company is subject to income taxes in the U.S. federal and various state jurisdictions. Tax regulations within each jurisdiction are subject to the interpretation of related tax laws and regulations


Table of Contents


INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

10. Income Taxes: (Continued)


and require significant judgment to apply. During the fiscal year ended September 30, 2008, the Internal Revenue Service concluded an examination for tax years through September 30, 2006. The Company also files income tax returns in various state jurisdictions, as appropriate, with varying statutes of limitation. There are no state income tax examinations in process at this time.

        The Company's policy is to recognize interest accrued and, if applicable, penalties related to unrecognized tax benefits in income tax expense for all periods presented. The Company has accrued approximately $21,000 for the payment of interest, net of tax benefits, at September 30, 2008 ($27,000 at October 1, 2007). There is no accrual recorded for penalties.

        For the fiscal year ended September 30, 2008, the Company recognized a benefit of $6,000 of interest (net of federal impact) within income tax expense.

        Following is a reconciliation of beginning and ending balances of total amounts of gross unrecognized tax benefits:

Balance at October 1, 2007

 $435,000 

Unrecognized tax benefits related to prior years

  (125,000)

Unrecognized tax benefits related to the current year

  72,000 

Settlements

   

Decrease in unrecognized tax benefits due to the lapse of applicable statute of limitations

  (58,000)
    

Balance at September 30, 2008

 $324,000 
    

        It is not anticipated that unrecognized tax benefits taken regarding previously filed returns will change significantly over the next twelve months.

10.11. Notes Payable:

        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 new office and manufacturing facility. The loan matureswas scheduled to mature in 2015 and


Table of Contents

10. Notes Payable: (Continued)


carries carried an interest rate set by the remarketing agent that iswas consistent with 30-day tax-exempt commercial paper. The loan agreement includes an optional redemption schedule allowing the Company the option of forgoing any principal pay-down until such time the bonds expire in 2015. The Company has exercised its option not to pay-down the outstanding balance and accordingly, the balance of the notes payable will be due in 2015.

        The loan agreement previously required the Company to maintain certain financial covenants including a ratio of liabilities to earnings before interest, taxes and depreciation and amortization (EBITDA), fixed charge ratio and a minimum tangible net worth. As of June 30, 2006, the Company was in violation of certain of these financial covenants. The defaults were subsequently waived and an amendment to the agreement was entered into with the lender whereby the defaulted covenants were modified. Effective November 30, 2007 prior loan agreement covenants were changed to only require the Company to maintain at all times unencumbered cash and marketable securities having a market value of at least $20.0 million and a minimum Tangible Net Worth of $65.0 million. The lender, however, agreed on January 10, 2008 to discontinue the Tangible Net Worth covenant so that the only remaining requirement is that the Company maintain at all times unencumbered cash and marketable securities having a value of at least $20.0 million.during August, 2009.

        The interest cost related to this debt for fiscal years 2010, 2009 and 2008 was $0, $45,000 and 2007 was $117,000, and $164,000 respectively. The interest rate on this debtCompany was 3.98% at September 30, 2008. The Company is also required to maintain a letter of credit in the amount of $5,000,000 covering the debt.debt, prior to the August, 2009 retirement.

11.12. Savings Plan:

        The Company sponsors a voluntary defined contribution savings plan covering all employees. The Company made contributions of $172,000, $0$175,000, $195,000, and $0$172,000 for the fiscal years ended September 30, 2008, 20072010, 2009 and 2006,2008, respectively.

12.13. Share-Based Compensation:

        Effective October 1, 2005 theThe Company adoptedaccounts for share-based compensation under the provisions of Statement of Financial Accounting Standards (SFAS) 123RASC Topic 505-50 and ASC Topic 718, using the modified prospective approach and now accounts for share-based compensation applying the fair value method for expensing stock options and non-vested stock awards.

        Total share-based compensation expense was $1,138,000, $726,000$371,000, $691,000 and $895,000$1,138,000 for the fiscal years ended September 30, 2008, 2007,2010, 2009, and 2006,2008, respectively. The total income tax (expense) benefitimpact is recognized as a (charge) credit to additional paid-in capital in the statement of operations forshareholders' equity related to share-based compensation arrangements was ($11,000)2,000), $265,000$2,000 and $420,000($11,000) for the fiscal years ended September 30, 2008, 2007,2010, 2009, and 2006,2008, respectively. Compensation expense related to share-based awards is recorded as a component of general and administrative expense.

        The Company maintains the 1998 Stock Option Plan (the "Plan""1998 Plan") and, the 2003 Restricted Stock Plan (the "Restricted Plan") and the 2009 Stock-Based Incentive Compensation Plan (the "2009 Plan"). These plans were approved by the Company's shareholders. The 1998 Plan expired on November 13, 2008.

1998 Stock OptionsOption Plan

        The 1998 Plan allowsallowed granting of incentive and nonqualified stock options to employees, officers, directors and independent contractors and consultants. Through September 30, 2008 noNo stock options have beenwere granted to independent contractors or consultants under this Plan.plan. Total compensation expense associated with awards under the 1998 Plan was $938,000, $506,000,$159,000, $492,000, and $655,000$938,000 for fiscal years ended September 30, 2010, 2009, and 2008 2007, and 2006 respectively. Incentive stock options granted under the Plan have exercise prices that must be at


Table of Contents

12.
INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

13. Share-Based Compensation: (Continued)


        Incentive stock options granted under the 1998 Plan have exercise prices that are at least equal to the fair value of the common stock on grant date. Nonqualified stock options granted under the Planplan have exercise prices that may beare less than, equal to or greater than the fair value of the common stock on the date of grant. The Company has reserved 3,389,000 shares of Common Stock for awards under the plan. At September 30, 2008 there were 1,502,173 shares remaining and available for grant under the Plan, however the Plan expired onOn November 13, 2008, the plan expired and no additional shares may bewere granted under the Plan after that date.

        Following is a summary of option activity under the Planplan for fiscal years ended September 30, 2008, 2007,2010, 2009, and 20062008 and changes during the periods then ended:

 
 Options Weighted Average
Exercise Price
 Aggregate
Intrinsic Value
 

Outstanding at September 30, 2005

  594,253 $8.76    
 

Granted

  204,000  14.36    
 

Exercised

  (25,300) 7.48    
 

Cancelled

  (71,099) 13.70    
         

Outstanding at September 30, 2006

  701,854 $8.76    
 

Granted

  49,000  24.42    
 

Exercised

  (57,995) 8.50    
 

Cancelled

  (119,900) 14.79    
         

Outstanding at September 30, 2007

  572,959 $10.30    
 

Granted

  409,000  10.16    
 

Exercised

  (4,497) 7.31    
 

Cancelled

  (226,854) 11.88    
        

Outstanding at September 30, 2008

  750,608 $9.76 $250,455 
        

Vested and expected to vest

  735,848 $8.04 $250,455 
        

Options exercisable at September 30, 2008

  455,408 $8.04 $250,289 
        

 
 Options Weighted
Average
Exercise
Price
 Aggregate
Intrinsic
Value
 

Outstanding at September 30, 2007

  572,959 $10.30    
 

Granted

  409,000  10.16    
 

Exercised

  (4,497) 7.31    
 

Cancelled

  (226,854) 11.88    
         

Outstanding at September 30, 2008

  750,608 $9.76    
 

Granted

        
 

Exercised

        
 

Cancelled

  (144,059) 11.09    
         

Outstanding at September 30, 2009

  606,549  9.45    
 

Granted

         
 

Exercised

         
 

Cancelled

  (115,349) 10.49    
         

Outstanding at September 30, 2010

  491,200 $9.21 $123,599 
        

Vested and expected to vest

  488,800 $8.33 $123,599 
        

Options exercisable at September 30, 2010

  443,200 $8.78 $123,599 
        

        In fiscal 2010 and 2009 there were no options granted or exercised under the 1998 Plan, therefore there is no weighted-average grant date fair value of individual options granted and no intrinsic value of exercised options. The weighted-average grant date fair value of individual options granted during the fiscal yearsyear ended September 30, 2008 2007 and 2006 was $5.05, $14.38 and $7.53, respectively. Thethe total intrinsic value of options exercised during the fiscal years ended September 30, 2008, 2007 and 2006 were $33,000, $620,000 and $187,000, respectively.was $33,000.

        Following table summarizes information about stock options under the Plan at September 30, 2008:

Options Outstanding Options Exercisable 
Range of Exercise Prices
 Outstanding
As of
September 30,
2008
 Weighted-
Average
Remaining
Contractual
Life
 Weighted-
Average
Exercise
Price
 As of
September 30,
2008
 Weighted-
Average
Exercise
Price
 

$— -$5.00

  201,909  3.3 $4.22  201,909 $4.22 

$5.01-$10.00

  209,099  5.6 $7.82  121,599 $7.69 

$10.01-$15.00

  251,200  8.0 $11.70  88,000 $11.73 

$15.01-$20.00

  40,600  6.1 $16.84  30,500 $16.84 

$20.01-$26.97

  47,800  6.1 $25.53  13,400 $24.52 
            

  750,608  6.3 $9.76  455,408 $8.04 
            

Table of Contents

12.
INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

13. Share-Based Compensation: (Continued)

        The following table summarizes information about stock options under the 1998 Plan at September 30, 2010:

Options Outstanding Options Exercisable 
Range of Exercise Prices
 Outstanding
As of
September 30,
2010
 Weighted-
Average
Remaining
Contractual
Life
 Weighted-
Average
Exercise
Price
 As of
September 30,
2010
 Weighted-
Average
Exercise
Price
 

0.00 - 5.00

  181,800  2.7 $4.21  181,800 $4.21 

5.01 - 10.00

  124,900  4.5  7.71  94,900  7.69 

10.01 - 15.00

  133,000  6.2  12.24  127,800  12.18 

15.01 - 20.00

  18,000  4.5  17.17  17,200  17.24 

20.01 - 26.00

  33,500  6.4  25.57  21,500  25.32 
            

  491,200  4.4 $9.21  443,200 $8.78 
            

        Fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model. Options are exercisable over a maximum term of ten years from date of grant and typically vest over periods of five years from the grant date. The expected term of options represents the period of time that options granted are expected to be outstanding and is based on historical experience. Expected volatility is based on historical volatility of the Company's stock. The risk free interest rate is based on U.S. Treasuries with constant maturities in effect at the time of grant. Compensation expense for employee stock options also includes an estimate for forfeitures and is recognized ratably over the vesting term. Below are fair value assumptions used to record compensation expense, related to the 1998 Plan, for the period identified:

 
 Fiscal Year Ended September 30, 
 
 2008 2007 2006 

Expected dividend rate

       

Expected volatility

  61.9% 64.4% 63.7%

Weighted average risk-free interest rate

  2.1% 2.3% 2.4%

Expected lives (years)

  8.00  8.62  8.41 


Fiscal Year Ended
September 30,

201020092008

Expected dividend rate

**

Expected volatility

**61.9%

Weighted average risk-free interest rate

**2.1%

Expected term of expected life (years)

**8.00

*
No options were granted in fiscal 2010 and 2009 from the 1998 plan; therefore the data in the above table is not applicable.

        At September 30, 2008,2010, there was approximately $1.6 million$199,000 of unrecognized compensation cost, net of forfeitures, related to non-vested stock options, which is expected to be recognized over a period of approximately 54 years.


Non-vested StockTable of Contents


INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

13. Share-Based Compensation: (Continued)

Restricted Plan

        The Restricted Plan for non-employee directors was approved by shareholders at the Company's February 26, 2004 Annual Meeting of Shareholders. It calls for an annual award of non-vested stock having a fair market value of $40,000 at close of business on October 1 of the current fiscal year for all eligible non-employee directors. The stock iswas awarded in four quarterly installments during the fiscal year provided the director is still serving on the board on the quarterly issue date. Total expense was $190,000, $200,000 $220,000 and $220,000$200,000 for the fiscal years ended September 30, 2008, 2007,2010, 2009, and 2006,2008, respectively. The last awards were made under this plan in 2010 and there are no further shares to award under this plan. The following table outlines restricted stock awards for fiscal years ended September 30, 2008, 2007,2010, 2009, and 2006:2008:

 
 Non-vested
Stock Awards
 Weighted Average
Share Price
 

Balance at September 30, 2005

  3,588 $16.68 
 

Granted

  15,738  15.25 
 

Issued

  (15,396) 15.58 
 

Cancelled

  (655) 15.25 
      

Balance at September 30, 2006

  3,275 $15.25 
 

Granted

  15,939  14.43 
 

Issued

  (15,056) 14.61 
 

Cancelled

  (693) 14.43 
      

Balance at September 30, 2007

  3,465 $14.43 
 

Granted

  10,525  19.00 
 

Issued

  (11,355) 17.61 
 

Cancelled

     
      

Balance at September 30, 2008

  2,635 $19.00 
      

 
 Non-vested
Stock Awards
 Weighted Average
Share Price
 

Balance at September 30, 2007

  3,465 $14.43 
 

Granted

  10,525  19.00 
 

Issued

  (11,355) 17.61 
 

Cancelled

     
      

Balance at September 30, 2008

  2,635 $19.00 
 

Granted

  36,230  5.52 
 

Issued

  (29,815) 6.71 
 

Cancelled

     
      

Balance at September 30, 2009

  9,050 $5.52 
 

Granted

  41,150  4.86 
 

Issued

  (37,862) 5.02 
 

Cancelled

     
      

Balance at September 30, 2010

  12,338  4.86 
      

2009 Stock-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 may be either "incentive stock options" as defined in section 422 of the Internal Revenue Code (the "Code"), or nonqualified stock options, as determined by 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 corporate transaction or event, the maximum number of shares of Common Stock available for Awards under the 2009 Plan shall be 1,200,000, all of which may be issued pursuant to Awards of incentive stock options. In addition, the Plan provides that no more than 300,000 shares may be awarded to any employee as a performance-based Award under Section 162(m) of the Code. At September 30, 2010 there were 1,150,000 shares of Common Stock available for awards under the plan.


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INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

13. Share-Based Compensation: (Continued)

        If any Award is forfeited, or if any Option terminates, expires or lapses without being exercised, shares of Common Stock subject to such Award will again be available for future grant. Any shares tendered by a participant in payment of the exercise price of an Option or the tax liability with respect to an Award (including, in any case, shares withheld from any such Award) will not be available for future grant under the 2009 Plan. If there is any change in the Company's corporate capitalization, the Committee shall proportionately and equitably adjust the number and kind of shares of Common Stock which may be issued in connection with future Awards, the number and kind of shares of Common Stock covered by Awards then outstanding under the 2009 Plan, the number and kind of shares of Common Stock available under the 2009 Plan, the exercise or grant price of any Award, or if deemed appropriate, make provision for a cash payment with respect to any outstanding Award, provided that no adjustment may be made that would adversely affect the status of any Award that is intended to be a performance-based Award under Section 162(m) of the Code, unless otherwise determined by the Committee. In addition, the Committee may make adjustments in the terms and conditions of any Awards, including any performance goals, in recognition of unusual or nonrecurring events affecting the Company or any subsidiary, or in response to changes in applicable laws, regulations or accounting principles, provided that no adjustment may be made that would adversely affect the status of any Award that is intended to be a performance-based Award under Section 162(m) of the Code, unless otherwise determined by the Committee.

        The following table summarizes information about stock options under the 2009 Plan at September 30, 2010:

Options Outstanding Options Exercisable 
Range of Exercise Prices
 Outstanding
As of
September 30,
2010
 Weighted-
Average
Remaining
Contractual
Life
 Weighted-
Average
Exercise
Price
 As of
September 30,
2010
 Weighted-
Average
Exercise
Price
 

0.00 - 5.00

  50,000  4.1 $4.50   $ 

5.01 - 10.00

           

10.01 - 15.00

           

15.01 - 20.00

           

20.01 - 26.00

           
            

  50,000  4.1 $4.50   $ 
            

        Fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model. Options are exercisable over a maximum term of ten years from date of grant and typically vest over periods of five years from the grant date. The expected term of options represents the period of time that options granted are expected to be outstanding and is based on historical experience. Expected volatility is based on historical volatility of the Company's stock. The risk free interest rate is based on U.S. Treasuries with constant maturities in effect at the time of grant. Compensation expense for employee stock options also includes an estimate for forfeitures and is


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INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

13. Share-Based Compensation: (Continued)


recognized ratably over the vesting term. Below are fair value assumptions used to record compensation expense, related to the 2009 Plan, for the period identified:


Fiscal Year Ended
September 30,

201020092008

Expected dividend rate

**

Expected volatility

70.0%**

Weighted average risk-free interest rate

2.6%**

Expected term of expected life (years)

4.15**

*
No options were granted in fiscal 2009 and 2008 from the 2009 plan; therefore the data in the above table is not applicable.

        Total compensation expense associated with awards under the 2009 Plan was $23,000, $0 and $0 for fiscal years ended September 30, 2010, 2009 and 2008 respectively. At September 30, 2010, there was approximately $101,000 of unrecognized compensation cost, net of forfeitures, related to non-vested stock options, which is expected to be recognized over a period of approximately 4 years.

14. Commitments and Contingencies:

        The Company leases certain equipment under capital leases with terms of five years and an implicit interest rate of 7.2%. The capitalized cost of $57,450 and related accumulatedannual amortization of $22,816$7,178, $10,050 and $8,207$22,816 have been included in property and equipment at September 30, 20082010, 2009 and 20072008 respectively. The balance due on these leases was $47,542$25,500, $36,899 and $57,450$47,542 as of September 30, 20082010, 2009 and 20072008 respectively. Future payments, including interest relating to these leases are $13,788 annually for the next fourtwo years.

        Rent expense under operating leases totaled $196,000, $109,000$25,900, $39,065 and $11,000$196,000 for the years ended September 30, 2008, 20072010, 2009 and 2006,2008, respectively. As of September 30, 2008,2010 the company has no future minimum payments related to allany non-cancelable operating leases is $11,000 in fiscal 2009.2010.

        The Company has product liability insurance of $50,000,000, which management believes is adequate to cover potential liabilities that may arise.

        In the ordinary course of business, we are at times subject to various legal proceedings. Except with respect to the fees incurred in connection with the matters described below, weproceedings and claims. We do not believe any such matters that any of the current legal proceedingsare currently pending will have a material adverse effect on our results of operations or financial position. On September 13, 2005 the Company filed a lawsuit in the United States District Court for the Western District of Tennessee against J2, Inc., a company founded and jointly owned by Joseph Cesar, a former employee of the Company, and James Zachary, a former sales consultant for the Company. The complaint alleged that the J2/Kollsman/Air Data Computer then being marketed by J2 and manufactured by Kollsman, Inc. infringed a patent assigned to IS&S.

        On November 18, 2010, Jeoffrey L. Burtch, the Chapter 7 2007 the Company received a favorable jury verdict in its trade secret misappropriation caseTrustee for AE Liquidation, Inc. (formerly Eclipse Aviation Corporation), filed avoidance actions against Kollsman, Inc. (a subsidiary of Elbit Systems Ltd.), J2 Inc., Joseph Caesar, James Zachary and Zachary Technologies, Inc. in the United States District Court for the Western District of Tennessee. The jury unanimously found that each of the defendants had misappropriated IS&S's air data computer technology. The jury found that IS&S had suffered damageson behalf of just over $4.4 million in lost profits and $1.6 million in defendants' net profits, for a total of over $6 million. The jury also found in favor of IS&S's claims for breach of duty and contract, and unfair competition against J2 Inc., Joseph Caesar, James Zachary and Zachary Technologies, Inc.

        On December 18, 2007, the court entered a temporary injunction aimed at preventing further use of the Company's trade secret and proprietary information. On March 14, 2008, the judge presiding over the case heard the Company's claims for a permanent injunction as well as punitive and exemplary damages and attorneys' fees against Kollsman and the other defendants.

        On July 7, 2008, the court issued several rulings in the case. In the rulings, the court awarded damages, interest and fees in addition to the more than $6 million in compensatory damages awarded by the jury when it rendered its verdict in the case in November 2007. The additional awards bring the damages assessed against Kollsman, Inc. to a total or more than $23 million. The court also entered an order granting the Company's request for permanent injunctive relief.


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13.
INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

14. Commitments and Contingencies: (Continued)


        On August 27, 2008,AE Liquidation, Inc. for the avoidance of seven payments totaling $321,095 as allegedly preferential transfers paid to IS&S during the 90 days preceding the filing of the bankruptcy petition of Eclipse Aviation Corporation on November 25, 2008. The Company believes it has meritorious defenses to these avoidance actions, intends to vigorously defend against them and believes that the likelihood of the avoidance actions prevailing is remote. Accordingly, the Company entered into a Settlement Agreement (the Settlement Agreement) with Kollsman, Inc. On August 29, 2008, the settlement became effective with respecthas not accrued any loss reserve related to all claims filed by the Company and Kollsman against each other in the United States District Court for the Western District of Tennessee and a Consent Order was entered. Under the Settlement Agreement, all claims between the Company and Kollsman have been dismissed with prejudice, a final agreed injunction has been entered and the matter has been fully and finally mutually settled without any admission of guilt by either party. In addition, an agreed settlement payment of $17 million has been made by Kollsman to the Company.

        On October 9, 2008, Zachary and ZTI consented to the entry of judgment against and to a permanent injunction, which resulted in the conclusion of all claims with respect to those parties. On November 17, 2008, the court granted the Company's motion to dismiss its patent infringement claims against Caesar and J2, and dismissed Caesar and J2's counterclaims for noninfringement, invalidity and unenforceability because there was no longer a justifiable claim or controversy with respect to those counterclaims.this claim.

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

        Through September 30, 2008 and 2007 the Company has incurred approximately $13.6 million and $8.0 million, respectively, in legal fees in connection with the two matters discussed above.

14.15. Related-Party Transactions:

        The Company incurred legal fees of $129,000, $146,000$138,000, $105,000 and $357,000$128,000 for the fiscal years ended September 30, 2010, 2009 and 2008, respectively with a law firm which is a shareholder of the Company for the years ended September 30, 2008, 2007 and 2006, respectively.Company. The fees paid and services rendered were comparable with the fees paid and services rendered prior to theother unrelated law firm's investment in the Company.firms.

        For the years ended September 30, 2008, 20072010, 2009 and 2006,2008, respectively, the Company incurred service fees of $67,000, $18,000$25,000, $0, and $25,000$67,000 with a commercial graphics firm controlled by an individual who is married to a shareholder and a daughter of the Company's Chairman and Chief Executive Officer.

15.16. Quarterly Financial Data (unaudited):

        Summarized quarterly results of operations of the Company for the years ended September 30, 20082010 and September 30, 20072009 are presented below:

 
 Year Ended September 30, 2008 
 
 First Quarter Second Quarter Third Quarter Fourth Quarter 

Net sales

 $4,725,647 $6,824,360 $8,751,309 $10,221,995 

Cost of sales

  3,659,059  3,790,661  4,568,303  8,533,834 

Gross profit

  1,066,588  3,033,699  4,183,006  1,688,161 

Operating loss

  (6,599,986) (4,477,323) (4,795,875) (9,230,657)

Net (Loss) Income

  (4,121,941) (7,060,157) (4,288,871) 7,573,721 

Net loss per common share

             
 

Basic

 $(0.24)$(0.42)$(0.25)$0.45 
 

Diluted

 $(0.24)$(0.42)$(0.25)$0.45 

 
 Fiscal Year Ended September 30, 2010 
 
 First Quarter Second Quarter Third Quarter Fourth Quarter 

Net Sales

 $4,607,239 $5,372,957 $7,813,816 $7,463,311 

Cost of sales

  2,836,773  2,942,496  3,010,810  2,729,950 

Gross profit

  1,770,466  2,430,461  4,803,006  4,733,361 

Operating income (loss)

  (1,545,378) (850,570) 1,589,723  1,209,692 

Net income (loss)

  (1,145,173) (745,765) 1,388,032  1,251,282 

Net income (loss) per common share

             
 

Basic

 $(0.07)$(0.04)$0.08 $0.07 
 

Diluted

 $(0.07)$(0.04)$0.08 $0.07 

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15.
INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

16. Quarterly Financial Data (unaudited): (Continued)

 

 
 Year Ended September 30, 2007 
 
 First Quarter Second Quarter Third Quarter Fourth Quarter 

Net sales

 $3,428,648 $3,955,298 $5,844,405 $5,119,777 

Cost of sales

  2,033,945  3,018,028  3,639,235  5,463,217 

Gross profit

  1,394,703  937,270  2,205,170  (343,440)

Operating loss

  (2,988,666) (4,417,238) (3,094,228) (6,326,780)

Net loss

  (1,098,444) (2,359,146) (1,350,857) (4,036,841)

Net loss per common share

             
 

Basic

 $(0.07)$(0.14)$(0.08)$(0.24)
 

Diluted

 $(0.07)$(0.14)$(0.08)$(0.24)

 
 Fiscal Year Ended September 30, 2009 
 
 First Quarter Second Quarter Third Quarter Fourth Quarter 

Net Sales

 $10,575,346 $10,465,726 $7,759,300 $7,933,778 

Cost of sales

  5,255,173  5,217,613  3,621,045  3,802,153 

Gross profit

  5,320,173  5,248,113  4,138,255  4,131,625 

Operating income (loss)

  1,680,365  1,365,346  1,010,287  821,655 

Net income (loss)

  1,823,386  1,347,530  1,252,311  585,434 

Net income (loss) per common share

             
 

Basic

 $0.11 $0.08 $0.07 $0.03 
 

Diluted

 $0.11 $0.08 $0.07 $0.03 

        Quarterly and total year earnings per share are calculated independently based on the weighted average number of shares outstanding during each period.

16.17. Business Segments

        The Company operates in one principal business segment which designs, manufactures and sells flight information computers, flat panel displays and advanced monitoring systems to the DoD, government agencies, commercial air transport carriers and corporate/general aviation markets. The Company currently derives virtually all of its revenues from the sale of this equipment. Almost all of the Company's sales, operating results and identifiable assets are in the United States. Net sales, operating results and identifiable assets outside the U.S. are not material. During fiscal 2008, 20072010, 2009 and 20062008 we derived 77%68%, 53%75%, and 38%,77% respectively, of our total revenues from the sale of Flat Panel Display Systems. During fiscal 2008, 2007,2010, 2009, and 20062008 we derived 23%32%, 47%25%, and 62%23% respectively, of total revenues from the sale of air data systems related products.

        Almost all of the Company's sales, operating results and identifiable assets are in the United States. Net sales, operating results and identifiable assets outside the U.S. are not material. In fiscal year 2008, 20072010, 2009 and 20062008 net sales outside the United States amounted to $1.7$2.8 million, $1.1$4.4 million and $2.8$1.7 million, respectively.

        Our current product line includes flat panel display systems and air data systems and components, During fiscal 2008, 20072010, 2009 and 2006,2008, the Company derived 77%68%, 53%75%, and 38%77%, respectively, of its revenue from sales of flat panel display systems. The remaining revenue for each of the fiscal years was from sales of air data systems and components.


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Item 9.    Changes in and disagreements with accountants on accounting and financial disclosure.

        None

Item 9A.    Controls and procedures

(a)
An evaluation was performed under supervision and with participation of the Company's management, including its Chief Executive Officer, or CEO, and Chief Financial Officer, or CFO, of the effectiveness of the Company's disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act") as of September 30, 2007.2010. Based on that evaluation, the Company's management, including the CEO and CFO, concluded the Company's disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act, is recorded, processed, summarized and reported as specified in Securities and Exchange Commission rules and forms and that such information is accumulated and communicated by the Company's management, including the CEO and CFO, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

(b)
Management's annual report on internal control over financial reporting and the attestation report of our independent registered public accounting firm are set forth below on this Annual Report on Form 10-K.

(c)
There were no changes in the Company's internal control over financial reporting identified in connection with the evaluation of such controls that occurred during the Company's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

Management's Report on Internal Control over financial reporting

        Management of Innovative Solutions & Support, Inc. and its subsidiaries (the Company) is responsible for establishing and maintaining adequate internal control over financial reporting. The Company's internal control over financial reporting is a process designed under the supervision of the Company's principal executive officer and principal financial officer to provide reasonable assurance regarding the reliability of financial reporting and preparation of the Company's financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.

        The Company's internal control over financial reporting includes policies and procedures that (1) pertain to maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of Company assets that could have a material effect on financial statements.

        Due to its inherent limitations, internal control over financial reporting may not prevent or detect misstatements and, even when determined to be effective, can only provide reasonable, not absolute, assurance with respect to financial statement preparation and presentation. Projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate as a result of changes in conditions or deterioration in the degree of compliance.

        As of September 30, 2008, managementManagement assessed the effectiveness of the Company's internal control over financial reporting as of September 30, 2010. This assessment was based on criteria establishedfor effective internal control over


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financial reporting described in Internal"Internal Control—Integrated Framework," issued by the Committee ofon Sponsoring Organizations of the Treadway Commission (COSO).Commission. Based on this assessment, management has determinedbelieves that, the Company'sas of September 30, 2010, internal control over financial reporting aswas effective to provide reasonable assurance regarding the reliability of September 30, 2008 is effective.financial reporting and the preparation of financial statements in accordance with U.S. generally accepted accounting principles.

        Our internal control over financial reporting has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report which is included herein.


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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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

        We have audited the internal control over financial reporting of Innovative Solutions and Support, Inc. and subsidiaries (the "Company") as of September 30, 2008,2010, based on criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.

        We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

        A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

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

        In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2008,2010, based on the criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.


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        We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended September 30, 20082010 of the Company and our report dated December 9, 200814, 2010 expressed an unqualified opinion on those consolidated financial statements and included an explanatory paragraph relating to the Company's adoption of Financial Accounting Standards Board (FASB) Interpretation No. 48 (FIN 48),Accounting for Uncertainty in Income Taxes (ASC Topic 740, Income Taxes), effective October 1, 2007.

DELOITTE & TOUCHE LLP

Philadelphia, Pennsylvania
December 9, 200814, 2010


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PART III

Item 10.    Directors, executive officers and corporate governance.

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

Item 11.    Executive compensation.

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

Item 12.    Security ownership of certain beneficial owners and management and related stockholder matters.

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

        The following table gives information about our common stock that may be issued upon the exercise of options and rights under all of our existing equity compensation plans and arrangements as of September 30, 2008, including the 1998 Stock Option Plan.2010.

Plan Category
 Number of Securities to
be issued upon exercise
of outstanding options
and rights
 Weighted-average
exercise price of
outstanding options
and rights
 Number of Securities
remaining available for future
issuance under equity
compensation plans
(excluding securities reflected
in second column)
 

Equity compensation plans approved by security holders

  753,243 $9.79  1,570,982 

Equity compensation plans not approved by security holders

   $   
        

  753,243 $9.79  1,570,982 
        

Plan Category
 Number of Securities
to be issued upon
exercise of outstanding
options and rights
 Weighted-average
exercise price of
outstanding options
and rights
 Number of Securities
remaining available for
future issuance under
equity compensation plans
(excluding securities
reflected in second column)
 

Equity compensation plans approved by security holders

  553,538 $8.68  1,151,138 

Equity compensation plans not approved by security holders

  
 
$

  
 

        The 2003 Restricted Stock Plan for non-employee directors was approved by shareholders at the Company's February 26, 2004 Annual Meeting of Shareholders. The Plan called for an annual award of restricted stock having a fair market value of $25,000 as of the close of business on October 1 of the current fiscal year for all eligible non-employee directors. In fiscal year 2005 the annual award was increased to $40,000 effective the fourth quarter of the fiscal year. The stock is awarded in four installments quarterly during the fiscal year provided the director is still serving on the board on the quarterly issue date. In fiscal year 2005 the annual award was increased to $40,000 effective the fourth quarter of the fiscal year.


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        In the fiscal years ended September 30, 2008, 20072010, 2009 and 2006,2008, awards to our non-employee directors under the Plan were 11,355, 15,05637,862, 29,815 and 15,39611,355 shares respectively.


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Item 13.    Certain relationships and related transactions and Director independence.

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

Item 14.    Principal accounting fees and services

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


PART IV

Item 15.    Exhibits, financial statement schedules.

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

(1)
Financial Statements

        See index to Financial Statements at Item 8 on page 29 of this report.

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


Exhibit
Number
 Exhibit Title
3.1  3.1^^Articles of Incorporation of IS&S.

  

  3.2^#

 

3.2 $
Bylaws of IS&S.

  

10.1*#

 

10.1
*#IS&S 1988 Incentive Stock Option Plan.

  

10.2*&

 

10.2
*&IS&S 1998 Stock Option Plan.

  

10.3*!

 

10.3
*!IS&S 2003 Restricted Stock Plan

  

10.4*@


Bond Purchase Agreement.

10.4

10.5**@


Employment Agreement by and between IS&S and John C. Long dated January 28, 2008

  

10.6*


Employment Agreement by and between IS&S and Raymond J. Wilson dated January 24, 2008

10.5

10.7*%@


Release Agreement by and between IS&S and Raymond J. Wilson dated November 10, 2008


10.8


Settlement Agreement by and between IS&S and Kollsman, Inc. dated August 27, 2008


10.9@


Reimbursement, Credit and Security Agreement.


10.11@


Trust Indenture.

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Exhibit Number
Exhibit Title
  10.12*
10.6IS&S 2009 Stock-Based Incentive Compensation Plan
 Employment Agreement by and between Roman G. Ptakowski and IS&S dated March 29, 2003.

21

21


Subsidiaries of IS&S.

  

23.1

 

23.1
Consent of Deloitte and Touche LLP.

  

31.1

 

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

  

31.2

 

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

  

32.1

 

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

  

99.1*

 

99.1
*@Amendment to the IS&S 1998 Stock Option Plan


99.2


Amendment to Reimbursement, Credit and Security Agreement dated November 29, 2002.


99.3


Amendment to Loan Documents dated March 30, 2004.


99.4


Third Amendment to Reimbursement, Credit and Security Agreement dated July 25, 2006.


99.5


Fourth Amendment to Reimbursement, Credit and Security Agreement dated January 29, 2007.


99.6


Fifth Amendment to Reimbursement, Credit and Security Agreement dated January 10, 2008.

*
Constitutes a management contract or compensatory plan or arrangement required to be filed as an exhibit to this form.


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^
Incorporated by reference from the Registrant's Current Report on Form 8-K filed with the Commission on September 19, 2007.

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

&
Incorporated by reference from the Registrant's Proxy Statement filed with the Commission on March 1, 2005.

@
Incorporated by reference from the Registrant's Form 10-K filed with the Commission for fiscal year 2000.2008.

Incorporated by reference from the registrant's Form 10-QRegistrant's Proxy Statement filed with the Commission for the quarter ended March 31, 2003.on January 28, 2009.

!
Incorporated by reference from the Registrant's Proxy Statement filed with the Commission on January 26, 2004

%$
Incorporated by reference from the Registrant's CurrentQuarterly Report on Form 8-K10-Q filed with the Commission on November 13, 2008.August 6, 2010.

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SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.




  INNOVATIVE SOLUTIONS AND SUPPORT, INC.

 

 

By:

 

/s/ GEOFFREY S.M.S. M. HEDRICK

Geoffrey S.M.S. M. Hedrick
Chairman & Chief Executive Officer

 

 

Dated: December 11, 2008
14, 2010

        Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

Signature
 
Title
 
Date

 

 

 

 

 
/s/ GEOFFREY S. M. HEDRICK

Geoffrey S. M. Hedrick
 Chairman & Chief Executive Officer December 11, 200814, 2010

/s/ ROMAN G. PTAKOWSKI

Roman G. Ptakowski

 

President

 

December 11, 200814, 2010

/s/ JOHNRONALD C. LONGALBRECHT

JohnRonald C. LongAlbrecht

 

Chief Financial Officer (Principal Accounting Officer)

 

December 11, 200814, 2010

/s/ GLEN R. BRESSNER

Glen R. Bressner

 

Director

 

December 11, 200814, 2010

/s/ WINSTON J. CHURCHILL

Winston J. Churchill

 

Director

 

December 11, 200814, 2010

/s/ IVAN M. MARKSROBERT MIONIS

Ivan M. MarksRobert Mionis

 

Director

 

December 11, 200814, 2010

/s/ ROBERT E. MITTELSTAEDT, JR.

Robert E. Mittelstaedt, Jr.

 

Director

 

December 11, 200814, 2010

/s/ ROBERT H. RAU

Robert H. Rau

 

Director

 

December 11, 200814, 2010