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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, 20102012

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



000-31157

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 section 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 oý    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 ýo Non-accelerated filer o
(Do not check if a
smaller reporting company)
 Smaller Reporting Company oý

         Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yeso Noý

         The aggregate market value of the Registrant's common stock held by non-affiliates of the Registrant as of March 31, 20102012 (the last business day of the registrant's most recently completed second quarter) was approximately $80.1$45.4 million. Shares of common stock held by each executive officer and director and by each person who owns 10% or more of ourthe Registrant's 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 04, 2010,November 30, 2012, there were 16,770,41516,583,037 outstanding shares of the Registrant's Common Stock

Documents Incorporated by Reference

         Portions of the Registrant's Proxy Statement for the 20112012 Annual Meeting of Shareholders to be filed prior to January 28, 201025, 2013 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.

20102012 Annual Report on Form 10-K

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 Page

Part I


Item 1.

 

Business

 35

Item 1A.

 

Risk Factors

 1316

Item 1B.

 

Unresolved Staff Comments

 1822

Item 2.

 

Properties

 1822

Item 3.

 

Legal Proceedings

 1822

Item 4.

 

Removed and ReservedMine Safety Disclosures

 1822

Part II

Item 5.

 

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

 1923

Item 6.

 

Selected Consolidated Financial Data

 2125

Item 7.

 

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

 2226

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

 3237

Item 8.

 

Financial Statements and Supplementary Data

 3237

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 6168

Item 9A.

 

Controls and Procedures

 6168

Part III


Item 10.

 

Directors, Executive Officers and Corporate Governance

 6570

Item 11.

 

Executive Compensation

 6570

Item 12.

 

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

 6570

Item 13.

 

Certain Relationships and Related Transactions and Director Independence

 6671

Item 14.

 

Principal Accounting Fees and Services

 6671

Part IV


Item 15.

 

Exhibits, Financial Statement Schedules

 6672

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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 these1934, as amended (the "Exchange Act"). These forward looking statements are based largely on our current expectations and projections about future events and trends affecting our business.the business, are not guarantees of future performance and involve a number of risks, uncertainties and assumptions that are difficult to predict. In this report, the words "believe,"anticipates," "believes," "may," "will," "estimate,"estimates," "continue,"continues," "anticipate,"anticipates," "intend,"intends," "forecast,"forecasts," "expect,"expects," "plan,"plans," "could," "should," "is"would,""is likely" and similar expressions, as they relate to ourthe business or ourto its management, are intended to identify forward looking statements, but they are not exclusive means of identifying them. Unless the context otherwise requires, all references herein to "IS&S," "the Registrant," "the Company," "we," "us" or "our" are to Innovative Solutions and Support, Inc. and its consolidated subsidiaries.

        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-lookingforward 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 undertakethe Company undertakes 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 resultsResults 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 ourthe Company's common stock.


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Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Form 10-K. The Company does not undertake any obligation to publicly release any revisions to these forward-looking statements to reflect events, circumstances or changes in expectations after the date of this Form 10-K, or to reflect the occurrence of unanticipated events. The forward-looking statements in this document are intended to be subject to the safe harbor protection provided by Sections 27A of the Securities Act of 1933, as amended (the "Securities Act") and 21E of the Exchange Act.

        Investors should also be aware that while we do,the Company, from time to time, communicatecommunicates with securities analysts, it is against ourits policy to disclose any material non-public information or other confidential commercial information. Accordingly, shareholders should not assume that we agreethe Company agrees with any statement or report issued by any analyst irrespective of the content of the statement or report. Furthermore, we havethe Company has 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," or "IS&S" or "we") was founded in 1988. The Company is a systems integrator that designs, manufactures and sells Flat Panel Display Systems, Flight Information Computersflight guidance and advanced monitoringcockpit display systems to the Department of Defense (DoD), government agencies, defense contractors, commercial air transport carriers,for original equipment manufacturers (OEMs),("OEMs") and corporate/general aviation markets.retrofit applications. The Company supplies integrated Flight Management Systems ("FMS") and advanced Global Positioning System ("GPS") receivers for precision reduced carbon footprint navigation.

        Increasingly, the Company is increasingly positioning itself as a system integrator; thisintegrator, which capability provides the Company with the potential to generate more substantive orders over a broader product base. The Company has demonstrated an ability to incorporate added electronic flight bag functionality such as electronic flight bags, charting and mapping systems into its Flat Panel Display SystemSystems ("FPDS") product line. OurThe strategy, as both a manufacturer and integrator, is to leverage the latest technologies developed for the personal computer and telecommunications industries into advanced and cost-effective solutions for both the general aviation, industrycommercial, the United States Department of Defense ("DoD")/governmental and DoD. We believe thisforeign military markets. This approach, combined with ourthe Company's industry experience, enables usIS&S to develop high-quality products and systems, reduce substantially reduce product time to market and achieve cost advantages over products offered by ourits competitors.

        For several years the Company has been working with advances in technology to provide pilots increasing amounts ofwith more information thatto enhance both the safety and efficiency of flying. These advances have come together in the Company'sflying, and has developed its COCKPIT/IP™ (CockpitIP® Cockpit Information Portal or CIP)("CIP") product line, referred to as Flat Panel Display System product line("FPDS"), that incorporates proprietary technology, low cost, reduced power consumption, decreased weight, and increased functionality. The Company's Flat Panel Display SystemCompany believes the FPDS product line is suited to address market demand that we believe will be driven by regulatory mandates, new technologies, and agingthe high cost of maintaining aging/obsolete equipment on airplanes that have been in service for up to fifty years. We believeIS&S believes that the transition to Flat Panel Display SystemsFPDS as part of airplane retrofit requirements continues. Thiswill continue. The shift in regulatory and technological environment is illustrated by the dramatic increase in the number of Wide Area Augmentation System (WAAS)("WAAS") approach qualified airports. Aircraft equipped with our Flat Panel Display Systemthe Company's FMS and FPDS product line (equipped with a WAAS enabled navigator) will be qualified to land at such airports and comply with upcoming Federal Aviation Administration ("FAA") mandates for Required Navigation Performance ("RNP"), and Automatic Dependent Surveillance-Broadcast ("ADS-B") navigation, a fact which we believeIS&S believes will further increase the demand for ourthe Company's products.

        In fiscal 2010, IS&S announced it received FAA certificationsells to both the retrofit market and OEMs. Customers include the DoD and its commercial contractors, aircraft operators, aircraft modification centers, foreign militaries, and various OEMs. Occasionally, IS&S sells its products directly to DoD; however, the Company sells its products primarily to commercial customers for its Class 3 Electronic Chartsend use in DoD programs. Sales to defense contractors are made on commercial terms, although some of the termination and XM Satellite Weather upgradeother provisions of government contracts are applicable to the AVIO NG integrated cockpit system of thethese contracts.

        In October 2012 Eclipse Aerospace, Inc. (EAI) EA500 Very Light Jet.placed a production order with IS&S commenced sales to EAIfor an initial fifty ship sets 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) certificationa three hundred ship set contract for the B757 to further addressIS&S advanced avionics suite for the needsproduction model Eclipse 550. IS&S is the supplier 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 CessnaPrimary Flight and Multi-Function Displays as well 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 DisplayIntegrated Flight Management System ("IFMS") for the WAAS program with LateralEclipse Jet. The advanced avionics suite will include Dual Flight Management systems, Auto Throttles, Synthetic Vision, integrated Terrain Awareness System ("TAWS") 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 DisplayEnhanced Vision System in fiscal 2009.

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


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panel display system        In August 2012, the FAA issued its Supplemental Type Certificate ("STC") to IS&S for its FPDS for use on Classic B-737 aircraft. This certification enables IS&S to expand its marketing of its FPDS to owners of B737 in the United States.

        In October 2011, Eclipse Aerospace Inc. selected IS&S to design and develop the advanced avionics suite for the production model Eclipse 550.

        In July 2011, the National Nuclear Security Administration ("NNSA") awarded IS&S a contract for the complete Systems Integration and Cockpit Avionics upgrade of their B737-400 classic aircraft. Upon completion, this upgrade will provide NNSA full Communication Navigation Surveillance/Air Traffic Management ("CNS/ATM") capabilities and similar efficiency and performance to the B737 Next Generation ("NG") at the fraction of the cost of a new aircraft. This program complements the IS&S FPDS contracts for more than 400 B757/B767 aircraft with more than 160 aircraft already in revenue service. The upgrade for the B737-300/-400/-500 series aircraft and the existing B757/B767 FPDS are platforms for compliance with NextGen and Single European Sky ATM Research ("SESAR") requirements, is Controller Pilot Data Link Communication ("CPDLC"), RNP, ADS-B and in-Trail capable, of interfacing with most third party avionics.provides power and weight savings, and reduces fuel consumption and CO2 emissions.

        In June 2011, Boeing awarded IS&S a contract to design and develop the Aerial Refueling Operator Control and Display Units ("AROCDU") for the KC-46A Tanker Program.

        In March 2011, IS&S announced it received FAA STC for its FMS and dual GPS receivers for the Eclipse Aerospace, Inc. ("EAI") Twin-Engine Jet. The Vantage system can be retrofitted into a variety of airframes. The Company launched a Wide AreaIS&S FMS displays controls all major systems on the aircraft and includes improvements to e-Chart, mapping and satellite weather functionality and precision navigation. Eclipse Twin-Engine Jet operators are now able to upgrade their aircraft within Integrated Flight Management System through EAI.

        In February 2011, the FAA issued its Technical Standard Order authorization ("TSO") to IS&S for its Beta-3 Global Positioning System ("GPS")—Satellite Based Augmentation System (WAAS) program with Lateral("SBAS") Receiver. This certification enabled IS&S to expand its product offering to include a GPS in its FPDS. Additionally, the FAA also issued a TSO in March 2011 for the IS&S Class Gamma 3 FMS and Vertical Precision Performance with a fully coupled auto-pilotType 2 FAA Letter of Acceptance ("LOA") that allows IS&S to provide navigation data. The combination of these certifications enables IS&S to be a flight management system provider to its customers.

        In December 2010, the European Aviation Safety Agency ("EASA"), the European counterpart of the FAA issued its Supplemental Type Certificate ("STC") to IS&S for the B757 FPDS. Further, in August 2011, IS&S obtained an STC from EASA for its PC-12 COCKPIT/IP™ Flat Panel Display System. WAAS capability allows PC-12 operatorsB767 FPDS. These certifications enable IS&S to fly precision approaches at smaller airports. This capability is also available on other aircraft platforms. IS&S received amended Supplemental Type Certificates (STC) for the Boeing 757/767 platform from the Federal Aviation Administration (FAA) adding increased functionalityexpand its marketing of its B757 and B767 FPDS to the COCKPIT/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.customers in Europe.

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 are becoming available for display in cockpits, such as satellite based weather and ground terrain maps, are becoming available for display in cockpits. We believemaps. The Company believes that 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, and navigation data. Aircraft heading and altitude information includes aircraft speed, altitude, and rates of ascent and descent. Flight critical aircraft control information includes engine data such as fuel and oil quantity, and other engine measurements. Navigation data includes radio position, flight management, Global Positioning System (GPS)GPS, and alternative source 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


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aircraft. Engine data are determined by measuring various indices such as temperature, volume, revolutions per minute (RPM)("RPM"), and pressure within an aircraft's engines and other mechanical equipment. GPS and alternative source information isare derived typically derived from satellites or equipment located on land and fed by satellite or radio signals to the aircraft. Pilots can thenpresently 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 mechanical instruments. In the early 1980s, digital displays using Cathode Ray Tubes (CRT)("CRT") began to replace some individual analog instruments. ThePresently, the industry now offers high resolution color flat panels using Active Matrix Liquid Crystal Displays (AMLCD)("AMLCD") to replace traditional analog instruments or CRT displays. We expectIS&S expects that the ability to display more information in a space efficient and customizedcustom platform will become increasingly important if additional information, such as weather depiction maps, traffic information, and surface terrain maps, becomebecomes mandated by regulation or demanded by pilots. Accordingly, we believethe Company believes flat panel displays, which can integrate and display a "suite" of information, will increasingly replace individual instruments and CRTs as the method for delivering and orderingdisplaying information displayed in cockpits.

        EquipmentIn the past, equipment data, such as engine and fuel related information, were traditionally displayed on conventional analog mechanical instruments. Engine and fuel instruments provide information on engine activity, including oil and hydraulic pressures, and temperature. These instruments are clustered throughout an aircraft's cockpit. Engine and fuel instruments tend to be replaced more frequently than other instruments due to increased obsolescence problems and normal wear-and-tear. AsInasmuch as information displayed by this instrumentationthese instruments is vital for safe and efficient flight, aircraft operators continue to purchase individual conventional engine and fuel instruments to replace older or non-functioning instruments.as replacements. Increasingly, operators are replacing their individual instrument clusters of analog mechanical instruments with integrated COCKPIT/IP™ Flat Panel Display Systems.


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        As the skies and airports are becomingbecome more crowded, the aviation industry and its 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 areprovide the best methodsolution to handle these and future requirements.

Strategy

        OurThe Company's objective is to become a leading supplier and integrator of cockpit information. We believe ourinformation, and believes that its industry experience and reputation, our technology and products, and our business strategy provide athe basis to achieve this objective. Key elements of ourthe Company's strategy include:


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Tableboth for retrofits and original equipment, and has won new and ongoing retrofit programs and two OEM programs. One of Contents


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Products

        Our currentCurrent line of products includes:

        In recent years color flat panel displays have been introduced into aircraft cockpits. Flat Panel Displayspanel displays are Liquid Crystal Display (LCD)("LCD") screens that can replicate the display of one or a suite of analog or digital displays on one screen. LikeAs with other instrumentation, flat panel displays can be installed in new aircraft or used to replace existing displays in aircraft already in use.legacy aircraft. LCDs are also used for security monitoring on-board aircraft and as tactical workstations on military aircraft. The flat panel product line also presents numerous advantages for presentation of engine performance data. During fiscal 2012, 2011 and 2010 2009revenues related to FPDS accounted for 87%, 79% and 2008 we derived 68%, 75% and 77% respectively, of our total revenues from sales of Flat Panel Display Systems.sales.

        We developed a Flat Panel Display System thatThe Company's FPDS can replace conventional analog and digital displays used currently used in a cockpit and can display additional information thatwhich is not now commonly displayed in the cockpit. Ourcockpit with conventional analog and digital displays. The COCKPIT/IP™IP® is capable of displaying nearly all types of air data, engine and fuel data, altitude, heading and navigational data, and alternative source information. As technology and information delivery systems develop further, develop, additional information will be displayed in the cockpit, such as surface terrain maps and data link messaging, will be displayed inmessaging. IS&S designed the cockpit. We designed our COCKPIT/IP™IP® to be capable of displaying information generated from a variety of sources, including ourits Reduced Vertical Separation Minimum (RVSM)("RVSM") air data system, engine and fuel instrumentation, and third-party data and information products.

        The Company's new Integrated Multifunction Standby Unit ("IMSU") can be installed in a variety of fixed wing aircraft and helicopters. The IMSU measures, processes, and displays altitude, attitude, airspeed, slip/skid, and navigation display information into an intuitive and concise single instrument display. The IMSU incorporates an integral Inertial Measurement Unit ("IMU") and includes an air data module to measure static and total pressure for independent display of altitude, airspeed, and Mach number. The unit also has an optional battery module that provides one hour of operation of the unit during emergency conditions or complete electrical system failures.

From time to time, customers may order one or more flat panel display systemsFPDSs customized to their particular requirements. Depending on the amount of non-recurring engineering effort needed to accommodate the customized request,Typically, the Company has and will continue to charge a feecharges for added development cost. This will result insource of revenue to the Company that is characterized as Engineering- modification and developmentEMD on the income statement.statement of operations. Consistent with this approach, engineering costcosts incurred in the performance of customizing the flat panel display system will be allocated from Operating expenses (Research and development) to Cost of Sales (Engineering—modification and development) and will beFPDSs are included in the Company's gross profit calculations.


Tablecost of Contentssales (Engineering—Modification and Development).

        OurThe Company's air data products calculate and display various measures such as aircraft speed, altitude, and rate of ascent and descent. The functionality of ourThese air data systems useproducts utilize advanced sensors to gather air pressure data and use customized algorithms to interpret data, thus allowing the system to calculate altitude more accurately calculate altitude.accurately. During fiscal 2010, 2009,2012, 2011, and 2008 we derived 32%, 25%, and 23%, respectively, of our total revenues from2010, sales of air data systems and related products.components accounted for 13%, 21%, and 32%, respectively, of total revenues.

        We sellIS&S sells individual components as well as partial and complete air data systems. OurThe components and systems include:


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        We develop, manufactureIS&S develops, manufactures and marketmarkets engine and fuel displays. OurThese solid-state multifunction displays convey information with respect to fuel and oil levels, and engine activity, such as oil and hydraulic pressure and temperature. This instrumentation includes individual and multiple displays clusteredinstalled throughout an aircraft'sthe cockpit. OurThe displays can be used in conjunction with our ownthe Company's engine and fuel data equipment or that of other manufacturers.

        Engine and fuel displays are found in all aircraft and are vital to safe and proper aircraft flight. In addition, accurate conveyance of engine and fuel information is critical for the monitoring of engine stress and the maintenance of engine parts. Engine and fuel displays tend to be replaced more frequently than other displays, and have remained largely unchanged since their introduction due to their low cost, standard design and universal use.

        We believe ourIS&S believes that its air data engine and fuel displays are extremely reliable, and we have been designed them to be programmable to adaptand adaptable easily without major modification to most modern aircraft. OurThese products have been installed on C-130H, DC-9, DC-10, P-3, F-16, and A-10 aircraft.

Customers

        OurThe Company's customers include the United States government (including DoD, DOI and the Department of Homeland Security), ABX Air, American Airlines, The Boeing Company, Bombardier Aerospace, Cessna Aircraft Corporation,BAE Systems, Eclipse Aerospace, Inc., Federal Express Corporation ("FedEx"), Icelandair, L-3 Communication,Communications, Lockheed Martin Corporation, Raytheon, Rockwell Collins, Marshalls of Cambridge, United Kingdom, and the Department of National Defense Canada,(Canada), among others. In fiscal 2012, the three largest customers, Eclipse Aerospace, FedEx and National Nuclear Security Administration, accounted for 20%, 14% and 13% of total revenue, respectively. In fiscal year 2011, the two largest customers, Eclipse Aerospace, Inc. and FedEx, accounted for 20% and 15% of total revenue, respectively. In fiscal year 2010 the two largest customers, Lockheed Martin and FedEx, accounted for 11% and 10% of total revenue, respectively.

        Historically, a majority of ourthe Company's sales have come from the retrofit market. Among other reasons, we haveIS&S has pursued the retrofit market because of its continued rapid growth in response to the increasing need to support the world's aging fleet of aircraft. In fiscal 2010, our two largest customers, Lockheed Martin and FedEx, accounted for 11% and 10% of our total revenue, respectively. In fiscal year 2009, our two largest customers, American Airlines and DoD, accounted for 24% and 11% of our total revenue, respectively. In fiscal year 2008 our two largest customers, Eclipse Aviation, Inc. and FedEx, accounted for 42%, and 10% of our total revenue, respectively.


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        Updating an individual aircraft's existing electronics equipment has become increasingly common as new technology makesobsoletes existing instrumentation outdated while an aircraft is still structurally and mechanically


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sound. Retrofitting an aircraft is generally a substantially less expensive alternative tothan purchasing a new aircraft. We expect ourIS&S expects its main customers in the retrofit market to be:

        Department of Defense and Defense Contractors.    We sell ourThe Company sells its products directly to the DoD as well asand to domestic and international defense contractors for end use on military aircraft retrofit programs. DoD programs generally take one of two forms,forms: a subcontract with a prime government contractor, such as Boeing, Lockheed Martin, or Rockwell Collins,L-3 Communications; or a direct contract with the appropriate government agency, such as the U.S. Air Force to satisfy its requirement for replacing Central Air Data Computers on its fleet of A-10 aircraft.Force. The government's desire for a cost-effective retrofittingretrofit of aircraft has led it to purchase commercial off-the-shelf equipment rather than requiring development ofto develop specially designed products, which are usually more costly and take longer to develop.implement. These contracts tend to be on arms length commercial terms, although some termination and other provisions of government contracts described under "Government Regulation" below are typically applicable to these contracts.contracts, as described under "Government Regulation" below. Each government agency or general contractor retains the right to terminate a contract at any time at its convenience. Upon such alteration or termination, we typicallyIS&S generally would be entitled to an equitable adjustment to the contract price so that weit would receive the purchase price for already delivered items, and reimbursement for allowable costs incurred.

        Aircraft Operators.    WeThe Company also sell oursells its products to aircraft operators, including commercial airlines, cargo carriers, and business and general aviation. Ouraviation aircraft owners or suppliers. The products are used mostly in retrofitting aircraft owned or operated by these customers, which generally retrofit and maintain their aircraft themselves. OurThe Company's commercial fleet customers include or have included, among others, American Airlines, ABX Air, Air Canada, Federal ExpressFedEx, Icelandair and Northwest Airlines. We sellIS&S sells these customers a range of products from flat panel display systemsFPDS to air data systems.

        Aircraft Modification Centers.    The primary retrofit market for private and corporate jets is through aircraft modification centers, which repair and retrofit private aircraft in a manner similar to the way auto mechanics service a person's car. We haveaircraft. IS&S has established relationships with a number of aircraft modification centers throughout the United States. These modification centers essentially act as distribution outlets for ourthe Company's products. We believe our air data systems and related components are being promoted by aircraft modification centers to update older or outdated equipment. Our large modification center customers include Bombardier Learjet, Western Aircraft, Aeromech, Star Aviation, Duncan Aviation, and Raytheon Aircraft Services.

        The Company has been selected to provide the cockpit avionics suite for the Eclipse Aerospace, Inc. ("Eclipse") new production aircraft designated the E550. Eclipse is the successor to Eclipse Aviation, Inc. ("Aviation") which declared bankruptcy in late 2008. In fiscallate 2010, Sikorsky Aircraft (a unit of United Technologies Corp.) announced its intention to invest in Eclipse. In October 2011, Eclipse announced the planned production in 2013 of the E550 aircraft and selected IS&S as the system integrator. During the years 2006 through late 2008, the Company suspended work on the Eclipse VLJ program and Eclipseprovided cockpit displays in support of Aviation Inc. filed for Chapter 11 Bankruptcy. New owners have resurrected the former Eclipse Aviation, Inc. and formed a new entity named Eclipse Aerospace, Inc to purchase Eclipse Aviation, Inc's assets. At the 2010 National Business Aviation Association (NBAA) convention, it was announced that Sikorsky Aircraft intends to invest in Eclipse Aviation, Inc. In fiscal 2010 the Company resumed deliveries to Eclipse Aerospace, Inc. of equipment and functionality to support upgrades to their existing fleetproduction of approximately 250150 aircraft. The Company believes that Eclipse aspirespurchased the assets of Aviation in 2009. During the past three years, IS&S has been providing, through Eclipse, enhanced capability through retrofits to begin new aircraft production.numerous owners of the Aviation produced aircraft.

        WeIS&S also market ourmarkets its products to other original equipment manufacturers, particularly manufacturers of corporate and private jets as well as to contractors manufacturing military jets.


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Customers of our products have included Bombardier, Gulfstream,including Boeing Raytheon, Piaggio and Lockheed Martin.

Backlog

        As of September 30, 20102012 and 2009, our2011, the Company's backlog was $32.3$19.7 million and $34.1$27.5 million, respectively. Backlog represents the value of contracts and purchase orders received, less the revenue recognized to date on those contracts and purchase orders. The year over year decrease of $1.8$7.8 million or 5.3%


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was the result of $29.9booking $28.2 million in new business offset by $25.3$24.6 million of recognized revenue and $6.4order reductions of $11.4 million of order de-bookings. The preponderance of the de-bookings relate to one customer and is due to the requirement to rebid the project in accordance with the procurement procedures.primarily by American Airlines. Air Data product backlog as of September 30, 2010 decreased2012 increased by $2.4$0.4 million from September 30, 2009; while Flat Panel Display Systems2011, and FPDS backlog as of September 30, 2010 increased2012 decreased by $0.6$8.2 million from September 30, 2009.2011. The Company expects backlog to improve in the future because of potential future sole source production sales resulting from the present customer-funded EMD contracts. Although the Company believes that the orders included in backlog are firm, most of the backlog involves orders that can be modified or terminated by the customer. As of September 30, 2012, approximately 36% of the Company's backlog is not expected to be filled within fiscal 2013.

Engineering Development

        The Company invests a large percentage of its sales on engineering development, both R&D and EMD. At September 30, 2012, approximately 50% of the Company's employees were engineers engaged in various engineering development projects. IS&S invests a large percentage of its sales in engineering development to allow its customers to benefit from the latest technological advancements. Total engineering development expense is comprised of both internally funded R&D and product development and design charges related to specific customer contracts. Engineering development expense consists primarily of payroll-related expenses of employees engaged in engineering development projects, engineering related product materials and equipment and subcontracting costs. R&D charges incurred for product design, product enhancements and future product development are expensed as incurred. Product development and design charges related to specific customer contracts are charged to cost of sales-engineering modification and development based on the method of contract accounting (either percentage of completion or completed contract) applicable to such contracts.

Sales and Marketing

        We focus ourIS&S focuses its sales efforts on passenger and cargo carrying aircraft operators, general aviation operators, aircraft modification centers, the DoD, DoD contractors, and OEMs. We continually evaluate ourThe Company periodically evaluates its sales and marketing efforts with respect to these focus areas and, where appropriate, have mademakes use of third-party sales representatives who receive compensation through commissions based on performance.

        We believe ourThe Company's ability to provide prompt and effective repair and upgrade service is critical to ourits marketing efforts. As part of ourThe customer service program we offeroffers a 24-hour hotline thatcustomer hotline. The Company services its customers can call for product repair or upgrade concerns. We employutilizing either field service engineers to service our equipmentor its in-house repair and depending on the service required, we may either dispatch a service crewupgrade facility. The Company can lend spare units to make necessary repairs or request the customer return the product to us for repairs or upgrades at our facility. In the event repairs or upgrades are required to be made at our facility, we provide spare products for use by our customers during the repair time. Ourperiods when it is repairing or overhauling their equipment. The Company's in-house turnaround times for both repairs and upgrades average less than 30 days. Before returning our products to customers, all repaired or upgraded products are retested for airworthiness.

        In connection with our customer service program, we typically provideGenerally, IS&S provides customers with a two-year warranty on new products. We also offerThe Company offers customers extended warranties of varying terms for additional fees.

        The majority of the Company's sales, operating resultspersonnel and identifiable assets are inwithin the United States. In fiscal year 2010, 2009,2012, 2011 and 20082010 net sales outside the United States amounted to $2.8 million, $4.4 million, $4.0 million and $1.7$2.8 million, respectively.

Government Regulation

        TheFAA regulations govern the manufacture and installation of ourthe Company's products in aircraft owned and operated in the United States, is governed by FAA regulations. We maintain a productionand the IS&S facility that is FAA certified. The most significant of the product and installation regulations focus on Technical Standard Order Authorizationsare TSO and Supplemental Type Certificates. These certifications set forthSTC, which establish the minimum product performance standards that a certain type of equipment should meet. As required, we deliver our product in accordance with FAA regulations.standards.

        SalesGenerally, sales of ourIS&S products to European or other non-U.S. owners of aircraft also typically require approval of the European Aviation Safety Agency (EASA),EASA, the European counterpart of the FAA, or another appropriateother relevant governmental agency. EASA certification requirements for manufacturing and installation of our products in European owned aircraft mirror FAA regulations. Much like the FAA certification process, the EASA has established a process for granting European Certifications.agencies.


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EASA certification requirements for the manufacture and installation of the Company's products in European owned aircraft mirror FAA regulations. The EASA process for granting European certifications is similar to that of the FAA.

        In addition to product related regulations, we are alsoIS&S is subject to U.S. Government procurement regulations with respect to the sale of ourthe Company's products to government entities or government contractors. These regulations dictate the manner inestablish requirements which products may be sold to the government and set forth other requirements thatcontractors must be met in ordermeet to do business with or on behalf of government entities. For example, the government agency or general contractor may alter the price, quantity or delivery schedule of our products. In addition, theThe government agency or general contractor retains the right to terminate thea contract at any time at its convenience. Upon such alteration or termination, we would typically beIS&S is generally entitled to an equitable adjustment to the contract price so that we would receivethe Company receives the purchase price for products or services already delivered, items and reimbursement for allowable costs incurred.incurred and for termination related costs.

Manufacturing, Assembly and Materials Acquisition

        OurThe Company's manufacturing activities consist primarily of assembling and testing components and subassemblies, and integrating them into a fully tested finished system. We believesystems. IS&S believes this methodapproach allows usit to achieve relatively flexible manufacturing capacity while minimizingand to minimize expenses. We typically purchaseTypically, the Company purchases components for our products from third-party suppliers and assembleassembles them in a clean room environment to reduce impurities and improve the performance of our products.environment. Many of the components we purchasepurchased are standard products, although certain parts are made to ourthe Company's specifications.

        When appropriate, we enterIS&S enters into long-term supply agreements and use ouruses its relationships with long-term suppliers to improve product quality and availability, and to reduce delivery times and product costs. In addition, we continually identifythe Company identifies alternative suppliers for important component parts. UsingGenerally, the introduction of component parts from new suppliers in ourexisting products generally requires FAA certification of the entire finished product if the newly sourced component varies significantly from ourthe original drawings and specifications. To date, we haveIS&S has not experienced any significant delays in delivery of our products caused by the inability to obtain either component parts or FAA approval of products incorporating new component parts.

Quality Assurance

        Product quality is of vital importance to ourthe Company's customers and we have taken steps to enhance the overall quality of our products. We areIS&S. The Company is ISO 9001 and AS 9100B9100C certified. ISO 9001 and AS 9100BThese standards arerepresent an international consensus on effective management practices with the goal of ensuring that a company can consistently deliver its products and related services consistently in a manner that meets or exceeds customer quality requirements. TheseIS&S's certification to these standards allow usallows the Company to represent to customers that we maintainit maintains high quality industry standards in the education of ourits employees, and in the design and manufacture of ourits products. In addition, ourthe Company's products undergo extensive quality control testing prior to being delivered to customers. As part of ourits quality assurance procedures, we maintainIS&S maintains detailed records of test results and ourits quality control processes.

Our Competition

        The market for ourthe Company's products is highly competitive, and characterized bythe Company competes in several industry niches in which a number of manufacturers specialize. Our competitorsCompetitors vary in size and resources, and substantially all of ourthe Company's competitors are much larger than we areIS&S and have substantially greater resources than we do.resources. With respect to air data systems and related products, ourthe Company's principal competitors include Honeywell International Inc., Rockwell Collins, Inc., Thales, and GE Aviation.Garmin. With respect to flat panel displays, our principal competitors currently include Honeywell, Rockwell Collins, Inc., L-3 Communications, and GE Aviation. However, because the flat panel display industry is a new and


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evolving market, as the demand for flat panel displays increases, weIS&S may face future competition in this area from additional companies in the future.


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        We believeThe Company believes that the principal competitive factors in its markets we serve are cost, development cycle time, responsiveness to customer preferences, product quality, technology, and reliability. We believe ourIS&S believes that its significant and long-standing customer relationships reflect ourthe Company's ability to compete favorably with respect to these factors.

Intellectual Property and Proprietary Rights

        We relyIS&S relies on patents to protect ourits proprietary technology. As of September 30, 20102012 the Company holds 2224 U.S. patents and has 25 U.S. patent applications pending relating to ourits technology. In addition, we hold 27IS&S holds 25 international patents and have 24has 25 international patent applications pending. Certain of these patents and patent applications cover technology relating to air data measurement systems and calibration techniques while others cover technology relating to flat panel display systems and other aspects of ourthe COCKPIT/IP™IP® solution. While we believeIS&S believes these patents have significant value in protecting ourits technology, we believe alsoit believes that the innovative skill, technical expertise, and know-how of ourthe Company's personnel in applying the technology reflected in ourits patents would be difficult, costly, and time consuming to reproduce.

        While we areIS&S is not aware of any pending lawsuits against usthe Company alleging patent infringement or the violation of other intellectual property rights, weit cannot be certain such infringement claims will not be asserted against usthe Company in the future.

Our Employees

        As of September 30, 2010, we2012, IS&S had 133 employees, 45 were in engineering, research and development, 55 in manufacturing and assembly operations, 8 in quality and 25 in selling and general administrative positions.

        Our105 employees. The Company's future success depends on ourits ability to attract, train and retain highly qualified personnel. We planIS&S plans to hire additional personnel, including, in particular sales and marketing personnel,R&D engineers, during the next twelve months. Competition for such qualified personnel is intense, and wethe Company may not be able to attract, train, and retain highly qualified personnel in the future. Our employees are not represented by a laborThe Company is non union.

Executive Officers of the Registrant

        The following is a list of ourthe Company's executive officers, their ages and their positions:

Name
 Age Position

Geoffrey S. M. Hedrick

  6870 Chairman of the Board and Chief Executive Officer
Roman G. Ptakowski

Shahram Askarpour

  6255 President

Ronald C. Albrecht

  6567 Chief Financial Officer

        Geoffrey S. M. Hedrick was the Chief Executive Officer from the time he founded the Company in February 1988 through June 4, 2007, and was reappointed as Chief Executive Officer on September 8, 2008. He has also been Chairman of the Board since 1997. Prior to founding IS&S, Mr. Hedrick served as President and Chief Executive Officer of Smiths Industries North American Aerospace Companies. He also founded Harowe Systems, Inc. in 1971, which was subsequently acquired by Smiths Industries. Mr. Hedrick has over 3540 years of experience in the avionics industry, and he holds a number of patents in the electronics, optoelectric, electromagnetic, aerospace, and contamination-controlcontamination control fields.

        Roman G. PtakowskiShahram Askarpour has been President since March 2003. Prior to that, Mr. Ptakowski served2012. Dr. Askarpour joined the Company as a Group Vice PresidentDirector of Engineering in 2003, and General Manager and, before that, as awas promoted to Vice President of SalesEngineering in 2005. Dr. Askarpour has more than 30 years of aerospace industry experience in managerial and Marketing at B/Etechnical positions. Prior to joining IS&S he was employed by Smiths Aerospace Inc. Previously, Mr. Ptakowski held(a division of Smiths Group PLC), Instrumentation Technology and Marconi Avionics. He holds a number of positions with increasing responsibility within ASEA Brown Boveri Power T&D Company, Inc. There, he was General Managerkey patents in


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of the Protective Relay Division before leaving to join B/E Aerospace, Inc. Mr. Ptakowskiaviation field. Dr. Askarpour received a B.S.his engineering education in the United Kingdom, and received an undergraduate degree in Electrical Engineering from New YorkMiddlesex University, a post graduate Certificate of Advanced Study in Systems Engineering, and a PhD in Automatic Control from Brunel University. He was awarded the title of Associate Research Fellow for three consecutive years by Brunel University, and a MBA from Duke University.has published numerous papers in leading international, peer reviewed journals. In addition, he has completed management courses at Carnegie Mellon University and finance courses at the Wharton Business School.

        Ronald C. Albrecht has been Chief Financial Officer since August 2010. Prior to joining the Company, Mr. Albrecht served in a number of executive positions, both operational and financial, with Smiths Aerospace (UK) and later. Smiths Aerospace was acquired by GE Aviation Systems (GEAS) following the GEAS purchase of Smiths Aerospace("GEAS") in 2007. Recently he hasMost recently, Mr. Albrecht served as Vice President and General Manager of Smiths Aerospace Electro Mechanical Business from 2003 to 2007 and, latersubsequently, of GEAS' Electro Mechanical Business.Business from 2007 to 2010. Prior to his operational roles, he served as Chief Financial Officer of Smiths Aerospace, based in London, and has substantial mergers & acquisition and strategic planning experience. Mr. Albrecht received a B.A. in Government and Economics from Dartmouth College and ana MBA in Finance from Stanford University. He is a Certified Public Accountant (California/Inactive).

        The public may read and copy any materials filed by usIS&S with the SEC at the SEC's public reference room located at 100 F Street, N.E., Washington, D.C. 20549. The public may obtain information about the operation of the SEC's public reference rooms by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website at http://www.sec.gov that contains reports, proxy and information statements and other information about issuers that file electronically with the SEC.

        Our primaryIS&S maintains its corporate website isat http://www.innovative-ss.com. We makewww.innovative-ss.com and makes available, free of charge, at our corporateon that website our(under the "Investor Relations" tab) the Company's annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those as reasonably practicable after weit electronically filefiles such material with, or furnishfurnishes it to, the SEC. The information on ourthe Company's web site is not incorporated as part of this annual report.


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Item 1A.    Risk Factors

        YouEach reader should carefully consider the risks, uncertainties and other factors described below, in addition to the other information set forth in this report, because they could materially and adversely affect ourthe Company's business, operating results, financial condition, cash flows, and prospects, as well as adversely affectand the value of an investment in ourIS&S common stock.

Risks Related to OurIS&S Business

Reductions in government expenditures could adversely affect IS&S business.

The recentBudget Control Act of 2011 (the "Budget Act") will result in reduced U.S. government funding of the defense industry unless Congress acts. The Budget Act set $900 billion in immediate cuts to discretionary government spending for 2012 through 2021. It also established a bi-partisan congressional Joint Select Committee on Deficit Reduction (the "Super Committee") and charged it with recommending legislation by November 23, 2011, the result of which would reduce net government spending by at least $1.2 trillion over the next 10 years, in addition to the $900 billion in immediate discretionary spending reductions. The failure of the Super Committee to meet its objectives has triggered an automatic sequestration of discretionary appropriations, which if not altered by Congress, will make up any shortfall necessary to achieve the $1.2 trillion target. Under the Budget Act, 50% of any shortfall from the $1.2 trillion target would automatically be applied as a reduction to discretionary appropriations for national defense programs. Unless the U.S. Government takes further action, the Budget Control Act of 2011 (Budget Act) will trigger substantial, automatic reductions in both defense and discretionary spending in January 2013. While the impact of sequestration is yet to be determined, automatic across-the-board cuts would be in addition to reductions already reflected in the defense funding over a ten-year period. The resulting automatic across-the board budget cuts in sequestration could have negative consequences to the Company's business and industry. There could be disruption of ongoing programs and initiatives, and the resulting personnel reductions could negatively impact the Company's manufacturing operations and engineering expertise, and accelerate the loss of skills and knowledge. The impact of any resulting reductions in defense appropriations, and/or reductions in U.S. defense spending could negatively affect the Company's revenues, financial condition and results of operations.

The global recession and credit tightening could adversely affect us.IS&S.

        The recent global recession and continued concern regarding credit availability, including failures of financial institutions, has initiated unprecedented government intervention in the U.S., Europe and other regions of the world. If these concerns continue or worsen, risks to usIS&S include:

        A portion of ourIS&S sales havehas been, and we expect willis expected to continue to be, to defense contractors or government agencies in connection with government aircraft retrofit or original equipment manufacturing contracts. Sales to government contractors and government agencies could decline as a result of DoD spending cuts and general budgetary constraints which may become more frequentsevere as tax revenues decline due to the weakeningfederal budget deficit remains high.


Table of general economic conditions.Contents

Tax changes could affect the Company's effective tax rate and future profitability.

        The Company's future results could be affected negatively by changes in the effective tax rate as a result of changes in the overall profitability and changes to statutory tax rates in the United States, changes in tax legislation, and the results of audits and examination of previously filed tax returns.

The loss of a key customer or a significant deterioration in the financial condition of a key customer could have a material adverse effect on ourthe Company's results of operations.

        OurThe Company's revenue is concentrated with a limited number of customers. During fiscal year 2010 we2012 IS&S derived 48%63% of revenue from the top 5 five customers. We derived 56% of revenue during fiscal year 2009 from five customers. We derived 72% of revenue during fiscal year 2008 from five customers. We expectIS&S expects a relatively small number of customers to account for a majority of ourits revenues for the foreseeable future. As a result of ourthe concentrated customer base, a loss of one or more of these customers or a dispute or litigation with one of these key customers could have a material adverse effect on ourits revenue and results of operations. In addition, we continually monitorthe Company monitors and evaluateevaluates the credit status of ourits customers and attemptattempts to adjust sales terms as appropriate. Despite these efforts, a significant deterioration in the financial condition or bankruptcy filing of a key customer could have a material adverse effect on ourthe Company's business, results of operations, and financial condition.

        On November 25, 2008, Eclipse Aviation,29, 2011, AMR Corporation, the parent company of American Airlines, Inc. and certain of its other U.S.-based subsidiaries, filed a voluntary petitionpetitions for relief under Chapter 11 ofreorganization in the U.S. Bankruptcy Code.Court for the Southern District of New owners have resurrectedYork. The Company's revenues from American Airlines, Inc. accounted for 5%, 8% and 8% total revenue for the former Eclipse Aviation, Inc.fiscal years 2012, 2011 and formed a new entity named Eclipse Aerospace, Inc.2010, respectively. (See Note 13—Commitments and Contingencies in Notes to purchase Eclipse Aviation, Inc.'s assets. In fiscal 2010 the Company began deliveries to Eclipse Aerospace, Inc. of equipment and functionality to support upgrades to their existing fleet of approximately 250 aircraft. The Company has not received and does not anticipate receiving any payment on its pre-petition claims. Additionally, claims have been made against the Company to try to recover amounts paid to the Company during the 90 days preceding the filingConsolidated Financial Statements attached).

Growth of the bankruptcy petition. See Item 3, Legal Proceedings.


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Growth of ourCompany's customer base could be limited by delays or difficulties in completing development and introduction of our planned products or product enhancements. If we failIS&S fails to enhance existing products, or to develop and achieve market acceptance for flat panel displays and other new products that meet customer requirements, ourits business will be adversely affected.

        Although historically a substantial majority of our revenue has come from sales of air data systems and related products, weIS&S currently spendspends a large portion of ourits research and development efforts in developing and marketing our flat panel display systemsthe FPDS and complementary products. OurThe Company's ability to grow and diversify ourits operations through introduction and sale of new products is dependent upon ourthe continued success in continuing product development and engineering activities, as well as ourits sales and marketing efforts, and our ability to obtain requisiteregulatory approvals to sell such products. Our salesSales growth will also depend in part on market acceptance of and demand for our CIPthe FPDS and future products. WeIS&S cannot be certain wethat it will be able to develop, introduce or market our CIPits FPDS or other new products or product enhancements in a timely or cost-effective manner, or that any new products will receive market acceptance or necessary regulatory approval.

        During fiscal 2010, 2009, and 2008 we derived 68%, 75% and 77% of our total revenue from the sale of flat panel display systems, respectively. We expect revenues from our air data products will decline as a percent of total sales as peak demand associated with the FAA's Reduced Vertical Separation Minimum (RVSM) mandate has been accommodated. Our revenues and profitability will decrease if new products such as our Flat Panel Display Systems do not receive market acceptance or if our existing customers do not continue to incorporate our products in their retrofitting or manufacturing of aircraft. In seeking new customers, itthe Company may be difficult for ourhave difficulty in displacing the products to displace competing products.of incumbent competitors. Accordingly, weIS&S cannot be assured that potential customers will accept ourits products or that existing customers will not abandon them.

OurThe Company's revenue and operating results may vary significantly from quarter to quarter, which may cause ourits stock price to decline.

        OurThe Company's revenue and operating results may vary significantly from quarter to quarter due to a number of factors, including:

    demand for our products and/or delivery schedule changes by ourits customers;

    capital expenditure budgets of aircraft owners and operators, and appropriation cycles of the U.S. government;

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    changes in the use of ourthe Company's products, including air data systems and flat panel displays;

    delays in introducing or obtaining government approval for new products;

    new product introductions by competitors;

    changes in ourIS&S pricing policies or pricing policies of our competitors, and

    costs related to possible acquisition of technologies or businesses.

        We planIS&S plans to expand ourstructure its sales and marketing operations and to fund levels of product development proportionatein proportion to ourits total sales. As a result, a delay in generating revenues could cause significant variations in ourits operating results from quarter to quarter.

Contracts can be terminated by customers at any time and, therefore, may not result in sales.

        OurThe Company's retrofit projects are generally pursuant to either a direct contract with a customer or a subcontract with a general contractor to a customer (including government agencies). Each contract, including our contracts with government agencies, includes various terms and conditions that impose certain requirements on us,IS&S, including the ability of the customer or general contractor to alter the


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price, quantity or delivery schedule of ourthe products. In addition, typically, the customer or general contractor typically retains the right to terminate the contract at any time at its convenience. Upon alteration or termination of these contracts, weIS&S could be entitled to an equitable adjustment to the contract price, so wethat it may receive the purchase price for items we havethat it has delivered and reimbursement for allowable costs we have incurred. Accordingly, because these contracts can be terminated, wethe Company cannot be assured that ourits retrofit backlog will result in sales.

The Company enters into fixed-price contracts or service arrangements to perform specified design and EMD services related to its products that could subject IS&S to losses in the event the Company incurs cost overruns on its projects.

        During fiscal 2012, approximately 25% percent of the Company's total sales were from fixed-price customer funded EMD service arrangements to perform specified design and EMD services related to its products. This allows IS&S to benefit by recovering some of the cost of its engineering development group, but it carries the burden of potential cost overruns because the Company assumes all of the cost risk. If the Company's initial cost estimates are incorrect, it can potentially incur large one time charges and losses on these contracts. These EMD service arrangements can expose the Company, potentially, to losses because the customer may compel IS&S to complete a project or, in the event of a termination for default, pay the incremental cost of its replacement by another provider regardless of the size of any cost overruns that occur over the life of the contract. Because some of these projects involve new technologies and applications, and can last for more than a year, unforeseen events such as technological difficulties, fluctuations in the price of raw materials, problems with subcontractors, and cost overruns can result in the contractual price becoming less favorable or even unprofitable to IS&S over time. Furthermore, if the Company does not meet project deadlines or specifications, it may need to renegotiate contracts on less favorable terms, be forced to pay penalties or liquidated damages, or suffer losses if the customer exercises its right to terminate. The Company's results of operations are dependent on its ability to maximize earnings from the EMD service arrangements. Lower earnings caused by cost overruns could have a negative impact on the Company's financial condition, operating results and cash flows.

We dependIS&S depends on key personnel to manage ourits business effectively, and if we are unablean inability to retain ourits key employees ourcould adversely impact the Company's ability to compete could be harmed.compete.

        OurThe Company's success depends on the efforts, abilities, and expertise of ourits senior management and other key personnel. There can be no assurance weIS&S will be able to retain such employees, the


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loss of some of whom could hurt ourdamage its ability to execute ourits business strategy. We intendThe Company intends to continue hiring key management, engineering, and sales and marketing personnel. In spite of a U.S. unemployment rate of 9.6% as of October, 2010,approximately 8% during 2012, competition for suchskilled personnel is intense, and weIS&S may not be able to attract or retain additional qualified personnel.

        OurThe Company's future success will depend in part on ourits ability to implement and improve ourits operational, administrative and financial systems and controls and to manage, train and expand ourits employee base. WeIS&S cannot be assured that, after giving effect to ourits cost containment initiatives, that our current and planned personnel levels, systems, procedures and controls will be adequate to support ourthe current and future customer base. If inadequate, weIn such a circumstance, the Company may not be able to exploit existing and potential market opportunities. Any delays or difficulties we encounterencountered could impair ourthe Company's ability to attract new customers or maintain ourits relationships with existing customers.

We relyIS&S relies on third party suppliers for components of ourits products, and any interruption in the supply of these components could hinder ourits ability to deliver our products.products on a timely basis.

        OurThe Company's manufacturing process consists primarily of assembling components purchased from ourits supply chain. TheseThe suppliers may not continue to be available to us.IS&S. If we arethe Company is unable to maintain relationships with key third party suppliers, the development and distribution of ourits products could be delayed until equivalent components can be obtained and integrated into ourthe products. In addition, substitution of certain components from other manufacturers may require product redesign, FAA or other approval, which could delay ourthe Company's ability to ship products.

OurThe Company's competition includes other manufacturers of air data systems and flight information displays against whom weit may not be able to compete successfully.

        The markets for ourthe Company's products are intensely competitive and subject to rapid technological change. Our competitorsCompetitors include Honeywell International Inc., Rockwell Collins, Inc., Thales Communications, Inc., GE Aviation and L-3 Communications. Substantially all of ourAll these competitors have substantially significantly greater financial, technical and human resources than we do.does IS&S. In addition, ourthese competitors have much greater experience in and resources for marketing their products. As a result, ourthese competitors may be able to respond more quickly to new or emerging technologies and customer preferences, or to devote greater resources to development, promotion and sale of their products than weIS&S can. OurThe Company's competitors may also have greater name recognition and more extensive customer bases that they can use to their benefit. Thisbases. Such competition could result in price reductions, fewer customer orders, reduced gross margins, and loss of market share.


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OurThe Company's success depends on ourits ability to protect ourits proprietary rights against potential risk of infringement. If we areIS&S is unable to protect and enforce ourits intellectual property rights, weit may be unable to compete effectively.

        OurThe Company's success and ability to compete will depend in part on ourits ability to obtain and maintain patent or other protection for ourits technology and products, both in the United States and abroad.internationally. In addition, weIS&S must operate without infringing the proprietary rights of others.

        WeIS&S currently hold 22holds 24 U.S. patents and have 2has 5 U.S. patent applications pending. In addition, we hold 27the Company holds 25 international patents and have 24has 25 international patent applications pending. WeIS&S cannot be certain that patents will be issued on any of ourits present or future applications. In addition, our existing patents or any future patents may not adequately protect ourthe Company's technology if they are not broad enough and are successfully challenged, or if other entities are able to develop competing methods without violating ourits patents. If we areIS&S is not successful in protecting ourits intellectual property, competitors could begin to offer products that incorporate ourthe Company's technology. Patent protection involves complex legal and factual questions, and, therefore, is highly uncertain, and litigationuncertain. Litigation relating to


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intellectual property is often very time consuming and expensive. If a successful claim of patent infringement were made against us or we areIS&S, and if the Company were unable to develop non-infringing technology, or to license the infringed or similar technology on a timely and cost-effective basis, wethe Company might not be able to produce and sell some of ourits products. In addition, we haveFurther, IS&S has incurred in the past and may continue in the future to incur significant legal and other costs in defense of ourits intellectual property.

A cybersecurity incident could have a negative impact.Potential lenders

        A cyber-attack that bypasses the Company's information technology (IT) security systems causing an IT security breach, may have suffered losses relatedlead to a material disruption of its IT business systems and/or the loss of business information resulting in an adverse business impact. Risks may include:

    negative impact on future results due to the weakening economytheft, destruction, loss, misappropriation, or release of confidential data or intellectual property;

    operational or business delays resulting from the disruption of IT systems and may not be able to provide ussubsequent clean-up and mitigation activities;

    negative publicity resulting in reputation or brand damage with needed financing.

            Potential lenders may have suffered losses related to their lending and other financial relationships, especially because of the general weakening of the national economy and increased financial instability of many borrowers. As a result, lenders may become insolventcustomers, partners or tighten their lending standards, which could make it more difficult for us to borrow or to obtain new financing on favorable terms or at all, if we determine that it would be in our interests to obtain such financing, whether to finance acquisitions or otherwise. Our financial condition and results of operations could be adversely affected if we were unable to obtain cost-effective financing in the future.

    industry peers.

WeIS&S may not be able to identify or complete acquisitions, or weit may consummate an acquisition that adversely affects ourthe Company's operating results.

        One of ourthe Company's strategies is to acquire businesses or technologies that complement ourits existing operations. We haveIS&S has limited experience in acquiring businesses or technologies. There can be no assurance weIS&S will be able to acquire or profitably manage acquisitions or successfully integrate them into ourits operations. Furthermore, certain risks are inherent in pursuing acquisitions, such as the demands of management's time and attention and combining disparate company cultures and facilities. Acquisitions may have an adverse effect on ourthe Company's operating results, particularly in quarters immediately following the consummation of such transactions, as we integratethe Company integrates operations of acquired businesses into ourits operations. Once integrated, acquisitions may not perform as expected.expected or be accretive to the Company's results of operations.

Risks Related to Ourthe Company's Industry

If we areIS&S is unable to respond to rapid technological change, ourits products could become obsolete and ourits reputation could suffer.

        Future generations of air data systems, engine and fuel displays, and flat panel displays embodyingwhich embody new technologies or new industry standards could render ourthe Company's products obsolete. The market for


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aviation products is subject to rapid technological change, new product introductions, changes in customer preferences, and evolving industry standards. Ourstandards and government regulations. The Company's future success will depend on ourits ability to:

    adapt toembrace rapidly changing technologies;

    adapt ourthe Company's products to evolving industry standards;standards and government regulations; and

    develop and introduce a variety oftimely, high quality, cost effective new products, and product enhancements to address the increasingly sophisticated needs of ourits customers.

        Our future success will also depend on our developing high quality, cost-effective products and enhancements to our products that satisfy needs of customers and on our introducing these new technologies to the marketplace in a timely manner. If we failIS&S fails to modify or improve ourits products in response to evolving industry standards ourand government regulations, its products could rapidly become obsolete.

        OurThe Company's products are currently subject to direct regulation by the FAA, its European counterpart, the European Aviation Safety Administration (EASA),EASA, and other comparableequivalent organizations. OurThe Company's products, as they relate to


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aircraft applications, must be approved by the FAA, EASA or other comparableequivalent organizations before they can be usedinstalled in an aircraft. To be certified, weIS&S must demonstrate that ourits products are accurate and able to maintain certain levels of repeatability over time. Although certification requirements of the FAA and the EASA are substantially similar, there is no formal reciprocity exists between the two systems.regulators. Accordingly, even though some of ourthe Company's products are FAA-approved, weit may need to obtain approval from the EASA or other appropriate organizations to have them certified for installation outside the United States.

        Significant delay in receiving certification for newly developed products or enhancements to ourthe Company's products, or losingthe loss of certification for ourits existing products could result in lost sales or delays in sales. Furthermore, adoption of additionalnew regulations or product standards, as well asand changes to existing product standards could require usIS&S to change ourits products and underlying technology. WeIS&S cannot assure youensure that weit will receive regulatory approval on a timely basis or at all.

Because ourInasmuch as the Company's products utilize sophisticated technology and are deployed in complex aircraft cockpit environments, problems with these products may arise that could seriously harm ourthe Company's reputation for quality assurance and, our business.consequently, its business prospects.

        OurThe Company's products use complex system designs and components that may contain errors, omissions, or defects, particularly when we incorporatethe Company incorporates new technologies into ourits products or we releasewhen it releases new versions or enhancements of ourits existing products. Despite ourthe Company's quality assurance process, errors, omissions or defects could occur in ourits current products, in new products, or in new versions or enhancements of existing products after commercial shipment has begun. Weproducts. IS&S may be required to redesign or recall those products or pay damages. Such an event could result in the following:

    delay or loss of revenues;

    cancellation of customer contracts;

    diversion of development resources;

    damage to ourthe Company's reputation;

    increased service and warranty costs; or

    litigation costs.

        Although we currently carryIS&S carries product liability insurance, this insurance may not be adequate to cover ourits losses in the event of a large product liability claim. Moreover, weIn addition, IS&S may not be able to maintain such insurance in the future.


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We haveThe Company has limited experience in marketing and distributing ourits products internationally.

        We expectIS&S expects to derive an increasing amount of ourits revenues from sales outside the United States, particularly in Europe. There are certain risksRisks inherent in doing business on an international basis, such as:internationally include:

    differing regulatory requirements for products being installed in aircraft;requirements;

    legal uncertainty regarding liability;

    tariffs, trade barriers, and other regulatory barriers;

    political and economic instability;

    changes in diplomatic and trade relationships;

    potentially adverse tax consequences;

    the impact of recessions in economies outside the United States; and

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    variancevariances and unexpected changes in local laws and regulations.

        Currently, all of ourthe Company's international sales are denominated in U.S. dollars. An increase in the dollar's value compared to other currencies could make ourrender its products less competitive in foreignthe international markets. In the future, weIS&S may be required to conduct sales in the foreign country's local currencies,currency, thus exposing usthe Company to changesfluctuations and volatility in exchange rates that could adversely affect ourits operating results.

Item 1B.    Unresolved Staff Comments.

None

Item 2.    Properties.

        In fiscal 2001, weIS&S purchased 7.5 acres of land in the Eagleview Corporate Park in Exton, Pennsylvania. Shortly thereafter, the Company constructed a 44,80045,000 square foot design, manufacturing and office facility on this site. Land development approval allows for expansion of up to 20,400 square feet. ThisSuch expansion would provide for a 65,200 square foot facility. The construction was principally funded with a Chester County, Pennsylvania, Industrial Revenue Bond. The building served as securityfacility which is adequate to meet the needs of the Company for the Industrial Revenue Bond until the bond was repaid in August 2009.foreseeable future.

Item 3.    Legal Proceedings.

        In the ordinary course of business, we are at timesthe Company is subject to various legal proceedings and claims. We doIS&S does not believe any such matters that are currently pending will have a material adverse effect on ourthe Company's results of operations or financial position.

        On November 18, 2010, Jeoffrey L. Burtch,September 26, 2011, Farhad Daghigh, a former employee of the Chapter 7 Trustee for AE Liquidation, Inc. (formerly Eclipse Aviation Corporation),Company, filed avoidance actionsa lawsuit against IS&S on behalfin the Court of AE Liquidation, Inc.Common Pleas of Chester County alleging breach of contract and violation of the Pennsylvania Wage Payment and Collection Law claiming unpaid sales commissions, prejudgment interest, and liquidated damages totaling approximately $583,000 for the avoidancefiscal years ended 2007, 2008, 2009 and 2010. The Company vehemently denies any allegations of seven payments totaling $321,095liability and is vigorously defending the lawsuit. This matter has not been resolved as allegedly preferential transfers paid to the Company during the 90 days preceding the filing of the bankruptcy petition of Eclipse Aviation Corporation on November 25, 2008.date hereof. The Company believes it has meritorious defenses to these avoidance actions, intends to vigorously defend against them, and believes that the likelihoodprobability of the avoidance actions prevailingan unfavorable outcome on this claim is remote. Accordingly, the Companyremote, and therefore, no contingent liability has not accrued any loss reserve related to this claim.been recorded as of September 30, 2012.

        On January 17, 2007 the Company filed suit in the Court of Common Pleas for Delaware County, Pennsylvania against Strathman Associates, a former software consultant for IS&S, alleging that Strathman had improperly used IS&S trade secret and proprietary information in assisting J2 and Kollsman in developing the J2/Kollsman Air Data Computer. The case is ongoing.has not been resolved as of the date hereof.

Item 4.    Removed and Reserved.Mine Safety Disclosures.

        Not applicable.


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Part II

Item 5.    Market for the Registrant's Common Equity, Related Stockholder Matters, and Issuer Repurchases of Equity Securities.

        OurThe Company's common stock has been traded on the NasdaqNASDAQ Stock Market, LLC under the symbol "ISSC" since ourits initial public offering on August 4, 2000. The following table lists the high and low per share sale prices for ourthe common stock for the periods indicated:


 Fiscal Year
2010
 Fiscal Year
2009
  Fiscal Year 2012 Fiscal Year 2011 
Period
 High Low High Low  High Low High Low 

First Quarter

 $5.37 $4.17 $7.65 $3.02  $4.80 $3.20 $6.07 $4.61 

Second Quarter

 7.14 3.81 6.06 2.52  4.51 3.50 6.16 5.67 

Third Quarter

 6.72 4.32 5.90 4.02  4.75 3.02 5.87 5.15 

Fourth Quarter

 6.28 2.12 6.00 3.34  4.50 3.20 5.80 4.42 

        On December 06, 2010,November 30, 2012, there were 1517 holders of record of the shares of outstanding common stock. This total does not reflect beneficial shareholders who hold their stock in nominee or "street" name through brokerage firms.

        NoThe Company did not pay dividends were paid in fiscal 20092012 or fiscal 2010. The Company does not expect to declare or pay2011. On December 7, 2012 the Company's Board of Directors declared a special cash dividends on our common stockdividend in the near future. We intendamount of $1.50 per share, payable on or about December 27, 2012 to retainshareholders of record as of the close of business on December 17, 2012. The aggregate amount of the payment to be made in connection with the dividend will be approximately $24.9 million. The declaration and payment of any earnings to financedividend in the growthfuture will be at the discretion of our business.the Company's Board of Directors.

        On February 16, 2010,18, 2011, the Company's Board of Directors approved the Company's repurchase program to acquire up to 1,000,000 shares of the Company's outstanding Common Stock.common stock. Under the repurchase program, the Company may purchase shares of its common stock through open market transactions, or in privately negotiated block purchases, or in other private transactions (either solicited or unsolicited). The timing and amount of repurchase transactions under this program will depend on market conditions, and corporate and regulatory considerations. The plan will expireprogram expired on February 16, 2011, unless10, 2012 and was extended by the Board of Directors; however, theDirectors on February 3, 2012 until February 10, 2013. The program may be discontinued or suspended at any time. During the year ended September 30, 20102012, the Company purchased 12,000211,722 shares of common stock under the program at a cost of $48,630, or$798,445 at an average market pricecost of $4.03$3.77 per share, financed with available cash. The following table sets forth the purchases made under this new plan for each month sinceof the extension date throughfiscal year ended September 30, 2010:2012:

Period
 Total Number of
Shares Purchased
 Average Price Paid
per Share
 Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs
 Number of
Shares that May
Yet Be Purchased
Under the
Program
 

January, 2010

         

February, 2010

  4,100 $4.16  4,100  995,900 

March, 2010

  1,100  4.20  1,100  994,800 

April, 2010

        994,800 

May, 2010

        994,800 

June, 2010

        994,800 

July, 2010

  6,800  3.93  6,800  988,000 

August, 2010

        988,000 

September, 2010

        988,000 
           

  12,000  4.03  12,000    
           
Period
 Total Number of
Shares Purchased
 Average Price
Paid
per Share
 Total Number of
Shares Purchased as
Part of Publicly
Announced Plans
or Programs
 Number of
Shares that
May Yet Be
Purchased Under
the Program
 

October 2011

  17,263 $4.67  17,263  908,337 

November 2011

  16,155  4.35  16,155  892,182 

December 2011

  55,098  3.56  55,098  837,084 

January 2012

  31,518  3.96  31,518  805,566 

February 2012

  19,726  4.02  19,726  785,840 

March 2012

  1,341  4.28  1,341  784,499 

April 2012

        784,499 

May 2012

  4,900  3.24  4,900  779,599 

June 2012

  34,500  3.33  34,500  745,099 

July 2012

  23,477  3.34  23,477  721,622 

August 2012

  3,944  3.32  3,944  717,678 

September 2012

  3,800  4.00  3,800  713,878 
           

  211,722 $3.75  211,722    
           

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COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Innovative Solutions and Support, Inc., The NASDAQ Composite Index,
The Russell 2000 Index And Dow Jones US Aerospace & Defense Index

 
 9/05 9/06 9/07 9/08 9/09 9/10 

Innovative Solutions and Support, Inc. 

  100.00  93.56  122.15  42.18  38.78  37.85 

NASDAQ Composite

  100.00  106.39  127.37  96.70  100.00  112.86 

Russell 2000

  100.00  109.92  123.49  105.60  95.52  108.27 

Dow Jones US Aerospace & Defense

  100.00  120.91  164.01  122.06  114.49  129.88 

*
$100 invested on 9/30/05 in stock or index—including reinvestment of dividends.
Fiscal year ending September 30.

        The graph abovebelow shows the cumulative shareholder return on $100 invested at the market close on September 30, 20052007 through and including September 30, 2010,2012, the last trading day before the end of ourthe Company's most recently completed fiscal year, with the cumulative total return over the same time period of the same amount invested in the Nasdaq,NASDAQ Composite Index, the Russell 2000 Index, and the Dow Jones US Aerospace & Defense Index.

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Innovative Solutions and Support, Inc., the NASDAQ Composite Index, the Russell 2000 Index, and the Dow Jones US Aerospace & Defense Index

 
 9/07 9/08 9/09 9/10 9/11 9/12 

Innovative Solutions and Support, Inc

  100.00  34.53  31.75  30.99  30.60  25.22 

NASDAQ Composite

  100.00  69.59  74.90  84.99  86.87  110.79 

Russell 2000

  100.00  85.52  77.35  87.68  84.58  111.57 

Dow Jones US Aerospace & Defense

  100.00  74.43  69.81  79.20  80.28  95.95 

*
$100 invested on 9/30/07 in stock or index—including reinvestment of dividends.

Fiscal year ending September 30.

Copyright© 2012 Dow Jones & Co. All rights reserved.


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Item 6.   Selected Consolidated Financial Data.Data.

        The following tables present portions of ourthe Company's consolidated financial statements. The following selected consolidated financial data set forth below should be read together with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and ourthe consolidated financial statements and related notes to ourthe consolidated financial statements appearing elsewhere herein. The selected statement of operations data for the fiscal years ended September 30, 2010, 20092012, 2011 and 20082010 and the balance sheet data as of September 30, 20102012 and 20092011 are derived from ourthe Company's audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The selected statements of operations data for the fiscal years ended September 30, 20072009 and 20062008 and the balance sheet data as of September 30, 2010, 2009 and 2008 2007 and 2006 are derivedextracted from ourthe Company's audited consolidated financial statements that are not included in this Annual Report on Form 10-K.



 Fiscal year ended September 30,  Fiscal year ended September 30, 


 2010 2009 2008 2007 2006  2012 2011 2010 2009 2008 

Statement of Operations Data:

Statement of Operations Data:

  

Net Sales

Net Sales

 25,257,323 36,734,150 30,533,311 18,348,128 16,721,967  $24,578,198 $25,737,652 $25,257,323 $36,734,150 $30,533,311 

Cost of sales

Cost of sales

 11,520,029 17,895,984 20,551,857 14,154,425 8,631,761  14,067,933 11,945,184 11,520,029 17,895,984 20,551,857 
                      

Gross profit

Gross profit

 13,737,294 18,838,166 9,981,454 4,193,703 8,090,206  10,510,265 13,792,468 13,737,294 18,838,166 9,981,454 

Research and development

Research and development

 5,234,240 5,313,007 10,304,279 5,180,360 6,749,426  2,693,554 5,500,924 5,234,240 5,313,007 10,304,279 

Selling, general and administrative

Selling, general and administrative

 8,099,587 8,647,506 22,306,016 15,840,255 9,863,758  7,400,199 7,683,637 8,099,587 8,647,506 22,306,016 

Asset Impairment

Asset Impairment

   2,475,000        2,475,000 
                      

Total operating expenses

 13,333,827 13,960,513 35,085,295 21,020,615 16,613,184 

Total operating expenses

 10,093,753 13,184,561 13,333,827 13,960,513 35,085,295 

Operating income (loss)

Operating income (loss)

 403,467 4,877,653 (25,103,841) (16,826,912) (8,522,978) 416,512 607,907 403,467 4,877,653 (25,103,841)

Interest income, net

Interest income, net

 185,815 315,765 1,415,732 2,886,602 3,091,986  100,414 142,433 185,815 315,765 1,415,732 

Other income

Other income

 50,000 50,099 17,300,000    65,005 150,010 50,000 50,099 17,300,000 
                      

Income (loss) before income taxes

Income (loss) before income taxes

 639,282 5,243,517 (6,388,109) (13,940,310) (5,430,992) 581,931 900,350 639,282 5,243,517 (6,388,109)

Income tax expense (benefit), net

 (109,094) 234,856 1,509,139 (5,095,022) (2,548,600)

Income tax (benefit) expense, net

 (2,397,063) 183,760 (109,094) 234,856 1,509,139 
                      

Net income (loss)

Net income (loss)

 748,376 5,008,661 (7,897,248) (8,845,288) (2,882,392) $2,978,994 $716,590 $748,376 $5,008,661 $(7,897,248)
                      

Net income (loss) per common share:

Net income (loss) per common share:

  

Basic

 0.04 0.30 (0.47) (0.52) (0.17)

Diluted

 0.04 0.30 (0.47) (0.52) (0.17)

Basic

 $0.18 $0.04 $0.04 $0.30 $(0.47)

Diluted

 $0.18 $0.04 $0.04 $0.30 $(0.47)

Weighted average shares outstanding:

Weighted average shares outstanding:

  

Basic

 16,751,528 16,745,379 16,887,049 16,865,028 17,388,524 

Diluted

 16,777,886 16,760,500 16,887,049 16,865,028 17,388,524 

Basic

 16,641,895 16,782,223 16,751,528 16,745,379 16,887,049 

Diluted

 16,641,900 16,824,621 16,777,886 16,760,500 16,887,049 

Cash dividends declared per Common Share

Cash dividends declared per Common Share

   
 
1.00
 
 
  $ $ $ $ $1.00 

 


 As of September 30,  As of September 30, 

 2010 2009 2008 2007 2006  2012 2011 2010 2009 2008 

Balance Sheet Data:

  

Cash and cash equivalents

 40,916,346 35,565,694 35,031,932 49,151,078 62,984,829  $42,977,501 $42,625,854 $40,916,346 $35,565,694 $35,031,932 

Working capital

 46,311,056 44,624,477 42,491,253 62,453,234 73,751,866  $49,087,538 $47,332,110 $46,311,056 $44,624,477 $42,491,253 

Total assets

 57,590,522 57,536,012 59,896,714 84,585,785 87,232,880  $62,597,231 $58,257,604 $57,590,522 $57,536,012 $59,896,714 

Debt and capital lease obligations, less current portion

 15,560 26,991 4,362,725 4,382,542 4,339,587  $ $ $15,560 $26,991 $4,362,725 

Total shareholders' equity

 53,468,037 52,398,742 46,804,126 70,733,779 78,201,353  $57,080,403 $54,260,787 $53,468,037 $52,398,742 $46,804,126 

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Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations.

        The following discussion and analysis should be read in conjunction with "Selected Consolidated Financial Data" and ourthe financial statements and related notes included in this report.

Overview

        Innovative Solutions and Support was founded in 1988. The Company is a systems integrator that designs, develops, manufactures, and sells flight information computers, large flat-panel displays,guidance and cockpit display systems for original equipment manufacturers ("OEMs") and retrofit applications. The Company supplies integrated flight management systems ("FMS") and advanced monitoringglobal positioning system ("GPS") receivers for precision reduced carbon footprint navigation. Increasingly, the Company is positioning itself as a system integrator, which capability provides the Company with the potential to generate more substantive orders over a broader product base. The Company has demonstrated an ability to incorporate added electronic flight bag functionality such as charting and mapping systems that measureinto its Flat Panel Display Systems ("FPDS") product line. The strategy, as both a manufacturer and display critical flight information, including data relativeintegrator, is to aircraft separation, airspeed, altitude as well as engineleverage the latest technologies developed for the computer and fuel data measurements.telecommunications industries into advanced and cost-effective solutions for the general aviation, commercial, the United States Department of Defense ("DoD")/governmental, and foreign military markets. This approach, combined with the Company's industry experience, enables IS&S to develop high-quality products and systems, reduce substantially product time to market, and achieve cost advantages over products offered by its competitors.

        OurThe Company's sales are derived from the sale of ourits products to both the retrofit market and to a lesser extent, original equipment manufacturers ("OEMs"). Our customersOEMs. Customers include the United States Department of Defense ("DoD")DoD and theirits commercial contractors, aircraft operators, aircraft modification centers, foreign militaries, and various OEMs. Although we occasionally sell ourOccasionally, IS&S sells its products directly to DoD; however, the DoD, we have sold ourCompany sells its products primarily to commercial customers for end use in DoD programs. Sales to defense contractors are made on commercial terms, although some of the termination and other provisions of government contracts are applicable to these contracts.

        Our costCost of sales related to product sales is comprised of material and components purchased through ourfrom the Company's supplier base and direct in-house assembly labor and overhead costs. Many components we useused in assembling ourthe products are standard, although certain parts are manufactured to meet ourthe Company's specifications. The overhead portion of cost of sales is comprised primarily comprised of salaries and benefits, building occupancy costs, depreciation, supplies, and outside service costs related to our production, purchasing, material control, and quality departments, and warranty costs.

        OurIS&S cost of sales related to Engineering—modificationEngineering-Modification and developmentDevelopment ("EMD") is comprised of engineering labor, consulting services, and other costcosts associated with specific design and development projects that are billable under specific customer agreements.

        We intendThe Company intends to continue investing in development of new products that complement ourits current product offerings and will expense associated costs as they are incurred.

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

        We sell ourIS&S sells its products to agencies of the United States and foreign governments, aircraft operators, aircraft modification centers, and original equipment manufacturers. OurThe Company's customers have been and may continue to be affected by the recentongoing adverse economic conditions that currently exist both in the United States and abroad. Such conditions may cause ourthe Company's customers to curtail or delay spending on both new and existing aircraft. Factors that can impact general economic conditions and the level of spending by ourIS&S customers include, but are not limited to, general levels of consumer spending, increases in fuel and energy costs, conditions in the real estate and mortgage markets, labor and healthcare costs, access to credit, consumer confidence, and other macroeconomic


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factors affectingwhich can affect spending behavior. In addition, future spending by government agencies may be further reduced due tobecause of declining tax revenues associated with thisthe present economic downturn.environment. If ourthe Company's customers curtail or delay their spending, or are forced to declare bankruptcy or liquidate their operations due to recentbecause of adverse economic conditions, ourIS&S's revenues and results of operations will be adverselynegatively affected. However, we believethe Company believes that, in a declining economic environment, a customercustomers that may have otherwise elected to purchase newly manufactured aircraft, will insteadmay be interested instead in retrofitting existing aircraft as a cost effective alternative, which will create a market opportunity for ourIS&S's products.


Table        On November 29, 2011, AMR Corporation, the parent company of ContentsAmerican Airlines, Inc. and certain of its other U.S.-based subsidiaries filed voluntary petitions for Chapter 11 reorganization in the U.S. Bankruptcy Court for the Southern District of New York. The Company's revenues from American Airlines, Inc. accounted for 5%, 8% and 8% total revenue for the fiscal years 2012, 2011 and 2010, respectively. As at September 30, 2012, orders from American Airlines, Inc. account for a material portion of the Company's backlog. (See Note 13—Commitments and Contingencies in Notes to Consolidated Financial Statements attached).

        The Company experienced significant reductions of headcountpersonnel costs in fiscal 20102012 and 2009, as2011, primarily through resignation and retirements of employees who were not replaced, and a result of a 52 person workforceplanned reduction that was implemented in late fiscal 2008.workforce. The reductions affected most departments in the Company with the majority coming from the engineering department.Company.

Results of Operations

        The following table sets forth statement of operations data expressed as a percentage of total net sales for the fiscal years indicated (some items may not add due to rounding):



 Twelve Months Ending
September 30,
  Twelve Months Ending
September 30,
 


 2010 2009 2008  2012 2011 2010 

Net sales:

Net sales:

  

Product

 74.4% 97.8% 92.6%

Engineering—modification and development

 25.6% 2.2% 7.4%

Product

 92.6% 86.7% 85.0%       

Engineering—modification and development

 7.4% 13.3% 15.0%
       
 

Total net sales

 100.0% 100.0% 100.0%

Total net sales

 100.0% 100.0% 100.0%
              

Cost of sales

Cost of sales

  

Product

 38.2% 45.8% 42.5%

Engineering—modification and development

 19.0% 0.6% 3.1%

Product

 42.5% 45.2% 57.6%       

Engineering—modification and development

 3.1% 3.5% 9.7%
       
 

Total cost of sales

 45.6% 48.7% 67.3%

Total cost of sales

 57.2% 46.4% 45.6%
              

Gross profit

Gross profit

 54.4% 51.3% 32.7% 42.8% 53.6% 54.4%

Operating expenses:

Operating expenses:

  

Research and development

 11.0% 21.4% 20.7%

Selling, general and administrative

 30.1% 29.9% 32.1%

Research and development

 20.7% 14.5% 33.7%       

Total operating expenses

 41.1% 51.3% 52.8%

Selling, general and administrative

 32.1% 23.5% 73.1%       

Asset impairment

 0.0% 0.0% 8.1%
       
 

Total operating expenses

 52.8% 38.0% 114.9%
       

Operating income (loss)

 1.6% 13.3% (82.2)%

Operating income

 1.7% 2.3% 1.6%

Interest income

Interest income

 
0.7

%
 
1.1

%
 
5.2

%
 0.4% 0.6% 0.7%

Interest (expense)

Interest (expense)

 (0.0)% (0.2)% (0.5)% (0.1%) (0.1%) (0.0%)

Other income

Other income

 0.2% 0.1% 56.7% 0.3% 0.6% 0.2%
              

Income (loss) before income taxes

 2.5% 14.3% (20.9)%

Income (loss) before income taxes

 2.3% 3.4% 2.5%

Income tax expense (benefit)

Income tax expense (benefit)

 
- -0.4

%
 
0.6

%
 
4.9

%
 (9.8%) 0.7% (0.4%)
              

Net income (loss)

 3.0% 13.6% (25.9)%

Net income

 12.1% 2.7% 3.0%
              

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    Fiscal Year Ended September 30, 20102012 Compared to Fiscal Year Ended September 30, 20092011

        Net sales.    Net sales decreased $11.5$1.2 million, or 31.2%4.5%, to $25.3$24.5 million for fiscal 20102012 from $36.7$25.7 million for fiscal 2009.2011. For fiscal 2010,2012, product sales decreased $8.5$6.9 million and EMD sales decreased $3.0increased $5.7 million from fiscal 2009.2011. The decrease in product sales was primarily driventhe result of decreased shipments to customers who slowed or delayed their respective retrofit programs, while the increase in EMD sales resulted from new customer design and EMD programs. For fiscal 2012 and 2011, the Company recognized equal amounts of revenue and cost of $2.4 million and $0, respectively, related to certain contracts for which a zero margin approach to applying the percentage of completion method is used in accordance with the guidance of Financial Accounting Standards Board Accounting Standards Codification Topic 605-35, "Construction-Type and Production-Type Contracts", which substantially explains the lower gross profit percentage on EMD revenues for the year ended September 30, 2012 when compared to the year ended September 30, 2011.

        Cost of sales.    Cost of sales increased $2.1 million, or 17.8%, to $14.1 million, or 57.2% of net sales for fiscal 2012 from $11.9 million, or 46.4% of net sales for fiscal 2011. The increase resulted primarily from the change in sales mix and the decrease in product sales volume in fiscal 2012 as compared to fiscal 2011. As a result of the decreased sales volume, product cost of sales for the year ended September 30, 2012 was lower as a percentage of total net sales at 38.2% compared to 45.8% for the year ended September 30, 2011. The combination of decreased net sales and change in product mix resulted in a lower gross profit percentage compared to the same period in the prior year.

        Research and development.    Research and development expense decreased $2.8 million, or 51.0%, to $2.7 million or 11.0% of net sales for fiscal 2012, from $5.5 million or 21.4% of net sales for fiscal 2011. The decrease in research and development expense for the year ended September 30, 2012 was primarily the result of the change in mix whereby a higher number of engineering hours were devoted to working on new customer design and EMD programs instead of internal research and development.

        Selling, general, and administrative.    Selling, general and administrative expenses decreased $0.3 million, or 3.7%, to $7.4 million, or 30.1% of net sales for fiscal 2012 from $7.7 million or 29.9% of net sales for fiscal 2011. The slight decrease in selling, general, and administrative expense for the year ended September 30, 2012 was primarily the result of a reduced number of personnel compared to the prior year period and cost containment efforts. The increase as a percentage of net sales for the year ended September 30, 2012, compared to the prior year ended September 30, 2011, is attributable primarily to the decrease in net sales.

        Interest income, net.    Net interest income decreased by customer delays$42,000 to $100,000 or 0.4% of net sales for fiscal 2012 from $142,000 or 0.6% of net sales for fiscal 2011. The decrease in delivery schedulesinterest income was primarily because of lower interest rates during fiscal 2012 compared to fiscal 2011.

        Other income.    Other income decreased marginally by $0.1 million in fiscal 2012 when compared to fiscal 2011 from proceeds of miscellaneous income items.

        Income taxes.    The income tax benefit for backlog orders,fiscal year ended September 30, 2012 was $2.4 million compared to an income tax expense of $0.2 million for the fiscal year ended September 30, 2011. The tax benefit was attributable primarily to the reversal of valuation allowances of $2.4 million for the fiscal year ended September 30, 2012 related to federal net deferred tax assets in accordance with ASC Topic 740 "Income Taxes" because of the recent history of income before income taxes, together with projections of profitability in fiscal 2013 and future years.

        The effective tax benefit rate for the year ended September 30, 2012 was (411.9%). The effective tax benefit rate differs from the statutory rate for the year ended September 30, 2012 primarily because of the reversal of valuation allowances of $2.4 million for the fiscal year ended September 30, 2012 related to federal net deferred tax assets in accordance with ASC Topic 740 "Income Taxes".


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        The effective tax rate for the year ended September 30, 2011 was 20.4%. The effective tax rate differs from the statutory rate for the year ended September 30, 2011 primarily due to the utilization of research and development tax credits.

        The Company had maintained a full valuation allowance against its deferred tax assets in prior years due to uncertainty as to the extent and timing of profitability in future periods. At September 30, 2012, the Company considered all available evidence, including the recent history of pre-tax income, together with projections of profitability in future periods. As a result of this analysis, the Company determined that the positive evidence at September 30, 2012 was sufficient to conclude that it was appropriate to reverse the valuation allowance previously recorded against its net federal deferred tax assets at September 30, 2012. The Company believes that its estimate of future taxable income is inherently uncertain, and if its current or future operations generate losses, further adjustments to the valuation allowance are possible. The current balance of the deferred tax valuation allowance relates principally to net operating losses ("NOL") of certain state taxing jurisdictions. There is currently no assurance of such future income before income taxes.

        Net income.    As a result of the factors described above, the Company's net income for fiscal 2012 was $3.0 million for fiscal 2012 compared to net income of $0.7 million for fiscal 2011. On a fully diluted basis, the net income per share was $0.18 for fiscal 2012, compared to $0.04 for fiscal 2011.

Fiscal Year Ended September 30, 2011 Compared to Fiscal Year Ended September 30, 2010

        Net sales.    Net sales increased $0.5 million, or 1.9%, to $25.7 million for fiscal 2011 from $25.2 million for fiscal 2010. For fiscal 2011, product sales increased $1.8 million and EMD sales decreased $1.3 million from fiscal 2010. The increase in product sales was primarily the result of sales to new commercial customers and retrofit upgrades for Eclipse E500 aircraft owners through Eclipse Aerospace Inc., while the decrease in EMD sales was primarily driven bythe result of a reduction in volume and a delayed contract award.

        Cost of sales.    Cost of sales decreased $6.4increased $0.4 million, or 35.6%3.7%, to $11.9 million, or 46.4% of net sales for fiscal 2011 from $11.5 million, or 45.6% of net sales for fiscal 20102010. The increase resulted primarily from $17.9 million, or 48.7% of net sales for fiscal 2009. The decrease was primarily driven by a decreasean increase in variable production costs associated with reducedincreased sales volume and higher material costs in fiscal 2010 as2011 compared to fiscal 2009, resumed sales associated with the Eclipse E500 aircraft that hadde minimis direct costs and a continued focus on cost reduction.


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        Research and development.    Research and development expense decreased $0.1increased $0.3 million, or 1.5%5.1%, to $5.5 million or 21.4% of net sales for fiscal 2011 from $5.2 million, or 20.7% of net sales for fiscal 2010—2010. This increase resulted from $5.3 million or 14.5% of net sales for fiscal 2009. This reductionresearch and development investment incurred to win EMD contracts, and is consistent with the Company's strategy to target a percentage of total costssales in a given period, for the purposes of continued investment in on-going research and developmentdevelopment. The Company's R&D expense consists primarily of our core products.payroll-related expenses of employees engaged in R&D activities, engineering related product materials and equipment and subcontracting costs.

        Selling, general, and administrative.    Selling, general and administrative expenses decreased $0.5$0.4 million, or 6.3%5.1%, to $7.7 million, or 29.9% of net sales for fiscal 2011 from $8.1 million or 32.1% of net sales for fiscal 2010 from $8.6 million or 23.5% of net sales for fiscal 2009.2010. The decrease was primarily due tothe result of a reduction in compensationselling expenses associated with(primarily reduced participation in trade shows) and travel expenses during the forfeiture of non-vested stock options of $0.3 million related to the resignation of the former CFO and of $0.1 million on the elimination of amortization expense related to an Industrial Development Bond that was retired in August, 2009.year.

        Interest (income) expense,income, net.    Net interest income decreased $0.1 millionslightly by $43,000 to $142,000 or 41.1%, to $0.2 million0.6% of net sales for fiscal 20102011 from $0.3 million$186,000 or 0.7% of net sales for fiscal 2009 which2010. The decrease was primarily the resultbecause of lower interest rates during fiscal 20102011 compared to fiscal 2009, partially offset by the elimination of interest related to an Industrial Development Bond that was retired in August, 2009.2010.

        Other income.    Other income wasincreased marginally by $0.1 million for bothin fiscal 2011 compared to fiscal 2010 and fiscal 2009.from proceeds of settlements of legal proceedings.


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        Income taxes.    The income tax benefitexpense for fiscal year ended September 30, 20102011 was $0.1$0.2 million compared to an income tax expensebenefit of $0.2$0.1 million for the fiscal year ended September 30, 2009.2010. The decreaseincrease in the amount of tax from a tax benefit to an expense was attributable primarily to athe increase in pre-tax income for the fiscal year ended 2011, and less net reversals of deductible temporary differences in the fiscal year ended September 30, 2011 compared to the fiscal year ended September 30, 2010.

        The effective tax rate for the year ended September 30, 2011 was 20.4%. The effective tax rate differs from the statutory rate for the year ended September 30, 2011 primarily due to the utilization of research and development tax credits.

        The effective tax benefit was primarily attributable to the decrease in pre-tax income.

        Effective tax ratesrate for the yearsyear ended September 30, 2010 and 2009 were (17.1)% and 4.5%, respectively.was (17.1%). The effective tax rate differs from the statutory rate for the year ended September 30, 2010 due to: 1)to the reversal of certain deductible temporary differences in the fiscal year ended September 30, 2010, which at September 30, 2009 were offset by a valuation allowance, as such reversals generated current tax benefits in the fiscal year ended September 30, 2010, and 2) decreases in uncertain tax positions due to the lapse of applicable statutes of limitations.

        The effective tax rate differs from the statutory rate for the year ended September 30, 2009 due to: 1) reversal of certain deductible temporary differences in the fiscal year ended September 30, 2009, which at September 30, 2008 were offset by a valuation allowance, as such reversals generated current tax benefits in the fiscal year ended September 30, 2009, and 2) utilization of research and experimentation tax credits.limitation.

        Net income (loss).income.    As a result of the factors described above, ourthe Company's net income for fiscal 20102011 was $0.7 million. The net incomemillion for both fiscal 2009 was $5.0 million.2011 and fiscal 2010. On a fully diluted basis, the net income per share ofwas $0.04 for both fiscal 2010 compared to a net income per share of $0.302011 and for fiscal 2009.2010.

    Fiscal Year Ended September 30, 2009 Compared to Fiscal Year Ended September 30, 2008

        Net sales.    Net sales increased $6.2 million, or 20.3%, to $36.7 million for fiscal 2009 from $30.5 for fiscal 2008. For fiscal 2009, product sales increased $5.9 million and EMD sales increased $0.3 million from fiscal 2008. The increase in product sales was primarily related to growth in flat panel display associated with B757/B767 and C130 aircraft, partially offset by sales declines associated with the Eclipse 500 aircraft ($12.8 million in 2008 and $0.1 million in 2009), which resulted due to the bankruptcy of Eclipse on November 25, 2008. Excluding Eclipse sales from fiscal 2008, the Company's net sales would have increased $19.0 million or 107% for fiscal 2009. The increase in EMD sales was primarily a result of a new agreement with the DoD.


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        Cost of sales.    Cost of sales decreased $2.7 million or 12.9%, to $17.9 million, or 48.7% of net sales for fiscal 2009 from $20.6 million, or 67% of net sales for fiscal 2008. The decrease was primarily driven by inventory reserves in fiscal 2008 of approximately $1.9 million, associated with suspension of activity related to the Eclipse program in anticipation of Eclipse's bankruptcy, which occurred on November 25, 2008, the financial impact of this event did not repeat in fiscal 2009. Decrease was also attributable to lower employee related expenses as a result of the cost containment efforts described at the end of the Overview section of Management's Discussion and Analysis of Financial Condition and Results of Operations, partially offset by the cost of sales associated with net sales growth. Cost of sales for fiscal 2009 included reserves of approximately $0.5 million for warranty and costs associated with product support program initiated by the Company.

        Research and development.    Research and development expense decreased $5.0 million or 48% to $5.3 million or 15% of net sales for fiscal 2009; from $10.3 million or 34% of net sales for fiscal 2008. The decreased expense in fiscal 2009 was primarily due to a reduction in headcount related costs and a decrease in costs from third-party subcontractors of $3.3 million and $3.5 million, respectively, offset by an increase in deferred EMD costs of $1.8 million.

        Selling, general, and administrative.    Selling, general and administrative expenses decreased $13.7 million, or 61.2%, to $8.6 million, or 23.5% of net sales for fiscal 2009 from $22.3 million or 73% of net sales for fiscal 2008. The decrease was primarily due to a reduction in professional fees, specifically legal costs incurred in connection with litigation related to protecting its intellectual property, and a decrease in headcount related costs of $5.7 million and $2.1 million respectively.

        Interest (income) expense, net.    Net interest income decreased $1.1 million or 78%, to $0.3 million for fiscal 2009 from $1.4 million for fiscal 2008 which was primarily the result of lower interest rates during fiscal 2009 compared to fiscal 2008.

        Other income.    Other income was $0.1 million for fiscal 2009 as compared to $17.3 million for fiscal 2008. Other income in fiscal 2008 was driven by the receipt of $17.0 million in proceeds related to the settlement of the Company's trade secret litigation and $0.3 million related to short-swing profit disgorgement proceeds from a shareholder that occurred in 2008.

        Income taxes.    Income tax expense for the fiscal year ended September 30, 2009 was $0.2 million compared to $1.5 million for the fiscal year ended September 30, 2008. The decrease in the amount of income tax expense is primarily the result of the reversal of certain deductible temporary differences in the fiscal year ended September 30, 2009 and the establishment of a full valuation allowance on the deferred tax assets during the fiscal year ended September 30, 2008.

        The effective tax rates for the years ended September 30, 2009 and 2008 were 4.5% and (23.6)%, respectively. The effective tax rate differs from the statutory rate for the year ended September 30, 2009 due to: 1) reversal of certain deductible temporary differences in the fiscal year ended September 30, 2009, which at September 30, 2008 were offset by a valuation allowance, as such reversals generated current tax benefits in the fiscal year ended September 30, 2009, and 2) utilization of research and experimentation tax credits. The effective tax rate differs from the statutory rate for the year ended September 30, 2008 due to the establishment of a full valuation allowance on net deferred tax assets during the quarter ended March 31, 2008.

        Net income (loss).    As a result of the factors described above, our net income for fiscal 2009 was $5.0 million. The net loss for fiscal 2008 was ($7.9 million). On a fully diluted basis, the net income per share of $0.30 for fiscal 2009 compares to a loss per share of ($0.47) for fiscal 2008.

Related-Party Transactions:

        The Company incurred legal fees of $138,000, $105,000 and $128,000 with a law firm whose partners are shareholders of the Company for the years ended September 30, 2010, 2009 and 2008 respectively. The fees paid and services rendered were comparable with fees paid to other unrelated law firms.


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        For the years ended September 30, 2010, 2009 and 2008, respectively, the Company incurred service fees of $25,000, $0 and $67,000 with a commercial graphics firm controlled by an individual who is married to a shareholder and daughter of the Company's Chairman and Chief Executive Officer.

Liquidity and Capital Resources

 
 September 30,
2012
 September 30,
2011
 

Cash and cash equivalents

 $42,977,501 $42,625,854 

Accounts receivable, net

 $3,978,512 $3,124,114 

Current assets

 $54,377,366 $50,572,834 

Current liabilities

 $5,289,828 $3,240,724 

Deferred revenue

 $1,426,552 $232,630 

Total debt and other non-current liabilities(1)

 $227,000 $769,282 

Quick ratio(2)

  8.88  14.12 

Current ratio(3)

  10.28  15.61 

 

 
 Twelve Months Ended September 30, 
 
 2012 2011 2010 

Cash flow activites:

          

Net cash provided by operating activites

 $1,380,831 $2,276,166 $5,600,467 

Net cash used in investing activites

  (217,533) (255,454) (189,790)

Net cash used in financing activites

  (811,651) (311,204) (60,025)

The following table highlights key financial measurements of the Company:

 
 September 30,
2010
 September 30,
2009
 

Cash and cash equivalents

 $40,916,346 $35,565,694 

Accounts receivable, net

  2,529,976  6,188,706 

Current assets

  49,607,834  48,792,791 

Current liabilities

  3,296,778  4,168,314 

Deferred revenue

  166,621  225,648 

Total debt and other non-current liabilities(1)

  826,927  918,072 

Quick ratio(2)

  13.18  10.02 

Current ratio(3)

  15.05  11.71 


 
 Twelve Months Ending
September 30,
 
 
 2010 2009 

Cash flow activites:

       
 

Net cash provided by operating activites

 $5,600,467 $5,319,549 
 

Net cash (used in) investing activites

  (189,790) (331,895)
 

Net cash (used in) financing activites

  (60,025) (4,453,892)

(1)
Excludes deferred revenue,revenue; includes current portion of capitalized lease obligations

(2)
Calculated as: (Cashthe sum of cash and cash equivalents and Accountsplus accounts receivable, net)net, divided by Currentcurrent liabilities

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

        Our primaryThe Company's principal source of liquidity washas been cash flow provided by operating activities. We requireflows from current year operations and cash accumulated from prior years' operations. Cash is used principally to finance inventory, payrollaccounts receivable and payroll.


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Operating Activities

        During fiscal 2012, the Company generated $1.4 million in cash from operating activities. Cash generated from operations was due primarily to increases in accounts receivable.payable, accrued expenses and deferred revenues resulting from advance billings to customers as scheduled by the respective EMD program contracts. These were offset partially by increases in inventory and unbilled receivables, which funded materials, inventory and third party service providers to fulfill the Company's obligations under the EMD programs.

        The Company generated $2.3 million in cash flow from operating activities during fiscal 2011. A focus on inventory reduction contributed to the positive cash flow, and was offset by increases in accounts receivable and decreases in accounts payable and accrued expenses. Increase in accounts receivable at the end of 2011 was due to higher sales to customers on normal credit terms at the end of the year compared to sales to customers on advance payment terms at the end of 2010.

        Cash flow provided by operating activities was $5.6 million in fiscal 2010, as compared to $5.3or a $0.3 million increase from operating activities in fiscal 2009, despite the $4.3 million decline in net income in fiscal 2010. The $0.3 million differenceincrease was attributable primarily attributable to decreasedecreases in accounts receivable, prepaid expenses, inventory reductions and a continued focus on inventory reduction,an increase in income tax payable, offset by a decrease in accounts payable and accrued expenses and income taxes payable. The Company had positive operating cash flow of $4.2 million for fiscal 2008 primarily as a result of a change in the provision for losses on accounts receivable, an increase to excess and obsolete expense, an asset impairment charge and a decrease in prepaid expenses and other assets, partially offset by the net operating loss realized.expenses.

Investing Activities

        Cash used in investing activities was $0.2 million, $0.3 million and $0.6$0.2 million for fiscal year 2010, 20092012, 2011 and 20082010 respectively, and consisted of spending for licensing fees, production equipment, and laboratory test equipment.equipment and licensing fees. The Company plans to continue investing in capital expenditures at approximately the same level it has in prior years.

Financing Activities

        Cash used in financing activities was $0.8 million for fiscal year 2012 and was used primarily for the repurchase of 211,722 shares of the Company's common stock. Cash used in financing activities was $0.3 million for fiscal year 2011 and consisted primarily of the repurchase of 62,400 shares of the Company's common stock. Cash used in financing activities was $0.1 million for fiscal year 2010 and consisted primarily of the repurchase of 12,000 shares of the Company's common stock for $0.1 million. Cash used in financing activities was $4.5 million for fiscal year 2009 and consisted primarily of the repayment in full of the Industrial Development Bond of $4.3 million and the repurchase of 25,000 shares of common stock forstock.


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$0.1 million. Cash used in financing activities was $17.7 million for fiscal year 2008 and consisted primarily of a special dividend of $16.7 million paid along with share repurchases of $1.0 million.

        To accommodate future growth, in 2001 the Company purchased 7.5 acres of land in the Eagleview Corporate Park, Exton, Pennsylvania, and built a 44,800 square foot facility that is expandable to 65,200 square feet. Both the land and building cost approximate $6.5 million, $4.3 million of which was funded through an Industrial Development Bond (IDB) and the remainder from cash from operations. The Company retired the IDB during August 2009, for $4.3 million.

        Our futureFuture capital requirements depend onupon numerous factors, including market acceptance of ourthe Company's products, (in particular flat panel display systems), the timing and rate of expansion of our business, acquisitions, joint ventures, and other factors. We haveIS&S has experienced increases in our expenditures since ourits inception, consistent with growth in our operations, personnel, and product line and we anticipateanticipates that our operations and expenditures will continue to increase in the foreseeable future. We believe ourOn December 7, 2012 the Company's Board of Directors declared a special cash dividend in the amount of $1.50 per share, payable on or about December 27, 2012 to shareholders of record as of the close of business on December 17, 2012. The aggregate amount of the payment to be made in connection with the dividend will be approximately $24.9 million. The Company believes that its cash and cash equivalents after payment of the special cash dividend will still be sufficient to provide sufficient capital to fund our operations for at least the next twelve months. However, weFurther, IS&S may need to raise additional funds through public or private financing or other arrangements if our business grows more rapidly than we anticipate. Potential lenders may have suffered losses related to their lending and other financial relationships, especially because of the general weakening of the national economy and increased financial instability of many borrowers. As a result, lenders may become insolvent or tighten their lending standards, which could make it more difficult for us to borrow or to obtain new financing on favorable terms or at all. Our financial condition and results of operations would be adversely affected if we were unable to obtain cost-effective financing in the future. Further, we may develop and introduce new or enhanced products, to respond to competitive pressures, to invest in or acquire businesses or technologies, or to respond to unanticipated requirements or developments. If additional funds are raised through the issuance of equity securities, dilution to existing shareholders may result. If insufficient funds are available, the Company may not be able to introduce new products or to compete effectively.


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Contractual Obligations

        OurThe Company's contractual obligations as of September 30, 20102012 mature as follows:

 
 Payments Due by Period 
Contractual Obligations
 Total Less than 1 Year 1-3 Years 4-5 Years After 5 Years 

Office lease

  10,577  10,577       

Purchase obligations*

  1,881,045  1,620,695  77,282  183,068   

Other liabilities

  98,002    98,002     
            

 $1,989,624 $1,631,272 $175,284 $183,068 $ 
            

 
 Payments Due by Period 
Contractual Obligations(1)
 Total Less than
1 Year
 1 - 3 Years 4 - 5 Years After 5
Years
 

Capital Leases, including interest

  25,468  9,908  15,560     

Purchase obligations(2)

  1,663,136  1,502,709  160,427     
            

  1,688,604  1,512,617  175,987     
            

(1)
Since we are unable to reasonably estimate the timing of ultimate payment, the amounts set forth above do not include any payments that may be made related to uncertain tax positions including interest.

(2)*
A "purchase obligation" is defined as an agreement to purchase goods or services that is enforceable and legally binding on the companyCompany and that specifies all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. These amounts are primarily comprised of open purchase order commitments entered in the ordinary course of business with vendors and subcontractors pertaining to fulfillment of ourthe Company's current order backlog.

Off-Balance Sheet Arrangements

        The Company has no off-balance sheet arrangements.


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Inflation

        We doIS&S does not believe inflation had a material effect on ourits financial position or results of operations during the past three years, however, weyears. However, it cannot predict future effects of inflation.

Critical Accounting Policies

        The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires management to make estimates and assumptions that affect reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. The Company's most critical accounting policies are revenue recognition, income taxes, inventory valuation, share based compensation and warranty reserves.

    Revenue recognition

        The Company enters into sales arrangements with customers that, in general, provide for the Company to design, develop, manufacture and deliver large flat-panel display systems, flight information computers, large flat-panel displays, and advanced monitoring systems that measure and display critical flight information, including data relative to aircraft separation, airspeed, and altitude, as well as engine and fuel data measurements. Additionally, during fiscal year ended September 30, 2010 the Company began delivery in accordance with a new arrangement with a new customer to provide, among other deliverables, functional upgrades to the Company's flight information computers and flat-panel displays. The Company's sales arrangements may include multiple deliverables as defined in FASB ASC Topic 605-25 "Multiple-Element Arrangements" (ASC("ASC Topic 605-25)605-25"), which typically include design and engineering services and the production and delivery of the flat panel display and related components. The Company includes any design and engineering services elements in EMD sales and any functional upgrade and product elements in product sales on the accompanying consolidated statement of operations.

        To the extent that an arrangement contains software elements that are essential to the functionality of tangible products sold in the arrangement, the Company recognizes revenue for the deliverables in


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accordance with the guidance included in FASB Accounting Standards Update 2009-14, "Revenue Arrangements That Include Software Elements", ("ASU 2009-14"), ASU 2009-13 and FASB ASC Topic 605, "Revenue Recognition" ("ASC Topic 605").

        To the extent that an arrangement contains software components, which include functional upgrades, that are sold on a standalone basis and which the Company has deemed outside the scope of the exception defined by ASU 2009-14, the Company recognizes software revenue in accordance with ASC Topic 985, "Software" ("ASC Topic 985").

Multiple Element Arrangements—

        The Company identifies all goods and/or services that are to be delivered separately under such a sales arrangement and allocates revenue to each deliverable (if more than one) based on that deliverable's selling price. The Company then considers the appropriate recognition method for each deliverable; deliverables under multiple element arrangements are typically purchased engineering and design services and product sales and/or the sale of functional upgrades.deliverable. The Company's multiple element arrangements can include typically include defined design and development activities and/or functional upgrades, along with product sales.

        The Company utilizes the selling price hierarchy that has been established by FASB Accounting Standards Update (ASU) 2009-13, "Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force" (ASU 2009-13)("ASU 2009-13"), which requires that the selling price for each deliverable be based on vendor-specific objective evidence if available, third-party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific objective evidence nor third-party evidence is available. To the extent that an arrangement includes a deliverable for which estimated selling price is used, the Company's determines the best estimate of selling price by applying the same pricing policies and methodologies that would be used to determine the price to sell the deliverable on a standalone basis.

        To the extent that an arrangement contains software elements that are essential to the functionality of tangible products sold in the arrangement, the Company recognizes revenue for the deliverables in accordance with the guidance included in FASB Accounting Standards Update 2009-14, "Revenue Arrangements That Include Software Elements", ASU 2009-13 and FASB ASC Topic 605, "Revenue Recognition" (ASC Topic 605).


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        To the extent that an arrangement contains defined design and developmentEMD activities as an identified deliverable in addition to products (resulting in a multiple element arrangement), the Company recognizes as Engineering—Modification and Development ("EMD")EMD revenue amounts earned during the design and development phase of the contract following the guidance included in FASB ASC Topic 605-35, "Construction-Type and Production-Type Contracts" (ASC("ASC Topic 605-35)605-35"). To the extent that multiple element arrangements include product sales, revenue is generally recognized once revenue recognition criteria for the product deliverable hashave been met based on the provisions of FASB ASC Topic 605, "Revenue Recognition"(ASC Topic 605).

        To605. The Company includes any design and engineering services elements in EMD sales and any functional upgrade and product elements in "Product" sales on the extent that an arrangement contains software components, which include functional upgrades, that are sold on a standalone basis and the Company has deemed outside the scope the exception defined by ASU 2009-14, the Company recognizes software revenue in accordance with ASC Topic 985, "Software" (ASC Topic 985).accompanying consolidated statement of operations.

Single Element Arrangements—

    Products—

        To the extent that a single element arrangement provides for product sales and repairs, the Company recognizes revenue is generally recognized oncewhen revenue recognition criteria for the product deliverable hashave been met based on the provisions of ASC Topic 605. The Company also receives orders for existing equipment and parts. RevenueGenerally, revenue from the sale of such products is generally recognized upon shipment to the customer.

        The Company offers its customers extended warranties for additional fees. These warranty sales are recorded as deferred revenue and recognized as sales on a straight-line basis over the warranty period.

    Engineering Services—Engineering—modification and development services

        The Company also may enter into service arrangementscontracts to perform specified design and developmentEMD services related to its products. The Company recognizes revenue from these arrangements as EMD revenue, following the guidance included in ASC Topic 605-35. The Company605-35, and considers the nature of these service arrangementscontracts (including


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term, size of contract, and level of effort) when determining the appropriate accounting treatment for a particular contract. The Company recognizes the revenue fromCertain of these contracts using eitherare accounted for under the percentage-of-completion method or completed contract method of accounting.

        The Company records revenue relating to these contracts using the percentage-of-completion methodaccounting when the Company determines that progress toward completion is reasonable and reliably estimable, and the contract is long-term in nature; thenature. The Company uses the completed contract method for all others.others contracts. Sales and earnings under the percentage-of-completion method are recorded based on the ratio of actual costs incurred to total estimated costs expected to be incurred related to the contract under the cost-to-cost method (for development effort).

            The percentage-of-completion method of accounting requires the Company to estimate the profit margin for each individual contract, and to apply that profit margin on a uniform basis as sales are recorded under the contract. The estimation of profit margins requires the Company to make projections of the total sales to be generated and the total costs that will be incurred under a contract. These projections require the Company to make numerous assumptions and estimates relating to items such as the complexity of design and related development costs, performance of subcontractors, availability and cost of materials, engineering productivity and cost, overhead and capital costs. These contracts sometime include purchase options for additional quantities and customer change orders for additional or revised product functionality. Sales and costs related to profitable purchase options are included in the Company's estimates only when the options are exercised, while sales and costs related to unprofitable purchase options are included in the Company's estimates when exercise is determined to be probable. Sales related to change orders are included in profit estimates only if they can be reliably estimated and collectability is reasonably assured. Purchase options and change orders are accounted for either as an integral part of the original contract, or separately depending upon the nature and value of the item. Anticipated losses on contracts are recognized in full in the period in which losses become probable and estimable.

            For contracts for which uncertainty regarding the performance against certain contract terms remains and in which no loss is expected, the Company uses the zero profit margin approach to applying the percentage of completion method following the guidance included in FASB ASC Topic 605-35.

            Estimates of profit margins for contracts are reviewed typically by the Company on a quarterly basis. Assuming the initial estimates of sales and costs under a contract are accurate, the percentage-of-completion method results in the profit margin being recorded evenly as revenue is recognized under the contract. Changes in these underlying estimates due to revisions in sales and cost estimates, or the exercise of contract options may result in profit margins being recognized unevenly over a contract as such changes are accounted for on a cumulative basis in the period estimates are revised. Significant changes in estimates related to accounting for long-term contracts may have a material effect on the Company's results of operations in the period in which the revised estimate is made. Cumulative catch-up adjustments resulting from changes in estimates did not have a material effect on our results of operations during the years ended September 30, 2012, 2011 or 2010.

    Income taxes

        Income taxes are recorded in accordance with FASB ASC Topic 740, "Income Taxes" (ASC"Income Taxes" ("ASC Topic 740)740"), which principally utilizes a balance sheet approach to provide for income taxes. Under this method, the Company recognizes deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of the Company's assets, liabilities and expected benefits of utilizing net operating loss and tax credit carry-forwards. The impact on deferred taxes of changes in tax rates and laws, if any, are applied to the years during which temporary differences are expected to be settled, and are reflected in the consolidated financial statements in the period of enactment.

        Deferred tax assets are reduced by valuation allowances if, based on the consideration of all available evidence, it is more likely than not that some portion of the deferred tax asset will not be


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realized. Significant weight is given to evidence that can be objectively verified.verified, and significant management judgment is required in determining any valuation allowances recorded against net deferred tax assets. The Company evaluates deferred income taxes on a quarterly basis to determine if valuation allowances are required by considering available evidence. Deferred tax assets are realized by having sufficientrecognized when expected future taxable income is sufficient to allow the related tax benefits to reduce taxes that would otherwise be payable. The sources of taxable income that may be available to realize the benefit of deferred tax assets are future reversals of existing taxable temporary differences, future taxable income exclusive of reversing temporary differences and credit carry-forwards, taxable income in carry-back years, and tax planning strategies thatwhich are both prudent and feasible. In the event theThe Company were to determinebelieves that it would be able to realize its deferred tax assets in theestimate of future in excess of the net recorded amount, an adjustment would be madetaxable income is inherently uncertain, and if its current or future operations generate losses, further adjustments to the valuation allowance which would reduceare possible. The current balance of the provision fordeferred tax valuation allowance relates principally to net operating losses ("NOL") of certain state taxing jurisdictions. There is currently no assurance of such future income before income taxes.

        The accounting for uncertainty in income taxes requires a more likely than not threshold for financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. The Company records a liability for the difference between the (i) benefit recognized and measured for financial statement purposes and (ii) the tax position taken or expected to be taken on ourthe Company's tax return. To the extent that ourthe Company's assessment of such tax positions changes, the change in estimate is recorded in the period in which the determination is made. The Company has elected to record any interest or penalties from theassociated with uncertain tax positionpositions as income tax expense.

        The Company files a consolidated United States federal income tax return. The Company prepares and files tax returns based on the interpretation of tax laws and regulations, and records estimates based on these judgments and interpretations. In the normal course of business, the tax returns are subject to examination by various taxing authorities. Such examinations may result in future tax and interest assessments by these taxing authorities, and the Company records a liability when it is probable that there will be an assessment. The Company adjusts the estimates periodically because of ongoing examinations by and settlements with the various taxing authorities, as well as changes in tax laws, regulations and precedent. The consolidated tax provision of any given year includes adjustments to prior year income tax accruals that are considered appropriate and any related estimated interest. Management believes that adequate accruals have been made for income taxes. Differences between estimated and actual amounts determined upon ultimate resolution, individually or in the aggregate, are not expected to have a material adverse effect on our consolidated financial position but could possibly be material to our consolidated results of operations or cash flow of any one period.

    InventoriesInventory valuation

        The Company values inventory at the lower of cost (first-in, first-out) or market through the establishment of inventory reserves.market. Inventories are written down for estimated obsolescence equal to the difference between inventory cost and estimated net realizable value based on a combination of historical usage and assumptions aboutbased on expected usage related to estimated future customer and market conditions.demands. The Company's reservemethod of valuing inventory contains uncertainties because the calculation requires management to consider inventory aging, to make assumptions regarding expected usage, and to apply judgment regarding inventory aging,judgments on forecasted future demand, market conditions, and technological obsolescence. If actual future demand or market conditions are less favorable than those projected by management, additional inventory write-downswrite-down may be required.

    Share-basedStock-based compensation

        The Company adopted the provisions ofaccounts for stock-based compensation under FASB ASC Topic 505-50, ""Equity-Based Payments to Non-Employees" ("ASC Topic 505-50") and FASB ASC Topic 718, "Stock Compensation"Compensation" ("ASC Topic 718"), usingwhich require the modified prospective approach and accountsCompany to measure the cost of employee or non-employee director services received in exchange for share-based compensation applyingan award of equity instruments based on the grant-date fair value methodof the award using an option pricing model. That cost is recognized over the period during which an employee or non-employee director is required to provide service in exchange for expensing stock options and non-vested stock awards.the award.

        Accordingly, adoption of SFAS 123(R)'s (ASCASC Topic 505-50505-50's and ASC Topic 718)718's fair value method results in recording compensation costs under the Company's stock based compensation plans. The


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Company determined the fair value of its stock option awards at the date of grant using the Black-Scholes option pricing model. Option-pricingOption pricing models and generally accepted valuation techniques require management to make assumptions and to apply judgment to determine the fair value of ourits awards. These assumptions and judgments include estimating future volatility of ourthe Company's stock price, expected dividend yield, future employee turnover rates and future employee stock option exercise behaviors.


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Changes in these assumptions can materially affect fair value estimates. The Company does not believe that there is a reasonable likelihood that there will be a material change in future estimates or assumptions used to determine stock-based compensation expense. However, if actual results are not consistent with the Company's estimates or assumptions, there may be exposurethe Company would have to changes in stock-based compensation expense thatadjust its estimates. Such adjustments could be material.have a material impact on the Company's financial position.

    Warranty reserves

        The Company offers warranties on someall products of various lengths. At the time of shipment, and when sold separately, the Company establishes a reserve for estimated costs of warranties based on theits 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 affectsaffect warranty cost. If actual warranty costs of warranties differ from the Company's estimated amounts, future results of operations could be adversely affected. Warranty cost is recorded as cost of sales and the reserve balance recorded as an accrued expense. While the Company maintains product quality programs and processes, its warranty obligation is affected by product failure rates and the related corrective costs. If actual product failure rates and/or corrective costs differ from the estimates, the Company revises estimated warranty liability.

New Accounting Pronouncements

        In October 2009,May 2011 the FASB issued Accounting Standards Update No. 2009-13 (ASU 2009-13),Multiple-Deliverable Revenue Arrangements which updates ASC Topic 605-25, Multiple Elements ArrangementsASU 2011-04, "Fair Value Measurement (Topic 820), Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs". ("ASU 2011-04"). ASU 2011-04 amends the fair value measurement and disclosure guidance to converge GAAP and IFRS requirements for measuring amounts at fair value as well as disclosures about these measurements. ASU 2011-04 was to be adopted prospectively and was effective for the interim and annual periods beginning after December 15, 2011. The adoption 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 arrangement considerations in a manner more consistent with the economics of the transaction. ASU 2009-13 establishes a selling price hierarchy for determining the selling price of each specific deliverable, which includes vendor-specific objective evidence ("VSOE") if available, third party evidence if VSOE is not available or estimated selling price if neither VSOE nor third party evidence is available. This update expands the disclosure requirements regarding a vendor's multiple-deliverable revenue arrangements. In accordance with ASU 2009-13 the Company has chosen to adopt this guidance retrospectively for fiscal 2010 and determined that it2011-04 did not have a material impact on the Company's consolidated financial condition or operating results, as the Company did not have a significant amount of sales that contained multiple elements. Additionally the Company has assessed any potential impact the new accounting guidance would have had on all prior periods 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 amendments in both ASU 2009-13 and 2009-14 in the same period and using the same transitional method.statements.

        In October 2009,June 2011, the FASB issued Accounting Standards UpdateASU No. 2009-14 (ASU 2009-14),Revenue Arrangements2011-05, "Comprehensive Income (Topic 220): Presentation of Comprehensive Income" ("ASU 2011-05") which requires that include Software Elements which amends ASC Topic 985-605,Software—Revenue Recognitionall non-owner changes in regard tostockholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the scope of software guidance. ASU 2009-14 excludes softwaretwo-statement approach, the first statement would present total net income and its components followed consecutively by a second statement that would present total other comprehensive income, the components of tangible products that function togetherother comprehensive income, and the total of comprehensive income. ASU 2011-05 is 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 guidancebe adopted retrospectively for fiscal 2010 and determined that it did not have a material 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,Software—Revenue Recognition. 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


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statements or operating results. The Company is required to adopt, and has adopted the amendments in both ASU 2009-13 and 2009-14 in the same period and using the same transitional method.

        In January 2010, the FASB issued Accounting Standards Update No. 2010-06 (ASU 2010-06),Fair Value Measurements and Disclosures which amends ASC Topic 820, adding new requirements for disclosures for Levels 1 and 2, separate disclosures of purchases, sales, issuances, and settlements relating to Level 3 measurements and clarification of existing fair value disclosures. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009 (the2011. The adoption of ASU 2011-05 will not have an impact on the Company's fiscal year 2011), except forconsolidated financial position, results of operations, or cash flows, because the requirement to provide Level 3 activityguidance only changes the presentation of purchases, sales, issuances, and settlements on a gross basis, which will be effective for fiscal years beginning afterfinancial information. On December 15, 2010 (the Company's fiscal year 2012); early adoption is permitted. The Company is currently evaluating the impact of adopting ASU 2010-06 on its financial statements.

        In April 2010,2011, 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 frameworkASU 2011-12 deferring the effective date for applying the milestone method, thus adding clarity in practice on its application. The objectiveimplementation of ASU 2010-17 is2011-05 related only to provide guidance on definingreclassification out of accumulated other comprehensive income until a milestone and determining whenlater date to applybe determined after further consideration by 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.FASB.

Business Segments

        The Company operates in one principal business segment which designs, manufactures and sells flight information computers, large flat-panel displays and advanced monitoring systems to the DoD, government agencies, defense contractors, commercial air transport carriers and corporate/general aviation markets. The Company currently derives virtually allthe majority of its revenues from the sale of this equipment and related EMD services. 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 significant.

In fiscal year 2010, 2009,2012, 2011, and 20082010 net sales outside the United States amounted to $4.4 million, $4.0 million and $2.8 million, $4.4 million and $1.7 million, respectively.


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Item 7A.    Quantitative and qualitative disclosures about market risk.

        The Company's operations are exposed to market risks primarily as a result of changes in interest rates. The Company does not use derivative financial instruments for speculative or trading purposes. The Company's exposure to market risk for changes in interest rates relates to its cash equivalents. The Company's cash equivalents consist of funds invested in money market accounts, which bear interest at a variable rate. Assuming that the balances during fiscal 20102012 were to remain constant and no actions were taken to alter the existing interest rate sensitivity, a hypothetical 1% increase in ourthe Company's variable interest rates would have affected interest income by approximately $0.4 million. This would result in a net impact on cash flows of approximately $0.4 million for fiscal 2010.2012.

Item 8.    Financial statements and supplementary data.

        The financial statements of Innovative Solutions and Support, Inc. listed in the index appearing under Item 8 herein are filed as part of this Report.


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Innovative Solutions and Support, Inc.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 
 Page

Report of Independent Registered Public Accounting Firm

 3439

Consolidated Balance Sheets

 3540

Consolidated Statements of Operations

 3641

Consolidated Statements of Shareholders' Equity

 3742

Consolidated Statements of Cash Flows

 3843

Notes to Consolidated Financial Statements

 39 - 6044-67

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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 accompanying consolidated balance sheets of Innovative Solutions and Support, Inc. and subsidiaries (the "Company") as of September 30, 20102012 and 2009,2011, and the related consolidated statements of operations, cash flows, and shareholders' equity for each of the three years in the period ended September 30, 2010.2012. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements based on our audits.

        We conducted our audits 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 the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

        In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 20102012 and 2009,2011, and the results of its operations and its cash flows for each of the three years in the period ended September 30, 2010,2012, in conformity with accounting principles generally accepted in the United States of America.

        As discussed in Note 10 to the consolidated financial statements, the Company adopted Financial Accounting Standards Board Interpretation No. 48,Accounting for Uncertainty in Income Taxes (ASC Topic 740,Income Taxes), effective October 1, 2007.

        We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of September 30, 2010,2012, based on the criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated December 14, 201012, 2012 expressed an unqualified opinion on the Company's internal control over financial reporting.

/s/ DELOITTE & TOUCHE LLP


Philadelphia, Pennsylvania
December 14, 20102012


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INNOVATIVE SOLUTIONS AND SUPPORT, INC.

CONSOLIDATED BALANCE SHEETS

 
 September 30,
2010
 September 30,
2009
 

ASSETS

 

Current Assets

       
  

Cash and cash equivalents

 $40,916,346 $35,565,694 
  

Accounts receivable, net

  2,529,976  6,188,706 
  

Inventories

  4,656,392  5,306,985 
  

Deferred income taxes

  522,352  503,993 
  

Prepaid expenses and other current assets

  982,768  1,227,413 
      
    

Total current assets

  49,607,834  48,792,791 
 

Property and equipment, net

  
7,761,538
  
8,343,701
 
 

Other assets

  
221,150
  
399,520
 
      

Total Assets

 $57,590,522 $57,536,012 
      

LIABILITIES AND SHAREHOLDERS' EQUITY

 

Current Liabilities

       
  

Current portion of capitalized lease obligations

 $9,908 $9,908 
  

Accounts payable

  543,877  1,207,990 
  

Accrued expenses

  2,585,060  2,785,560 
  

Deferred revenue

  157,933  164,856 
      
   

Total current liabilities

  3,296,778  4,168,314 
  

Long-term portion of capitalized lease obligations

  
15,560
  
26,991
 
  

Deferred revenue

  8,688  60,792 
  

Deferred income taxes

  649,929  642,651 
  

Other liabilities

  151,530  238,522 
      
    

Total Liabilities

  4,122,485  5,137,270 
      
  

Commitments and contingencies

     

Shareholders' Equity

       
  

Preferred Stock, 10,000,000 shares authorized, $.001 par value, of which 200,000 shares are authorized as Class A Convertible stock. No shares issued and outstanding at September 30, 2010 and 2009

  
  
 
  

Common stock, $.001 par value: 75,000,000 shares authorized, 18,244,701 and 18,206,839 issued at September 30, 2010 and 2009, respectively

  
18,245
  
18,207
 
  

Additional paid-in capital

  
46,831,646
  
46,462,135
 
  

Retained earnings

  25,909,652  25,161,276 
 

Treasury stock, at cost, 1,482,510 and 1,470,510 shares at September 30, 2010 and 2009, respectively

  (19,291,506) (19,242,876)
      
    

Total Shareholders' Equity

  53,468,037  52,398,742 
      

Total Liabilities and Shareholders' Equity

 $57,590,522 $57,536,012 
      
 
 September 30,
2012
 September 30,
2011
 

ASSETS

 

Current assets

       

Cash and cash equivalents

 $42,977,501 $42,625,854 

Accounts receivable, net

  3,978,512  3,124,114 

Inventories

  3,801,547  3,508,595 

Deferred income taxes

  1,588,162  438,635 

Prepaid expenses and other current assets

  2,031,644  875,636 
      

Total current assets

  54,377,366  50,572,834 

Property and equipment, net

  7,214,378  7,476,362 

Non-current deferred income taxes

  846,887   

Other assets

  158,600  208,408 
      

Total assets

 $62,597,231 $58,257,604 
      

LIABILITIES AND SHAREHOLDERS' EQUITY

 

Current liabilities

       

Current portion of capitalized lease obligations

 $ $13,189 

Accounts payable

  1,139,464  443,516 

Accrued expenses

  2,723,812  2,551,389 

Deferred revenue

  1,426,552  232,630 
      

Total current liabilities

  5,289,828  3,240,724 

Non-current deferred income taxes

  128,998  566,963 

Other liabilities

  98,002  189,130 
      

Total liabilities

  5,516,828  3,996,817 
      

Commitments and contingencies (See Note 13)

     

Shareholders' equity

       

Preferred Stock, 10,000,000 shares authorized, $.001 par value, of which 200,000 shares are authorized as Class A Convertible stock. No shares issued and outstanding at September 30, 2012 and 2011

     

Common stock, $.001 par value: 75,000,000 shares authorized, 18,329,314 and 18,286,884 issued at September 30, 2012 and 2011, respectively

  18,329  18,287 

Additional paid-in capital

  47,845,732  47,206,690 

Retained earnings

  29,605,236  26,626,242 

Treasury stock, at cost, 1,756,632 and 1,544,910 shares at September 30, 2012 and 2011, respectively

  (20,388,894) (19,590,432)
      

Total Shareholders' Equity

  57,080,403  54,260,787 
      

Total liabilities and shareholders' equity

 $62,597,231 $58,257,604 
      

The accompanying notes are an integral part of these statements.


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INNOVATIVE SOLUTIONS &AND SUPPORT, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS



 For the Fiscal Year Ended September 30,  For the Fiscal Year Ended September 30, 


 2010 2009 2008  2012 2011 2010 

Net sales:

Net sales:

  

Product

 $18,289,963 $25,174,846 $23,383,504 

Engineering—modification and development

 6,288,235 562,806 1,873,819 

Product

 $23,383,504 $31,855,060 $25,946,917        

Total net sales

 24,578,198 25,737,652 25,257,323 

Engineering—modification and development

 1,873,819 4,879,090 4,586,394        

Cost of sales

 

Product

 9,389,904 11,790,885 10,732,091 

Engineering—modification and development

 4,678,029 154,299 787,938 
              
 

Total net sales

 25,257,323 36,734,150 30,533,311 
       

Cost of sales:

 

Product

 10,732,091 16,601,739 17,584,314 

Engineering—modification and development

 787,938 1,294,245 2,967,543 
       
 

Total cost of sales

 11,520,029 17,895,984 20,551,857 

Total cost of sales

 14,067,933 11,945,184 11,520,029 
              

Gross profit

Gross profit

 13,737,294 18,838,166 9,981,454  10,510,265 13,792,468 13,737,294 
              

Operating expenses:

Operating expenses:

  

Research and development

 2,693,554 5,500,924 5,234,240 

Selling, general and administrative

 7,400,199 7,683,637 8,099,587 

Research and development

 5,234,240 5,313,007 10,304,279        

Total operating expenses

 10,093,753 13,184,561 13,333,827 

Selling, general and administrative

 8,099,587 8,647,506 22,306,016        

Asset impairment

   2,475,000 
       
 

Total operating expenses

 13,333,827 13,960,513 35,085,295 
       

Operating income (loss)

 403,467 4,877,653 (25,103,841)

Operating income

 416,512 607,907 403,467 

Interest income

Interest income

 
188,171
 
398,041
 
1,576,599
  
101,012
 
143,942
 
188,171
 

Interest (expense)

Interest (expense)

 (2,356) (82,276) (160,867) (598) (1,509) (2,356)

Other income

Other income

 50,000 50,099 17,300,000  65,005 150,010 50,000 
              

Income before income taxes

 581,931 900,350 639,282 

Income tax (benefit) expense

 
(2,397,063

)
 
183,760
 
(109,094

)

Income (loss) before income taxes

 639,282 5,243,517 (6,388,109)       

Income tax expense (benefit)

 
(109,094

)
 
234,856
 
1,509,139
 

Net income

 $2,978,994 $716,590 $748,376 
              

Net income (loss)

 $748,376 $5,008,661 $(7,897,248)

Net income per common share:

 

Basic

 $0.18 $0.04 $0.04 
              

Net income (loss) per common share:

 

Basic

 $0.04 $0.30 $(0.47)
       

Diluted

 $0.04 $0.30 $(0.47)

Diluted

 $0.18 $0.04 $0.04 
              

Weighted Average Shares Outstanding:

Weighted Average Shares Outstanding:

  

Basic

 16,641,895 16,782,223 16,751,528 

Basic

 16,751,528 16,745,379 16,887,049        

Diluted

 16,641,900 16,824,621 16,777,886 
              

Diluted

 16,777,886 16,760,500 16,887,049 
       

The accompanying notes are an integral part of these statements.


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INNOVATIVE SOLUTIONS AND SUPPORT, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY


 Common
Stock
 Additional
Paid-In
Capital
 Retained
Earnings
 Treasury
Stock
 Total  Common
Stock
 Additional
Paid-In
Capital
 Retained
Earnings
 Treasury
Stock
 Total 

Balance, September 30, 2007

 18,161 44,607,993 44,194,053 (18,086,428) 70,733,779 

Exercise of options to purchase common stock

 
5
 
22,055
 
 
 
22,060
 

Balance, September 30, 2009

 $18,207 $46,462,135 $25,161,276 $(19,242,876)$52,398,742 

Share-based compensation

  938,013   938,013  
 
169,565
 
 
 
169,565
 

Issuance of stock to directors

 11 199,899   199,910  38 199,946   199,984 

Purchase of treasury stock

    (1,048,198) (1,048,198)    (48,630) (48,630)

Cumulative effect of adoption of FIN 48

   587,324  587,324 

Dividends

   (16,731,514)  (16,731,514)

Net loss

   (7,897,248)  (7,897,248)

Net Income

   748,376  748,376 
                      

Balance, September 30, 2008

 18,177 45,767,960 20,152,615 (19,134,626) 46,804,126 

Balance, September 30, 2010

 $18,245 $46,831,646 $25,909,652 $(19,291,506)$53,468,037 
                      

Share-based compensation

  494,084   494,084   177,399   177,399 

Issuance of stock to directors

 30 200,091   200,121  42 197,645   197,687 

Purchase of treasury stock

    (108,250) (108,250)    (298,926) (298,926)

Net income

   5,008,661  5,008,661    716,590  716,590 
                      

Balance, September 30, 2009

 18,207 46,462,135 25,161,276 (19,242,876) 52,398,742 

Balance, September 30, 2011

 $18,287 $47,206,690 $26,626,242 $(19,590,432)$54,260,787 
                      

Share-based compensation

  169,565   169,565   439,085   439,085 

Issuance of stock to directors

 38 199,946   199,984  42 199,957   199,999 

Purchase of treasury stock

    (48,630) (48,630)    (798,462) (798,462)

Net income

   748,376  748,376    2,978,994  2,978,994 
                      

Balance, September 30, 2010

 18,245 46,831,646 25,909,652 (19,291,506) 53,468,037 

Balance, September 30, 2012

 $18,329 $47,845,732 $29,605,236 $(20,388,894)$57,080,403 
                      

The accompanying notes are an integral part of these statements.


Table of Contents


INNOVATIVE SOLUTIONS AND SUPPORT, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS



 For the Twelve Months Ended
September 30,
  For the Fiscal Year Ended September 30, 


 2010 2009 2008  2012 2011 2010 

CASH FLOWS FROM OPERATING ACTIVITIES:

CASH FLOWS FROM OPERATING ACTIVITIES:

  

Net income

 $2,978,994 $716,590 $748,376 

Adjustments to reconcile net income to net cash provided by operating activities:

 

Depreciation and amortization

 529,325 672,196 826,748 

Deposit forfeiture, installation kits

   118,660 

Share-based compensation expense:

 

Stock options

 444,507 170,586 171,491 

Nonvested stock awards

 199,998 199,712 199,946 

Excess tax adjustment from share-based compensation:

 

Nonvested stock awards

 (5,422) 6,813 (1,926)

Provision for (recovery) loss on accounts receivable

 (1,373) 17,225  

Loss on disposal of property and equipment

  2,413 4,917 

Excess and obsolete inventory cost

 113,456 471,496  

Deferred income taxes

 (2,434,379) 751 (11,081)

(Increase) decrease in:

 

Accounts receivable

 (853,025) (611,363) 3,658,730 

Inventories

 (406,408) 676,301 650,593 

Prepaid expenses and other current assets

 (1,156,008) 78,066 273,711 

Other non-current assets

  (121,237)  

Increase (decrease) in:

 

Accounts Payable

 695,948 (100,362) (664,113)

Accrued expenses

 192,101 (188,354) (200,500)

Income taxes payable

 (110,805) 219,324 (116,058)

Deferred revenue

 1,193,922 66,009 (59,027)

Net (Loss) income

 $748,376 $5,008,661 (7,897,248)       

Adjustments to reconcile net income to net cash provided by operating activities:

 
 

Depreciation and amortization

 826,748 1,085,316 1,048,267 
 

Deposit forfeiture, installation kits

 118,660   
 

Share-based compensation expense:

 
 

Stock options

 171,491 490,989 938,013 
 

Nonvested stock awards

 199,946 200,121 199,910 
 

Tax benefit from share-based compensation:

 
 

Stock options

   10,497 
 

Nonvested stock awards

 (1,926) 3,095 (21,655)
 

Provision for loss on accounts receivable

  185,848 4,077,319 
 

Excess tax benefits from share-based payment arrangements

   (11,424)
 

Loss on disposal of property and equipment

 4,917 56,678 9,531 
 

Excess and obsolete inventory cost

  506,656 1,856,827 
 

Asset Impairment

   2,475,000 
 

Deferred income taxes

 (11,081) (89,357) 1,227,955 
 

(Increase) decrease in:

 
 

Accounts receivable

 3,658,730 (2,156,111) (2,047,156)
 

Inventories

 650,593 3,547,616 (1,854,289)
 

Prepaid expenses and other current assets

 273,711 178,847 4,802,544 
 

Other non-current assets

  (1,870) (41,080)
 

Increase (decrease) in:

 
 

Accounts Payable

 (664,113) (1,141,991) (1,727,808)
 

Accrued expenses

 (200,500) (1,658,551) 1,046,955 
 

Income taxes payable

 (116,058) (686,352)  
 

Deferred revenue

 (59,027) (339,350) (145,937)
 

Other non-current liabilities

  129,304 249,969 
       
 

Net cash provided by operating activities

 5,600,467 5,319,549 4,196,190 

Net cash provided by operating activities

 1,380,831 2,276,166 5,600,467 
              

CASH FLOWS FROM INVESTING ACTIVITIES:

CASH FLOWS FROM INVESTING ACTIVITIES:

  

Purchases of property and equipment

 (217,533) (255,454) (189,790)
 

Purchases of property and equipment

 (189,790) (332,515) (573,357)       
 

Proceeds from the sale of property and equipment

  620 3,000 
       
 

Net cash used in investing activities

 (189,790) (331,895) (570,357)

Net cash (used in) investing activities

 (217,533) (255,454) (189,790)
              

CASH FLOWS FROM FINANCING ACTIVITIES:

CASH FLOWS FROM FINANCING ACTIVITIES:

  

Purchase of treasury stock

 (798,462) (298,926) (48,630)

Repayment of capitalized lease obligations

 (13,189) (12,278) (11,431)

Other

   36 
 

Repayment of Industrial Development Bond

  (4,335,000)         

Net cash (used in) financing activities

 (811,651) (311,204) (60,025)
 

Proceed from exercise of stock options

   33,218        
 

Purchase of treasury stock

 (48,630) (108,250) (1,048,198)
 

Dividend paid

   (16,731,514)
 

Repayment of capitalized lease obligations

 (11,431) (10,642) (9,909)
 

Excess tax benefits from share-based payment arrangements

   11,424 
 

Other

 36   
       
 

Net cash used in financing activities

 (60,025) (4,453,892) (17,744,979)
       

Net increase (decrease) in cash and cash equivalents

 5,350,652 533,762 (14,119,146)

Net increase in cash and cash equivalents

 351,647 1,709,508 5,350,652 

Cash and cash equivalents, beginning of year

Cash and cash equivalents, beginning of year

 35,565,694 35,031,932 49,151,078  42,625,854 40,916,346 35,565,694 
              

Cash and cash equivalents, end of year

Cash and cash equivalents, end of year

 $40,916,346 $35,565,694 $35,031,932  $42,977,501 $42,625,854 $40,916,346 
              

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

  

Cash paid for interest

 $599 $1,509 $2,357 
 

Cash paid for interest

 $2,357 $48,303 120,650        

Cash paid for income tax

 $153,327 $11,500 $121,473 
              

Cash received from income tax refund

 $4,096 $43,253 $1,000 
 

Cash paid for income tax

 $121,473 $804,486 9,073        
       
 

Cash received from income tax refund

 $(1,000)$(25,115) (5,107,269)
       

The accompanying notes are an integral part of these statements.


Table of Contents


INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Background:

        Innovative Solutions and Support, Inc., (the "Company" or "IS&S"), was incorporated in Pennsylvania on February 12, 1988. The Company's primary businessCompany is the design, manufacturea systems integrator that designs, manufactures and sale ofsells flight information computers, large flat panel displaysguidance and advanced monitoringcockpit display systems tofor original equipment manufacturers ("OEMs") and retrofit applications. Customers include commercial air transport carriers and corporate/general/aviation companies, the Department of Defense ("DoD"), defense and its commercial contractors, commercial air transportaircraft operators, aircraft modification centers, foreign militaries and corporate/general aviation markets.various OEMs.

2. Concentrations:

    Major Customers and Products

        In fiscal 2010, 2009,2012, 2011 and 20082010, the Company derived 48%63%, 56%61%, and 72%48%, respectively, of total sales from five customers, although not all the same customers in each year. Accounts receivable related to those top five customers was $1.7 million, $1.8 million, and $0.3 million $2.8 million, and $2.3 million for the twelve month periods endedas at September 30, 2010, 2009,2012, 2011 and 2008,2010, respectively.

        During fiscal 2012, three of the Company's customers, Eclipse Aerospace, FedEx, and National Nuclear Security Administration accounted for 20%, 14%, and 13% of total sales, respectively. In fiscal 2011, two of the Company's customers, Eclipse Aerospace and FedEx, accounted for 20% and 15% of total sales, respectively. In fiscal 2010, two of the Company's customers, Lockheed Martin and FedEx, accounted for 11% and 10% of total sales, respectively. In fiscal 2009 two of the Company's customers, American Airlines and United States Department of Defense accounted for 24% and 11% of total sales, respectively. In fiscal 2008 two of the Company's customers, Eclipse and Fed Ex, accounted for 42% and 10% of total sales, respectively.

        Sales of air data systems and components were 32%13%, 25%21%, and 23%32% of total sales for the years ended September 30, 2010, 2009,2012, 2011 and 20082010, respectively. Flat Panel sales were 68%87%, 75%79%, and 77%68% of total sales in the years ended September 30, 2010, 2009,2012, 2011 and 20082010, respectively. Sales to government contractors and agencies accounted for approximately 43%45%, 46%30%, and 23%43% of total sales during fiscal years 2010, 2009,2012, 2011 and 2008,2010, respectively. While under these contracts the government agency or general contractor typically retains the right to terminate the contract at any time at its convenience, to date these contracts have generally have included provisions requiring the payment to the Company of all revenue earned and costs incurred by the Company through the date of contract termination and do not entitle the customer to receive a refund of any previously paid fees.

            On November 29, 2011, AMR Corporation, the parent company of AAI and certain of its other U.S.-based subsidiaries filed voluntary petitions for Chapter 11 reorganization in the U.S. Bankruptcy Court for the Southern District of New York. The Company's revenues from AAI accounted for 5%, 8% and 8% total revenue for the fiscal years 2012, 2011 and 2010, respectively. (See also Note 13—Commitments and Contingencies).

    Major Suppliers

        The Company currently buys several of its components from sole source suppliers. Although there are a limited number of manufacturers of particular components, management believes other suppliers could provide similar components on comparable terms.

        During fiscal 20102012 and 2011 the Company had one supplersupplier who accounted for 22%20% and 27%, respectively, of the Company's total inventory related purchases. During fiscal 2009 the Company had two suppliers who accounted for 38% and 10%


Table of the Company's total inventory related purchases.Contents


    INNOVATIVE SOLUTIONS AND SUPPORT, INC.

    NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

    2. Concentrations: (Continued)

    Concentration of Credit Risk

        Financial instruments that potentially subject the Company to concentration of credit risk consist principally of cash balances and accounts receivable. The Company invests its excess cash where preservation of principal is the major consideration. The Company's customer base consists principally consists of companies within the aviation industry. The Company routinely requestsmay request advance payments and/or letters of credit from new customers.


Table of Contents


INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. Concentrations: (Continued)customers or existing customers whose credit ratings do not meet the Company's standards for extending normal credit terms.

        The Company maintained a reservereserves for doubtful accounts in the amount of $0.2 million and $0.2 million for fiscal year 2010at September 30, 2012 and 2009,2011, respectively. The reserve balancebalances for both fiscal 20102012 and 2009 is2011 related to sales of Engineering Engineering—Modification and Development (EMD) services ("EMD") to a customer that was negatively impacted by the current economic environment. As of September 30, 2012, the Company had pre-Bankruptcy outstanding accounts receivable of $760,000 from AAI. Based on the present status of the Bankruptcy proceedings, the Company is not able to determine the amount, if any, that could be uncollectible. (See also Note 13—Commitments and Contingencies).

3. Summary of Significant Accounting Policies:

    Principles of Consolidation

        The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant inter-company balances and transactions have been eliminated in consolidation.

    Use of Estimates

        Preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities, as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates are used in accounting for, among other items, allowance for doubtful accounts, inventory obsolescence, product warranty cost liability, income taxes, percentage of completion on customer funded EMD contracts, and contingencies. Actual results could differ materially from those estimates.

    Cash and Cash Equivalents

        Highly liquid investments purchased with an original maturity of three months or less are classified as cash equivalents. Cash equivalents at September 30, 20102012 and 20092011 consist of fundscash invested in money market accountsfunds with financial institutions.


    Table of Contents


    INNOVATIVE SOLUTIONS AND SUPPORT, INC.

    NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

    3. Summary of Significant Accounting Policies: (Continued)

    InventoriesInventory valuation

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


 September 30,
2010
 September 30,
2009
  September 30,
2012
 September 30,
2011
 

Raw materials

 $2,725,268 $3,535,109  $2,752,833 $2,520,437 

Work-in-process

 236,060 315,179  555,495 223,437 

Finished goods

 1,695,064 1,456,697  493,219 764,721 
          

 $4,656,392 $5,306,985  $3,801,547 $3,508,595 
          

        The balances above are net of excess and obsolete inventory reserves of $3.2 million and $3.3 million for fiscal 2010 and 2009, respectively.

    Property and Equipment

        Property and equipment are stated at cost. Depreciation is provided using an accelerated method over estimated useful lives of the assets (the lesser of three to seven years or over the lease term), except for the corporate airplane and manufacturing facility, which are depreciated using the straight-line method


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INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

3. Summary of Significant Accounting Policies: (Continued)

over estimated useful lives of ten years and thirty-nine years. During fiscal 2012, no depreciation was provided for the airplane because it had been depreciated to its estimated salvage value. Major additions and improvements are capitalized, while maintenance and repairs that do not improve or extend the life of assets are charged to expense as incurred. Depreciation expense was $0.8 million, $0.9 million and $1.0 million for the fiscal years ended September 30, 2010, 2009 and 2008, respectively.

    Long-Lived Assets

        The Company assesses the impairment of long-lived assets in accordance with FASB ASC Topic 360-10, "Property, Plant and Equipment". This statement requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. In addition, long-lived assets to be disposed of should be reported at the lower of the carrying amount or fair value less cost to sell. The Company considers historical performance and future estimated results in its evaluation of potential impairment and then compares the carrying amount of the asset to estimated future cash flows expected to result from use of the asset. If the carrying amount of the asset exceeds the estimated expected undiscounted future cash flows, the Company measures the amount of the impairment by comparing the carrying amount of the asset to its fair value. The estimation of fair value is generally measured by discounting expected future cash flows. No impairment charges were recorded in fiscal year 2010, 2009years 2012, 2011 or 2008.2010.

    Revenue Recognition

        The Company enters into sales arrangements with customers that, in general, provide for the Company to design, develop, manufacture and deliver large flat-panel display systems, flight information computers large flat-panel displays, and advanced monitoring systems that measure and display critical flight information, including data relative to aircraft separation, airspeed, and altitude, as well asand engine and fuel data measurements. Additionally, during the three months ended June 30, 2010 the Company began delivery in accordance with a new arrangement with a new customer to provide, among other deliverables, functional upgrades to the Company's flight information computers and flat-panel displays. The Company's sales arrangements may include multiple deliverables as defined in FASB ASC Topic 605-25, ""Multiple-Element Arrangements"Multiple Element Arrangements (ASC" ("ASC Topic 605-25)605-25"), which typically include customer funded design, and engineeringEMD services, and the production and delivery of the flat panel display and related components. The Company includes any design and EMD elements in EMD sales, and any


Table of Contents


INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

3. Summary of Significant Accounting Policies: (Continued)

functional upgrades and product elements in product sales on the accompanying consolidated statement of operations.

        To the extent that an arrangement contains software elements that are essential to the functionality of tangible products sold in the arrangement, the Company recognizes revenue for the deliverables in accordance with the guidance included in FASB Accounting Standards Update No. 2009-14, "Revenue Arrangements That Include Software Elements" ("ASU 2009-14"), ASU 2009-13, and FASB ASC Topic 605, "Revenue Recognition" ("ASC Topic 605").

        To the extent that an arrangement contains software components, which include functional upgrades, that are sold on a standalone basis and which the Company has deemed outside the scope of the exception defined by ASU 2009-14, the Company recognizes software revenue in accordance with ASC Topic 985,"Software", although no such sales have occurred to date.

Multiple Element Arrangements—Arrangements

        The Company identifies all goods and/or services that are to be delivered separately under such a sales arrangement and allocates revenue to each deliverable (if more than one) based on that deliverable's selling price. The Company then considers the appropriate recognition method for each deliverable; deliverables under multiple element arrangements are typically purchased engineering and design services, product sales and/or the sale of functional upgrades.deliverable. The Company's multiple element arrangements can typically include defined design and developmentEMD activities and/or functional upgrades, along with product sales.

        The Company utilizes the selling price hierarchy that has been established by FASB Accounting Standards Update (ASU)No. 2009-13, "Multiple-DeliverableMultiple Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force"Force (ASU 2009-13)" ("ASU 2009-13"), which requires that the selling price for each deliverable be based on vendor-specificvendor specific objective evidence if available, third-partythird party evidence if vendor-specificvendor specific objective evidence is not available, or estimated selling price if neither vendor-specificvendor specific objective evidence nor third party evidence is available. To the extent that an arrangement includes a deliverable for which estimated selling price is used, the Company determines the best estimate of selling price by applying the same pricing policies and methodologies that would be used to determine the price to sell the deliverable on a standalone basis.

        To the extent that an arrangement contains defined design and EMD activities as an identified deliverable in addition to products (resulting in a multiple element arrangement), the Company recognizes as EMD revenue amounts earned during the design and EMD phase of the contract following the guidance included in FASB ASC Topic 605-35, "Construction-Type and Production-Type Contracts" ("ASC Topic 605-35"). To the extent that multiple element arrangements include product sales, the Company recognizes revenue when revenue recognition criteria for the product deliverable have been met based on the provisions of ASC Topic 605. The Company includes any design and engineering services elements in EMD sales, and any functional upgrades and product elements in product sales on the accompanying consolidated statement of operations.

Single Element Arrangements

Products

        To the extent that a single element arrangement provides for product sales and repairs, the Company recognizes revenue when revenue recognition criteria for the product deliverable have been


Table of Contents


INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

3. Summary of Significant Accounting Policies: (Continued)


third-party evidence is available. To the extent that an arrangement includes a deliverable for which estimated selling price is used, the Company's determines the best estimate of selling price by applying the same pricing policies and methodologies that would be used to determine the price to sell the deliverable on a standalone basis.

        To the extent that an arrangement contains software elements that are essential to the functionality of tangible products sold in the arrangement, the Company recognizes revenue for the deliverables in accordance with the guidance included in FASB Accounting Standards Update 2009-14, "Revenue Arrangements That Include Software Elements" (ASU 2009-14), ASU 2009-13 and FASB ASC Topic 605, "Revenue Recognition" (ASC Topic 605).

        To the extent that an arrangement contains defined design and development activities as an identified deliverable in addition to products (resulting in a multiple element arrangement), the Company recognizes as EMD revenue amounts earned during the design and development phase of the contract following the guidance included in the FASB ASC Topic 605-35, "Construction-Type and Production-Type Contracts" (ASC Topic 605-35). To the extent that multiple element arrangements include product sales, revenue is generally recognized once revenue recognition criteria for the product deliverable has been met based on the provisions of ASC Topic 605.

        To the extent that an arrangement contains software components, which include functional upgrades, that are sold on a standalone basis and the Company has deemed outside the scope the exception defined by ASU 2009-14, the Company recognizes software revenue in accordance with ASC Topic 985, "Software", although no such sales have occurred to date.

Single Element Arrangements—

    Products—

        To the extent that a single element arrangement provides for product sales and repairs, revenue is generally recognized once revenue recognition criteria for the product deliverable has been met based on the provisions of ASC Topic 605. The Company also receives orders for existing equipment and parts. RevenueGenerally, revenue from the sale of such products is generally recognized upon shipment to the customer.

        The Company offers its customers extended warranties for additional fees. These warranty sales are recorded as deferred revenue and recognized as sales on a straight-line basis over the warranty period.

    Engineering Services—Engineering—modification and development services

        The Company also may enter into service arrangementscontracts to perform specified design and developmentEMD services related to its products. The Company recognizes revenue from these arrangements as EMD revenue, following the guidance included in ASC Topic 605-35. The Company605-35, and considers the nature of these service arrangementscontracts (including term, size of contract, level of effort) when determining the appropriate accounting treatment for a particular contract. The Company recognizes the revenue fromCertain of these contracts using eitherare accounted for under the percentage-of-completion method or completed contract method of accounting.

        The Company records revenue relating to these contracts using the percentage-of-completion methodaccounting when the Company determines that progress toward completion is reasonable and reliably estimable, and the contract is long-term in nature. The Company uses the completed contract method for all others contracts. Sales and earnings under the percentage-of-completion method are recorded based on the ratio of actual costs incurred to total estimated costs expected to be incurred related to the contract under the cost-to-cost method (for development effort).

        The percentage-of-completion method of accounting requires the Company to estimate the profit margin for each individual contract, and to apply that profit margin on a uniform basis as sales are recorded under the contract. The estimation of profit margins requires the Company to make projections of the total sales to be generated and the total costs that will be incurred under a contract. These projections require the Company to make numerous assumptions and estimates relating to items such as the complexity of design and related development costs, performance of subcontractors, availability and cost of materials, engineering productivity and cost, overhead and capital costs. These contracts sometime include purchase options for additional quantities and customer change orders for additional or revised product functionality. Sales and costs related to profitable purchase options are included in the Company's estimates only when the options are exercised, while sales and costs related to unprofitable purchase options are included in the Company's estimates when exercise is determined to be probable. Sales related to change orders are included in profit estimates only if they can be reliably estimated and collectability is reasonably assured. Purchase options and change orders are accounted for either as an integral part of the original contract, or separately depending upon the nature and value of the item. Anticipated losses on contracts are recognized in full in the period in which losses become probable and estimable.

        For contracts for which uncertainty regarding the performance against certain contract terms remains and in which no loss is expected, the Company uses the zero profit margin approach to applying the percentage of completion method following the guidance included in FASB ASC Topic 605-35.

        Estimates of profit margins for contracts are reviewed typically by the Company on a quarterly basis. Assuming the initial estimates of sales and costs under a contract are accurate, the percentage-of-completion method results in the profit margin being recorded evenly as revenue is recognized under the contract. Changes in these underlying estimates due to revisions in sales and cost estimates, or the exercise of contract options may result in profit margins being recognized unevenly over a contract as such changes are accounted for on a cumulative basis in the period estimates are


Table of Contents


INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

3. Summary of Significant Accounting Policies: (Continued)


estimable andrevised. Significant changes in estimates related to accounting for long-term contracts may have a material effect on the contractCompany's results of operations in the period in which the revised estimate is long-termmade. Cumulative catch-up adjustments resulting from changes in nature;estimates did not have a material effect on our results of operations during the Company uses the completed contract method for all others.years ended September 30, 2012, 2011 or 2010.

    Income Taxes

        Income taxes are recorded in accordance with FASB ASC Topic 740, "Income Taxes" (ASC("ASC Topic 740)740"), which principally utilizes a balance sheet approach to provide for income taxes. Under this method, the Company recognizes deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of the Company's assets, liabilities and expected benefits of utilizing net operating loss and tax credit carry-forwards. The impact on deferred taxes of changes in tax rates and laws, if any, are applied to the years during which temporary differences are expected to be settled and are reflected in the consolidated financial statements in the period of enactment.

        Deferred tax assets are reduced by valuation allowances if, based on the consideration of all available evidence, it is more likely than not that some portion of the deferred tax asset will not be realized. Significant weight is given to evidence that can be verified objectively, verified.and significant management judgment is required in determining any valuation allowances recorded against net deferred tax assets. The Company evaluates deferred income taxes on a quarterly basis to determine if valuation allowances are required by considering available evidence. Deferred tax assets are realized by having sufficientrecognized when expected future taxable income is sufficient to allow the related tax benefits to reduce taxes that would otherwise be payable. The sources of taxable income that may be available to realize the benefit of deferred tax assets are future reversals of existing taxable temporary differences, future taxable income exclusive of reversing temporary differences and credit carry-forwards, taxable income in carry-back years, and tax planning strategies thatwhich are both prudent and feasible. In the event theThe Company were to determinebelieves that it would be able to realize its deferred tax assets in theestimate of future in excess of the net recorded amount, an adjustment would be madetaxable income is inherently uncertain, and if its current or future operations generate losses, further adjustments to the valuation allowance which would reduceare possible. The current balance of the provision fordeferred tax valuation allowance relates principally to net operating losses ("NOL") of certain state taxing jurisdictions. There is currently no assurance of such future income before income taxes.

        The accounting for uncertainty in income taxes requires a more likely than not threshold for financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. The Company records a liability for the difference between the (i) benefit recognized and measured for financial statement purposes and (ii) the tax position taken or expected to be taken on ourthe Company's tax return. To the extent that ourthe Company's assessment of such tax positions changes, the change in estimate is recorded in the period in which the determination is made. The Company has elected to record any interest or penalties from theassociated with uncertain tax positionpositions as income tax expense.

        The Company files a consolidated United States federal income tax return. The Company prepares and files tax returns based on the interpretation of tax laws and regulations, and records estimates based on these judgments and interpretations. In the normal course of business, the tax returns are subject to examination by various taxing authorities. Such examinations may result in future tax and interest assessments by these taxing authorities, and the Company records a liability when it is probable that there will be an assessment. The Company adjusts the estimates periodically becauseas a result of ongoing


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INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

3. Summary of Significant Accounting Policies: (Continued)

examinations by and settlements with the various taxing authorities, as well asand changes in tax laws, regulations and precedent. The consolidated tax provision of any given year includes adjustments to prior yearyears' income tax accruals that are considered appropriate, and any related estimated interest. Management believes that adequate accruals have been made for income taxes. Differences between estimated and actual amounts determined upon ultimate resolution, individually or in the aggregate,


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INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

3. Summary of Significant Accounting Policies: (Continued)


are not expected to have a material adverse effect on ourthe Company's consolidated financial position, but could possibly be material to ourits consolidated results of operations or cash flow of any one period.

    Research andEngineering Development

        ResearchTotal engineering development expense is comprised of both internally funded R&D and product development and design charges related to specific customer contracts. Engineering development expense consists primarily of payroll-related expenses of employees engaged in engineering development projects, engineering related product materials and equipment and subcontracting costs. R&D charges incurred for product design, product enhancements and future product development are expensed as incurred. Product development and design charges incurred related to a specific customer agreement thatcontracts are billable are capitalized and then charged to cost of sales—engineeringsales-engineering modification and development asbased on the revenue relatedmethod of contract accounting (either percentage of completion or completed contract) applicable to the agreements are recognized.such contracts.

    Comprehensive Income

        Pursuant to FASB ASC Topic 220, "Comprehensive Income""Comprehensive Income" ("ASC Topic 220"), the Company is 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 ourits condensed consolidated balance sheets. For fiscal 20102012 and 2009,2011, comprehensive income consistsconsisted of net income only, and there were no items of other comprehensive income for any of the periods presented.

    Fair Value of Financial Instruments

        The Company adopted FASB ASC Topic 820, "Fair Value Measurementsnet carrying amounts of cash and Disclosures" (ASC Topic 820) in the first quarter of fiscal 2009 for financial assetscash equivalents, accounts receivable, cash overdraft, accounts payable and liabilities. This standard definesshort-term debt approximate their fair value asdue to the price at which an asset could be exchanged in a 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.

        Assetsshort-term nature of these instruments. For financial assets and liabilities measured at fair value are categorized based uponon a recurring basis, fair value is the level of judgment associatedprice the Company would receive to sell an asset or pay to transfer a liability in an orderly transaction with a market participant at the measurement date. A three-level fair value hierarchy prioritizes the inputs used to measure their fair value. Hierarchical levels, defined by ASC Topic 820 and directly related to the amount of subjectivity associated with the inputs to fair valuation of these assets and liabilities, arevalue as follows:

      Level 1—Unadjusted quoted prices that are available in active markets for the identical assets or liabilities at the measurement date.

      Level 2—Other observable inputs available at the measurement date, other than quoted prices included in Level 1, either directly or indirectly, including:

        Quoted prices for similar assets or liabilities in active markets;

        Quoted prices for identical or similar assets in non-active markets;

        Inputs other than quoted prices that are observable for the asset or liability; and

        ���
        Inputs that are derived principally from or corroborated by other observable market data.

      Level 3—Unobservable inputs that cannot be corroborated by observable market data and reflect the use of significant management judgment. These values are generally determined

Level 1—Unadjusted quoted prices that are available in active markets for the identical assets or liabilities at the measurement date.



Level 2—


Other observable inputs available at the measurement date, other than quoted prices included in Level 1, either directly or indirectly, including:

Quoted prices for similar assets or liabilities in active markets;

Quoted prices for identical or similar assets in non-active markets;

Inputs other than quoted prices that are observable for the asset or liability; and

Inputs that are derived principally from or corroborated by other observable market data.


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INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

3. Summary of Significant Accounting Policies: (Continued)

      using pricing models for which the assumptions utilize management's estimates of market participant assumptions.




Level 3—


Unobservable inputs that cannot be corroborated by observable market data and reflect the use of significant management judgment. These values are generally determined using pricing models for which the assumptions utilize management's estimates of market participant assumptions.

        The following table sets forth by level within the fair value hierarchy the Company's financial assets and liabilities that were accounted for at fair value on a recurring basis as of September 30, 20102012 and 2009,2011, 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, 2012 
 
 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

 $40,384,756 $ $ 

 

 
 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 $ $ 
 
 Fair Value Measurement on September 30, 2011 
 
 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

 $40,330,266 $ $ 

    Stock-BasedShare-Based Compensation

        The Company accounts for stock-basedshare-based compensation under FASB ASC Topic 505-50, "Equity-Based Payments to Non-Employees" (ASC("ASC Topic 505-50)505-50") and ASC Topic 718, "Stock Compensation" (ASC("ASC Topic 718)718"), which requires the 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.

    Warranty

        We offerIS&S offers warranties on someall products of various lengths. At the time of shipment, we establishthe Company establishes a reserve for estimated costs of warranties based on ourits 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 affectsaffect warranty cost. If actual warranty costs differ from ourthe Company's estimated amounts, future results of operations could be adversely affected.

    New Accounting Pronouncements

        In October 2009, Warranty cost is recorded as cost of sales and the FASB issued ASU 2009-13, which updates ASC Topic 605-25, ofreserve balance recorded as an accrued expense. While 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,Company maintains product quality programs and if so allows companies to allocateprocesses, its warranty obligation is affected by product failure rates and the related corrective costs. If actual product failure rates and/or corrective costs differ from the estimates, the Company revises estimated warranty liability.


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INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

3. Summary of Significant Accounting Policies: (Continued)

arrangement considerations in a manner more consistent with the economics of the transaction. ASU 2009-13 establishes a selling price hierarchy for determining the selling price of each specific deliverable, which includes vendor-specific objective evidence ("VSOE") if available, third party evidence if VSOE is not available or estimated selling price if neither VSOE nor third party evidence is available. This update expands the disclosure requirements regarding a vendor's multiple-deliverable revenue arrangements. In accordance with ASU 2009-13 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 have a significant amount of sales that contained multiple elements. Additionally the Company has assessed any potential impact the new accounting guidance would have had on all prior periods 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 amendments in ASU 2009-13 using the same transitional method.New Accounting Pronouncements

        In October 2009,May 2011 the FASB issued ASU 2009-14 which amends ASC Topic 985-605,2011-04,Software—Revenue Recognition"Fair Value Measurement (Topic 820), Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs". (ASC Topic 985-605) in regard("ASU 2011-04"). ASU 2011-04 amends the fair value measurement and disclosure guidance 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 2010converge GAAP 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. 2010-06 (ASU 2010-06),Fair Value Measurements and Disclosures which amends ASC Topic 820, adding newIFRS requirements for disclosures for Levels 1 and 2, separate disclosures of purchases, sales, issuances, and settlements relating to Level 3 measurements and clarification of existingmeasuring amounts at fair value disclosures.as well as disclosures about these measurements. ASU 2010-06 is2011-04 was to be adopted prospectively and was effective for the interim and annual periods beginning after December 15, 2009 (the2011. The adoption of ASU 2011-04 did not have a material impact on the Company's fiscal year 2011), except for the requirement to provide Level 3 activity of purchases, sales, issuances, and settlements on a gross basis, which will be effective for fiscal years beginning after December 15, 2010 (the Company's fiscal year 2012); early adoption is permitted. The Company is currently evaluating the impact of adopting ASU 2010-06 on itsconsolidated financial statements.

        In April 2010,June 2011, the FASB issued Accounting Standards UpdateASU No. 2010-17 (ASU 2010-17),2011-05, "Revenue Recognition—Milestone MethodComprehensive Income (Topic 220): Presentation of Comprehensive Income" ("ASU 2011-05") which amends ASC Topic 605,Revenue Recognition, providingrequires that all non-owner changes in stockholders' equity be presented either in a consistent framework for applyingsingle continuous statement of comprehensive income or in two separate but consecutive statements. In the milestone method, thus adding clarity in practice ontwo-statement approach, the first statement would present total net income and its application. The objectivecomponents followed consecutively by a second statement that would present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income. ASU 2010-172011-05 is to provide guidance on defining a milestonebe adopted retrospectively and determining when to apply the milestone method of revenue recognition to research and development transactions. ASU 2010-17 is effective for annual periods beginning after December 2011. The adoption of ASU 2011-05 will not have an impact on the Company, prospectively,Company's consolidated financial position, results of operations, or cash flows, because the guidance only changes the presentation of financial information. In December 15, 2011, the FASB issued ASU 2011-12 deferring the effective date for milestones achieved in fiscal years, and interim periods within those years, beginning on orimplementation of ASU 2011-05 related only to reclassification out of accumulated other comprehensive income until a later date to be determined after June 15, 2010 (the Company's fiscal year 2011); early adoption is permitted. The Company is currently evaluatingfurther consideration by 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)FASB.

4. Net Income (Loss) Per Share:

        Net income (loss) per share is calculated pursuant to ASC Topic 260,Earnings per shareShare ("ASC Topic 260"). Basic earnings per share (EPS) excludes("EPS") exclude potentially dilutive securities and is computed by dividing net income by the weighted average number of Common shares outstanding for the period. Diluted EPS is computed assuming the conversion or exercise of all dilutive securities such as employee stock options.

        In fiscal 2012 there was a difference of five shares between basic weighted average shares outstanding and diluted weighted average shares outstanding used in the computation of diluted EPS. In fiscal 2011 there was a difference of 42,398 shares between basic weighted average shares outstanding and diluted weighted average shares outstanding used in the computation of diluted EPS. In fiscal 2010 there was a difference of 26,358 shares between basic weighted average shares outstanding and 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 average shares outstanding used to compute diluted EPS for fiscal 2008, due to the Company experiencing a net loss.

        The number of incremental shares from the assumed exercise of stock options is calculated by using the treasury stock method. As of September 30, 20102012 and 2009,2011, there were 491,200836,200 and 606,549617,800 options to purchase common stock outstanding, respectively. For fiscal year 2010, 240,7702012, 806,200 options to purchase common stock were excluded from the computation of diluted earnings per share, asbecause the effect would be anti-dilutive. For fiscal year 2009, 425,9492011, 184,300 options to purchase common stock were excluded from the computation of diluted earnings per share, asbecause the effect would be anti-dilutive.

5. Prepaid expenses and other current assets:

        Prepaid expenses and other current assets consist of the following:

 
 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)

5. Prepaid expenses and other current assets:

        Prepaid expenses and other current assets consist of the following:

 
 September 30,
2012
 September 30,
2011
 

Revenue recognized not yet invoiced

 $1,595,436 $384,640 

Prepaid insurance

  176,340  254,171 

Other

  259,868  236,825 
      

 $2,031,644 $875,636 
      

6. Property and equipment:

        Property and equipment, net consists of the following balances:



 September 30,
2010
 September 30,
2009
  September 30,
2012
 September 30,
2011
 

Computer equipment

Computer equipment

 $1,968,365 $1,986,028  $2,090,556 $2,055,128 

Corporate airplane

Corporate airplane

 3,082,186 3,082,186  3,082,186 3,082,186 

Furniture and office equipment

Furniture and office equipment

 1,077,698 1,074,031  1,076,849 1,074,279 

Manufacturing facility

Manufacturing facility

 5,576,466 5,558,553  5,605,616 5,605,616 

Equipment

Equipment

 4,070,171 4,037,689  4,378,714 4,205,243 

Land

Land

 1,021,245 1,021,245  1,021,245 1,021,245 
          

 16,796,131 16,759,732  17,255,166 17,043,697 

Less: Accumulated depreciation and amortization

 (10,040,788) (9,567,335)

Less: Accumulated depreciation and amortization

 (9,034,593) (8,416,031)     
      $7,214,378 $7,476,362 

 $7,761,538 $8,343,701      
     

        Depreciation and amortization related to property and equipment was approximately $0.8$0.5 million, $0.9$0.5 million and $1.0$0.8 million for fiscal 2010, 20092012, 2011 and 2008,2010, respectively.

7. Other assets:

        Other assets consist of the following:

 
 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 
      
 
 September 30,
2012
 September 30,
2011
 

Intangible assets, net of accumulated amortization of $441,637 and $391,829 at September 30, 2012 and September 30, 2011

 $158,600 $208,408 
      

        Intangible assets consist of licensing and certification rights which are amortized over a defined number of units. The Company had no non-cash purchases of other assets of $0, $100,000in 2012, 2011 and $0 in 2010, 2009 and 2008, respectively.2010. No impairment charge wascharges were recorded in fiscal 20102012, 2011 or 2009. The Company recorded an asset impairment charge of $2.5 million in 2008 related to acquired engineering software that was determined to offer no future cash flow generation and is no longer part of the Company's product offerings.2010.

        Total intangible amortization expense was approximately $0.1 million, $0.2$0.1 million and $0.1 million for fiscal 2012, 2011 and 2010, 2009 and 2008, respectively. BecauseSince the intangible assets are being amortized over a defined number of units, the timing of future amortization expense over the next five years cannot be determined at this time.is not determinable.


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INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

8. Accrued expenses:

        Accrued expenses consist of the following:

 
 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, 2009 is severance related to the former Chief Executive Officer which is payable under the terms of the Release Agreement dated November 10, 2008.
 
 September 30,
2012
 September 30,
2011
 

Warranty

 $850,499 $955,549 

Salary, benefits and payroll taxes

  531,862  476,152 

Professional fees

  330,858  352,559 

Income taxes payable

  132,980  152,658 

Materials on order

  43,374  89,392 

Other

  834,239  525,079 
      

 $2,723,812 $2,551,389 
      

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 by the related material, labor and delivery costs incurred in correcting a product failure. ShouldIf actual product failure rates, material or labor costs differ from the Company's estimates, further revisions to the estimated warranty liability would be required.recorded.

        Warranty cost and accrual information for fiscal years ended September 30, 20102012 and 2009:2011:


 2010 2009  2012 2011 

Warranty Accrual as of October 1,

 808,544 736,815  $955,549 $933,270 

Accrued expense for fiscal year

 410,551 353,726  89,815 244,408 

Warranty cost incurred for fiscal year

 (285,825) (281,997) (194,865) (222,129)
          

Warranty accrual as of September 30,

 933,270 808,544  $850,499 $955,549 
          

10. Income Taxes:

        Income taxes are recorded in accordance with ASC Topic 740 ""Income TaxesTaxes"", which utilizes a balance sheet approach to provide for income taxes. Under this method, the Company recognizes deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of the Company's assets, liabilities, and expected benefits of utilizing net operating loss and tax credit carry-forwards. The impact on deferred taxes of changes in tax rates and laws, if any, are applied to the years during which temporary differences are expected to be settled, and 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)

        The components of income taxes are as follows:

 
 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
 
        
 
 For the Fiscal Year Ended September 30, 
 
 2012 2011 2010 

Current provision (benefit):

          

Federal

 $46,792 $183,527 $(33,770)

State

  (9,476) (518) (64,243)
        

Total current provision (benefit)

  37,316  183,009  (98,013)
        

Deferred (benefit) provision:

          

Federal

  (2,435,049)    

State

  670  751  (11,081)
        

Total deferred (benefit) provision

  (2,434,379) 751  (11,081)
        

Total current and deferred (benefit) provision

 $(2,397,063)$183,760 $(109,094)
        

Table of Contents


INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

10. Income Taxes: (Continued)

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



 For the Fiscal Year Ended
September 30,
  For the Fiscal Year Ended September 30, 


 2010 2009 2008  2012 2011 2010 

Federal statutory tax rate

 34.0% 34.0% 34.0%

U.S. Federal statutory tax rate

 34.0% 34.0% 34.0%

State income taxes, net of federal benefit

State income taxes, net of federal benefit

 13.8% (0.1)% 7.3% 6.5% (7.1)% 13.8%

Permanent items

 (1.8)% (0.4)% 1.3%

Research and development tax credits

Research and development tax credits

 (20.7)% (13.1)% 1.8% (3.6)% (27.5)% (20.7)%

Valuation allowance

Valuation allowance

 (38.7)% (14.1)% (74.5)% (433.5)% 14.2% (38.7)%

Additional benefit from federal amended and carryback claims

 0.0% 0.0% 6.3%

Other

 (5.5)% (2.2)% 1.5%

Change in unrecognized tax benefits

 (13.5)% 7.2% (6.8)%
              

Effective income tax rate

 (411.9)% 20.4% (17.1)%

Effective income tax rate

 (17.1)% 4.5% (23.6)%       
       

        In October 2008,December of 2010, Congress enacted a two-year extension of the Emergency Economic Stabilization Act of 2008 was enacted,Research and Development Tax Credit ("R&D Tax Credit"), which retroactively reinstated and extended the Federal Research & Development (R&D)federal R&D Tax Credit for amounts paid or incurred from January 1, 20082010 to December 31, 2009.2011. The Company recognized the entire impact of this retroactive extension was recognized in the first quarter of the fiscal year ending September 30, 2009ended December 31, 2010, as required by ASC Topic 740; accordingly the740. The Company's effective income tax rate for thatthe year reflectedended September 30, 2011 reflects the benefit of the R&D creditTax Credit generated over the period January 1, 20082010 through September 30, 2009. Due to2011. The amount reported above for 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, 2010.2012 reflects R&D Tax Credits generated from October 1, 2011 through December 31, 2011.

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

 
 As of September 30, 
 
 2012 2011 
 
 Current Non Current Current Non Current 

Deferred tax assets:

             

Deferred revenue

 $ $ $3,058 $ 

Reserves and accruals

  1,514,711  240,390  1,677,183  238,179 

Research and development credits          

  80,000  774,318  80,000  848,669 

NOL carryforwards—state

    1,236,554    1,226,649 

Stock options

    614,087    503,978 

Other

    6,304    12,973 
          

  1,594,711  2,871,653  1,760,241  2,830,448 

Less: Valuation allowance

  (6,549) (1,448,177) (1,307,517) (2,696,113)
          

Total deferred tax assets

  1,588,162  1,423,476  452,724  134,335 
          

Deferred tax liabilities:

             

Depreciation

    (705,587)   (701,298)

Other

      (14,089)  
          

Total deferred tax liabilities

    (705,587) (14,089) (701,298)
          

Net deferred tax asset (liability)

 $1,588,162 $717,889 $438,635 $(566,963)
          

Table of Contents


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.

 
 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 endedAt September 30, 2010,2012, the Company generated a federal net operating loss (NOL) of approximately $155,000. The Company plans to carry back this NOL to a previous tax year, such that a refund receivable of $29,000 has been recorded. As of September 30, 2010, the Company hashad state net operating losses ("NOL") carryforwards of $20.2$21.1 million, which begin to expire in varying amounts after fiscal year ending September 30, 2026. In addition, the Company has federal research and development tax creditR&D Tax Credit carryforwards of approximately $655,000,$646,000, which begin to expire in varying amounts after fiscal year ending September 30, 2028, and state research and development tax creditR&D Tax Credit carryforwards of $208,000 (net of federal impact), which begin to expire in varying amounts after fiscal year ending September 30, 2023.

        Deferred tax assets are reduced by valuation allowances if, based on the consideration of all available evidence, it is more likely than not that some portion of the deferred tax asset will not be realized. Significant weight is given to evidence that can be verified objectively, and significant management judgment is required in determining any valuation allowances recorded against net deferred tax assets. The Company 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 planning strategies thatwhich are both prudent and feasible. ASC Topic 740 "Income Taxes" 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. 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. As of

        At September 30, 2010,2012, 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 timingrecent history of income before income taxes, together with projections of profitability in future periods. As a result of this analysis, the Company determined that the positive evidence, which relates primarily to the recent history of income before income taxes, and projections of future profits, was sufficient to conclude that it was appropriate to reverse the valuation allowances previously recorded against its net federal deferred tax assets. The valuation allowance decreased by $2.4 million for the year ended September 30, 2012 primarily because of the reversal of certain valuation allowances described above. The valuation allowance decreased by $48,000 for the year ended September 30, 2011 primarily because of net reversals of deductible temporary differences.

        The current balance of the deferred tax valuation allowance relates principally to net operating losses ("NOL") of certain state taxing jurisdictions. In the event the Company were to determine that it would be able to realize these deferred tax assets in the future, an adjustment would be made to the valuation allowance which would reduce the provision for income taxes. The Company will continue to maintain the balance of the valuation allowance until an appropriate level of profitability is sustained to warrant a conclusion that it is no longer more likely than not that a portion of these net deferred tax assets will not be realized in future periods. There is currently no assurance of such future income before taxes. The Company believes that its estimate of future taxable income is inherently uncertain, and if its current or future operations generate losses, further adjustments to the valuation allowance are possible.


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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 year ended September 30, 2010, and the Company continues to carry a full valuation allowance against its net deferred tax assets. 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 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 and changes in UTP's, if any.

        In accordance with ASC Topic 740, the Company adopted the provisions related to accounting for uncertain income tax positions on October 1, 2007. 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,
  For the Fiscal Year Ended September 30, 

 2010 2009 2008  2012 2011 2010 

Balance at beginning of year

 $474,000 $324,000 $435,000  $491,000 $425,000 $474,000 

Unrecognized tax benefits related to prior years

   (125,000)    

Unrecognized tax benefits related to current year

 34,000 191,000 72,000  12,000 67,000 34,000 

Settlements

        

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

 (83,000) (41,000) (58,000) (100,000) (1,000) (83,000)
              

Balance at end of year

 $425,000 $474,000 $324,000  $403,000 $491,000 $425,000 
              

        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$403,000, $491,000 and $324,000$425,000 at September 30, 2010, 20092012, 2011 and 2008,2010, respectively. It is not anticipated that the balance of unrecognized tax benefits taken regarding previously filed returnsat September 30, 2012 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 has accrued approximately $8,000$4,000 and $19,000$12,000 for the payment of interest, net of tax benefits, at September 30, 20102012 and 2009,2011, respectively. There is no accrual recorded for penalties.

        For the fiscal year ended September 30, 2010, 20092012, 2011 and 2008,2010, the Company recognized a benefitexpense (benefit) of $10,000, $2,000$(8,000), $4,000 and $6,000,($10,000), respectively, offor interest (net of federal impact) within income tax 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 and require significant judgment to apply. The Company's federal income tax returns for the fiscal years ended September 30, 2009 and thereafter are open years subject to examination by the Internal Revenue Service ("IRS"). The Company also files income tax returns in various state jurisdictions, as appropriate, with varying statutes of limitation. During fiscal year 2012, the IRS examined the Company's income tax return for the year ended September 30, 2010; no adjustments resulted from this examination. There are no state income tax examinations in process at this time.

11. Savings Plan:

        The Company sponsors a voluntary defined contribution savings plan covering all employees. The Company made contributions of $145,000, $167,000, and $175,000 for the fiscal years ended September 30, 2012, 2011 and 2010, respectively.


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.

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 was scheduled to mature in 2015 and carried an interest rate set by the remarketing agent that was consistent with 30-day tax-exempt commercial paper. The Company exercised its option to pay-down the outstanding balance during August, 2009.

        The interest cost related to this debt for fiscal years 2010, 2009 and 2008 was $0, $45,000 and $117,000, respectively. The Company was required to maintain a letter of credit in the amount of $5,000,000 covering the debt, prior to the August, 2009 retirement.

12. Savings Plan:

        The Company sponsors a voluntary defined contribution savings plan covering all employees. The Company made contributions of $175,000, $195,000, and $172,000 for the fiscal years ended September 30, 2010, 2009 and 2008, respectively.

13. Share-Based Compensation:

        The Company accounts for share-based compensation under the provisions of ASC Topic 505-50 and ASC Topic 718 by using the modified prospective approach and 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 $645,000, $371,000 $691,000 and $1,138,000$371,000 for the fiscal years ended September 30, 2010, 2009,2012, 2011 and 2008,2010, respectively. The total income tax impact is recognized as a (charge) credit to additional paid-inpaid—in capital in the statement of shareholders' equity related to share-based compensation arrangements was ($2,000)5,000), $2,000$7,000 and ($11,000)2,000) for the fiscal years ended September 30, 2010, 2009,2012, 2011 and 2008,2010, respectively. Compensation expense related to share-based awards is recorded as a component of general and administrative expense.

        The Company maintainshas three share-based compensation plans, the 1998 Stock Option Plan (the "1998 Plan"), 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. The last awards under the Restricted Plan were made in 2010 and no further shares remain to award under the Restricted Plan.

1998 Stock Option Plan

        The 1998 Plan allowed granting of incentive and nonqualified stock options to employees, officers, directors and independent contractors and consultants. No stock options were granted to independent contractors or consultants under this plan. Total compensation expense associated with awards under the 1998 Plan was $159,000, $492,000, and $938,000 for fiscal years ended September 30, 2010, 2009, and 2008 respectively.


Table of Contents


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 plan have exercise prices that are less than, equal to or greater than the fair value of the common stock on the date of grant. The Company reserved 3,389,000 shares of Common Stock for awards under the plan. On November 13, 2008, the plan1998 Plan expired and no additional shares were granted under the Plan after that date.

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

 
 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 year ended September 30, 2008 was $5.05, and the total intrinsic value of options exercised was $33,000.


Table of Contents


INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

13.12. Share-Based Compensation: (Continued)

        Following is a summary of option activity under the 1998 Plan for fiscal years ended September 30, 2012, 2011, and 2010 and changes during the periods then ended:

 
 Options Weighted
Average
Exercise
Price
 Aggregate
Intrinsic
Value
 

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 $ 

Granted

       

Exercised

       

Cancelled

  (103,400) 10.95   
        

Outstanding at September 30, 2011

  387,800 $8.74 $ 

Granted

       

Exercised

       

Cancelled

  (11,600) 12.65   
        

Outstanding at September 30, 2012

  376,200 $8.62   
        

Vested and expected to vest

  375,200 $8.60 $ 
        

Options exercisable at September 30, 2012

  366,200 $8.64 $ 
        

        In fiscal 2012 and 2011, no options were 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 attributable to exercised options.

        The following table summarizes information about stock options under the 1998 Plan at September 30, 2010:2012:

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 
            
 
 Options Outstanding Options Exercisable 
Range of Exercise Prices
 Outstanding
As of September 30,
2012
 Weighted-
Average
Remaining
Contractual
Life
 Weighted-
Average
Exercise
Price
 As of
September 30,
2012
 Weighted-
Average
Exercise
Price
 

$ —  - $  5.00

  181,800  0.6 $4.21  181,800 $4.21 

$  5.01 - $10.00

  101,400  3.3  7.60  91,400  7.58 

$10.01 - $15.00

  47,500  2.5  13.62  47,500  13.62 

$15.01 - $20.00

  12,000  2.5  16.93  12,000  16.93 

$20.01 - $27.00

  33,500  4.3  25.57  33,500  25.57 
            

  376,200  1.9 $8.62  366,200 $8.64 
            

        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 three to five years from the grant date. The expected term of options


Table of Contents


INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

12. Share-Based Compensation: (Continued)

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 toBecause no options were granted from the 1998 Plan for the period identified:


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 20102012, 2011 and 2009 from the 1998 plan; therefore2010, the data in the above tablefor expected dividend, expected volatility, weighted average risk-free interest rate and expected lives is not applicable.

        Total compensation expense associated with stock option awards to employees under the 1998 Plan was $67,000, $117,000, and $159,000 for fiscal years ended September 30, 2012, 2011 and 2010, respectively.

        At September 30, 2010, there was approximately $199,000 of2012, unrecognized compensation cost,expense of $11,000, net of forfeitures related to non-vested stock options, which is expected to be recognized over a period of approximately 4 years.


Table of Contents


INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

13. Share-Based Compensation: (Continued)during fiscal 2013.

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 callscalled 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 fiscaleach year for all eligible non-employee directors. The stock was awarded in four quarterly installments during the fiscal year provided the director iswas still serving on the board on the quarterly issue date. The last awards under the Restricted Plan were made in 2010, and no further shares remain to award under this Plan. However, the Company continued to make an annual grant of non-vested stock under the 2009 Plan. Total share-based compensation expense associated with the annual grant of non-vested stock to non-employee directors under the Restricted Plan was $190,000, $200,000$0, $0 and $200,000 for the fiscal years ended September 30, 2012, 2011 and 2010, 2009, and 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 from the Restricted Plan for fiscal years ended September 30, 2010, 2009,2012, 2011 and 2008:2010:


 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

   
      Non-vested
Stock Awards
 Weighted Average
Share Price
 

Balance at September 30, 2009

Balance at September 30, 2009

 9,050 $5.52  9,050 $5.52 

Granted

 41,150 4.86 

Issued

 (37,862) 5.02 

Cancelled

   

Granted

 41,150 4.86 

Issued

 (37,862) 5.02 

Cancelled

   
          

Balance at September 30, 2010

Balance at September 30, 2010

 12,338 4.86  12,338 $4.86 

Granted

 43,385 4.61 

Issued

 (42,237) 5.49 

Cancelled

   
          

Balance at September 30, 2011

 13,486 $4.61 

Granted

   

Issued

   

Cancelled

   
     

Balance at September 30, 2012

 13,486 $4.61 
     

Table of Contents


INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

12. Share-Based Compensation: (Continued)

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 of 1986, as amended (the "Code"), or nonqualified stock options, as determined by the Compensation Committee of the Company's Board of Directors (the "Committee""Compensation 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 Stockcommon 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 of common stock may be awarded to any employee as a performance-based Award under Section 162(m) of the Code. At September 30, 20102012 there were 1,150,000655,333 shares of Common Stockcommon stock available for awards under the plan.


Table of Contents


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, the related shares of Common Stockcommon 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 Compensation Committee shallmust proportionately and equitably adjust the number and kind of shares of Common Stockcommon stock which may be issued in connection with future Awards, the number and kindtype of shares of Common Stockcommon stock covered by Awards then outstanding under the 2009 Plan, the number and kindtype of shares of Common Stockcommon 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 Compensation Committee. In addition, the Compensation 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 Compensation Committee.


Table of Contents


INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

12. Share-Based Compensation: (Continued)

        Following is a summary of option activity under the 2009 Plan for fiscal years ended September 30, 2012 and 2011, and changes during the periods then ended:

 
 Options Weighted
Average
Exercise
Price
 Aggregate
Intrinsic
Value
 

Outstanding at September 30, 2010

  50,000 $4.50 $ 

Granted

  180,000  5.28   

Exercised

       

Cancelled

       
        

Outstanding at September 30, 2011

  230,000 $5.11 $ 

Granted

  280,000  3.92   

Exercised

       

Cancelled

  (50,000) 4.50   
        

Outstanding at September 30, 2012

  460,000 $4.45 $ 
        

Vested and expected to vest

  460,000 $4.45 $ 
        

Options exercisable at September 30, 2012

  60,003 $5.28 $ 
        

        In fiscal 2012 and 2011, no options were exercised under the 2009 Plan; therefore, there is no intrinsic value attributable to exercised options.

        The following table summarizes information about stock options under the 2009 Plan at September 30, 2010:2012:

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   $ 
            
 
 Options Outstanding Options Exercisable 
Range of Exercise Prices
 Outstanding
As of
September 30,
2012
 Weighted-
Average
Remaining
Contractual Life
 Weighted-
Average
Exercise Price
 As of
September 30, 2012
 Weighted-
Average
Exercise
Price
 

$ —  - $  5.00

  280,000  9.4 $3.92   $ 

$5.01 - $10.00

  180,000  8.9  5.28  60,003  5.28 
            

  460,000  9.2 $4.45  60,003 $5.28 
            

        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 three to 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.experience and the expected turnover rate of the employees receiving the options. 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.


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INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

13.12. Share-Based Compensation: (Continued)


recognized ratably over the vesting term.        Below are the 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.
2009 Plan 
 
 Fiscal Year Ended September 30, 
 
 2012 2011 2010 

Expected dividend rate

       

Expected volatility

  71.1% 63.0% 70.0%

Weighted average risk-free interest rate

  2.1% 1.9% 2.6%

Expected lives (years)

  8.70  10.00  4.15 

        Total compensation expense associated with stock option awards to employees under the 2009 Plan was $23,000, $0$377,000, $54,000 and $0$23,000 for fiscal years ended September 30, 2012, 2011 and 2010, respectively.

        Total share-based compensation expense associated with the annual grant of restricted stock to non-employee directors under the 2009 Plan was $200,000, $200,000 and 2008$0 for the fiscal years ended September 30, 2012, 2011 and 2010, respectively.

        At September 30, 2010, there was approximately $101,000 of2012, unrecognized compensation cost,expense of approximately $1,074,000, net of forfeitures, related to non-vested stock options whichunder the 2009 Plan, is expected to be recognized over a period of approximately 42 years.

14.13. Commitments and Contingencies:

    Capital Lease

        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 annual amortization of $7,178, $10,050$5,000, $5,000 and $22,816$7,000 have been included in property and equipment at September 30, 2010, 20092012, 2011 and 20082010, respectively. The balance due on these leases was $25,500, $36,899$0, $13,000 and $47,542$26,000 as of September 30, 2012, 2011 and 2010, 2009 and 2008 respectively. Future payments, including interest relating to these leases are $13,788 annually for the next two years.

    Operating Leases

        Rent expense under operating leases totaled $25,900, $39,065$30,000, $31,000 and $196,000$26,000 for the years ended September 30, 2010, 20092012, 2011 and 2008,2010, respectively. As of September 30, 20102012 the companyCompany has no future minimum payments related to any non-cancelable operating leases in fiscal 2010.2012.

    Product Liability

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

    Legal Proceedings

        In$50,000,000. The Company has not experienced any material product liability claims in the ordinary course of business, we are at times subject to various legal proceedings and claims. We do not believe any such matters that are currently pending will have a material adverse effect on our results of operations or financial position.

        On November 18, 2010, Jeoffrey L. Burtch, the Chapter 7 Trustee for AE Liquidation, Inc. (formerly Eclipse Aviation Corporation), filed avoidance actions against IS&S on behalf ofpast.


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INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

14.13. Commitments and Contingencies: (Continued)


AE Liquidation, Inc.Legal Proceedings

        In the ordinary course of business, the Company is at times subject to various legal proceedings and claims. IS&S does not believe any such matters that are currently pending will have a material effect on its results of operations or financial position.

        On November 29, 2011, AMR Corporation, the parent company of AAI and certain of its other U.S. based subsidiaries filed voluntary petitions for Chapter 11 reorganization in the U.S. Bankruptcy Court for the avoidanceSouthern District of sevenNew York (the "Bankruptcy"). For the year ended September 30, 2012 and 2011, AAI accounted for approximately 5% and 8%, respectively, of net sales. AAI continued to purchase and pay for products from the Company in the ordinary course of business after November 29, 2011. As of November 29, 2011, the Company had pre-Bankruptcy outstanding accounts receivable of $760,000 from AAI. Based on the present status of the Bankruptcy proceedings, the Company is not able to determine the amount, if any, that could be uncollectible. In the 90 days preceding the filing of the Bankruptcy petition, the Company received $828,000 from AAI in the ordinary course of business. Under the U.S. bankruptcy laws, debtors have the right to avoid certain payments totaling $321,095 as allegedly preferential transfers paid to IS&Smade during the 90 days preceding the filing of the bankruptcy petitionpetition. No such avoidance action has been asserted or filed, and the Company believes that it would have valid defenses against any such action.

        On September 26, 2011, Farhad Daghigh, a former employee of Eclipse Aviation Corporation on November 25, 2008.the Company, filed a lawsuit against IS&S in the Court of Common Pleas of Chester County alleging breach of contract and violation of the Pennsylvania Wage Payment and Collection Law claiming unpaid sales commissions, prejudgment interest and liquidated damages totaling approximately $583,000 for the fiscal years ended 2007, 2008, 2009 and 2010. The Company vehemently denies any allegations of liability and will vigorously defend the lawsuit. This matter has not been resolved as of the date hereof. The Company believes it has meritorious defenses to these avoidance actions, intends to vigorously defend against them and believes that the likelihoodprobability of the avoidance actions prevailingan unfavorable outcome on this claim is remote. Accordingly, the Companyremote, and, therefore, no contingent liability has not accrued any loss reserve related to this claim.been recorded as at September 30, 2012.

        On January 17, 2007 the Company filed suit in the Court of Common Pleas for Delaware County, Pennsylvania against Strathman Associates, a former software consultant for IS&S, alleging that Strathman had improperly used IS&S trade secret and proprietary information in assisting J2 and Kollsman in developing the J2/Kollsman Air Data Computer. The case is ongoing.has not been resolved as of the date hereof.

15. Related-Party14. Related Party Transactions:

        The Company incurred legal fees of $138,000, $105,000$110,000, $116,000 and $128,000$138,000 for the fiscal years ended September 30, 2010, 20092012, 2011 and 2008,2010, respectively with a law firm which is a shareholder of the Company. The fees paid and services rendered were comparable with fees paid to other unrelated law firms.

        For the years ended September 30, 2010, 20092012, 2011 and 2008,2010, respectively, the Company incurred service fees of $25,000,$2,000, $0, and $67,000$25,000 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.


16.Table of Contents


INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

15. Quarterly Financial Data (unaudited):

        Summarized quarterly results of operations of the Company for the years ended September 30, 20102012 and September 30, 20092011 are presented below:



 Fiscal Year Ended September 30, 2010  Fiscal Year Ended September 30, 2012 


 First Quarter Second Quarter Third Quarter Fourth Quarter  First Quarter Second Quarter Third Quarter Fourth Quarter 

Net Sales

Net Sales

 $4,607,239 $5,372,957 $7,813,816 $7,463,311  $4,755,459 $6,760,221 $6,134,492 $6,928,026 

Cost of sales

Cost of sales

 2,836,773 2,942,496 3,010,810 2,729,950  2,629,860 3,659,505 3,518,867 4,259,701 

Gross profit

Gross profit

 1,770,466 2,430,461 4,803,006 4,733,361  2,125,599 3,100,716 2,615,625 2,668,325 

Operating income (loss)

Operating income (loss)

 (1,545,378) (850,570) 1,589,723 1,209,692  (658,199) 346,543 355,162 373,006 

Net income (loss)

Net income (loss)

 (1,145,173) (745,765) 1,388,032 1,251,282  (342,979) 288,873 259,971 2,773,129 

Net income (loss) per common share

Net income (loss) per common share

  

Basic

 $(0.07)$(0.04)$0.08 $0.07 

Diluted

 $(0.07)$(0.04)$0.08 $0.07 

Basic

 $(0.02)$0.02 $0.02 $0.17 

Diluted

 $(0.02)$0.02 $0.02 $0.17 


 
 Fiscal Year Ended September 30, 2011 
 
 First Quarter Second Quarter Third Quarter Fourth Quarter 

Net Sales

 $6,529,811 $6,746,070 $5,971,494 $6,490,277 

Cost of sales

  2,935,655  2,873,414  2,811,960  3,324,155 

Gross profit

  3,594,156  3,872,656  3,159,534  3,166,122 

Operating income (loss)

  151,200  466,686  (104,935) 94,956 

Net income (loss)

  284,780  499,152  (78,981) 11,639 

Net income (loss) per common share

             

Basic

 $0.02 $0.03 $(0.00)$0.00 

Diluted

 $0.02 $0.03 $(0.00)$0.00 

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

16. Business Segments:

        The Company operates in one business segment which designs, manufactures and sells flat panel displays, flight information computers, and advanced monitoring systems to the DoD, DOI, 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 and related EMD services. Most of the Company's sales, operating results and identifiable assets are in the United States. During fiscal 2012, 2011 and 2010, IS&S derived 87%, 79% and 68%, respectively, of its total revenues from the sale of FPDS. During fiscal 2012, 2011 and 2010, the Company derived 13%, 21% and 32%, respectively, of total revenues from the sale of air data systems related products. During fiscal 2012, 2011 and 2010, the Company derived 26%, 2% and 7%, respectively, of total revenues from the sale of EMD services.


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INNOVATIVE SOLUTIONS AND SUPPORT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

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


 
 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.

17. Business SegmentsGeographic Data

        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 allMost 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 2010, 2009 and 2008 we derived 68%, 75%, and 77% respectively, of our total revenues from the sale of Flat Panel Display Systems. During fiscal 2010, 2009, and 2008 we derived 32%, 25%, and 23% respectively, of total revenues from the sale of air data systems related products.

    Geographic Data

        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 2010, 20092012, 2011 and 20082010, net sales outside the United States amounted to $4.4 million, $4.0 million and $2.8 million, $4.4 million and $1.7 million, respectively.

    Product Data

        OurThe Company's current product line includes flat panel display systemsFPDS and air data systems and components,components. During fiscal 2010, 20092012, 2011 and 2008,2010, the Company derived 68%87%, 75%,79% and 77%68%, respectively, of its revenue from sales of flat panel display systems.FPDS. The remaining revenue for each of the fiscal years was from sales of air data systems and components.

17. Subsequent Event:

        On December 7, 2012 the Company's Board of Directors declared a special cash dividend in the amount of $1.50 per share, payable on or about December 27, 2012 to shareholders of record as of the close of business on December 17, 2012. The aggregate amount of the payment to be made in connection with the dividend will be approximately $24.9 million.


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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,("CEO"), and Chief Financial Officer, or CFO,("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, 2010.2012. 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 ourthe Company's 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 Reportreport on Internal Controlinternal control over financial reporting

        Management of Innovative Solutions & Support, Inc. and its subsidiaries (the Company)"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.

        Management assessed the effectiveness of the Company's internal control over financial reporting as of September 30, 2010.2012. This assessment was based on criteria for effective internal control over


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financial reporting described in "Internal Control—Integrated Framework," issued by the Committee on Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that, as of September 30, 2010,2012, internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. generally accepted accounting principles.

        OurThe Company's 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, 2010,2012, 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, 2010,2012, 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, 20102012 of the Company and our report dated December 14, 201012, 2012 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.statements.

/s/ DELOITTE & TOUCHE LLP


Philadelphia, Pennsylvania
December 14, 20102012


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

Item 11.    Executive compensation.

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

    Equity Compensation Plan Information

        The following table gives information about ourthe Company's common stock that may be issued upon the exercise of options and rights under all of ourits existing equity compensation plans and arrangements as of September 30, 2010.2012.

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)
  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  870,668 $6.37 656,471 

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. The last awards under the Restricted Plan were made in 2010, and there are no further shares to award under this Plan. However, the Company continued to make an annual grant of restricted shares under the 2009 Plan. Total share-based compensation expense for non-employee


directors was $200,000, $200,000 and $200,000 for the fiscal years ended September 30, 2012, 2011 and 2010, respectively.

        In the fiscal years ended September 30, 2010, 20092012, 2011 and 2008,2010, awards to ourthe Company's non-employee directors under the Plan were 37,862, 29,81542,430, 42,237 and 11,35537,862 shares respectively.


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

Related Party Transactions

        This information will be included in ourthe Company's Proxy Statement relating to ourits Annual Meeting of Shareholders, which will be filed within 120 days after close of ourthe Company's 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 ourthe Company's Proxy Statement relating to ourits Annual Meeting of Shareholders, which will be filed within 120 days after close of ourthe Company's 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)1.
    Financial Statements

        See index to Financial Statements at Item 8 on page 2931 of this report.

          (2)2.
          Financial Statement Schedules

          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.

            (3)3.
            The following exhibits are filed as part of, or incorporated by reference into this report:

        Exhibit
        Number
         Exhibit Title
        3.1^Articles of Incorporation of IS&S.(2)
           
        3.2 $ Bylaws of IS&S.(7)
         10.1 
        10.1*#IS&S 1988 Incentive Stock Option Plan.(1)(3)
         10.2 
        10.2*&IS&S 1998 Stock Option Plan.(1)(4)
         10.3 
        10.3*!IS&S 2003 Restricted Stock PlanPlan(1)(6)
         10.4 
        10.4*@Employment Agreement by and between IS&S and John C. Long dated January 28, 2008
        10.5@Settlement Agreement by and between IS&S and Kollsman, Inc. dated August 27, 2008
        10.6IS&S 2009 Stock-Based Incentive Compensation PlanPlan(5)
         10.5 Employment Agreement, dated February 14, 2012, between IS&S and Shahram Askarpour(10)
        21 Subsidiaries of IS&S.
         
        23.1 Consent of Deloitte and Touche LLP.
         
        31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
         
        31.2 Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)
         
        32.1 Certification Pursuant to U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
         99.1 
        99.1*@Amendment to the IS&S 1998 Stock Option PlanPlan.(1)(8)
        101
        101.INSXBRL Instance Document(9)
        101.SCHXBRL Taxonomy Extension Scheme Document(9)
        101.CALXBRL Taxonomy Extension Calculation Linkbase Document(9)
        101.DEF.XBRL Taxonomy Extension Definition Linkbase Document(9)
        101.LABXBRL Taxonomy Extension Label Linkbase Document(9)
        101.PRE.XBRL Taxonomy Extension Presentation Linkbase Document(9)


        *(1)
        Constitutes a management contract or compensatory plan or arrangement required to be filed as an exhibit to this form.


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        ^(2)
        Incorporated by reference from the Registrant's Current Report on Form 8-K filed with the Commission on September 19, 2007.

        #(3)
        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.

        &(4)
        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 2008.

        (5)
        Incorporated by reference from the Registrant's Proxy Statement filed with the Commission on January 28, 2009.


        !(6)
        Incorporated by reference from the Registrant's Proxy Statement filed with the Commission on January 26, 2004

        $(7)
        Incorporated by reference from the Registrant's Quarterly Report on Form 10-Q filed with the Commission on August 6, 2010.

        (8)
        Incorporated by reference from the Registrant's Form 10-K filed with the Commission for the fiscal year 2008.

        (9)
        Pursuant to Regulation S-T, these interactive data files are deemed not filed or incorporated in any registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability under those sections.

        (10)
        Incorporated by reference from the Registrant's Current Report on Form 8-K filed with the Commission on April 2, 2012.

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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. HEDRICK

        Geoffrey S. M. Hedrick
        Chairman & Chief Executive Officer

         

         

        Dated: December 14, 20102012

                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 14, 20102012

        /s/ ROMAN G. PTAKOWSKISHAHRAM ASKARPOUR

        Roman G. PtakowskiShahram Askarpour

         

        President

         

        December 14, 20102012

        /s/ RONALD C. ALBRECHT

        Ronald C. Albrecht

         

        Chief Financial Officer (Principal Accounting Officer)

         

        December 14, 20102012

        /s/ GLEN R. BRESSNER

        Glen R. Bressner

         

        Director

         

        December 14, 20102012

        /s/ WINSTON J. CHURCHILL

        Winston J. Churchill

         

        Director

         

        December 14, 20102012

        /s/ ROBERT MIONIS

        Robert Mionis

         

        Director

         

        December 14, 20102012

        /s/ ROBERT E. MITTELSTAEDT, JR.

        Robert E. Mittelstaedt, Jr.

         

        Director

         

        December 14, 20102012

        /s/ ROBERT H. RAU

        Robert H. Rau

         

        Director

         

        December 14, 20102012