Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended June 30, 20162017

 

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. 000-31157

 

INNOVATIVE SOLUTIONS AND SUPPORT, INC.

(Exact name of registrant as specified in its charter)

 

PENNSYLVANIA

 

23-2507402

(State or Other Jurisdiction

 

(I.R.S. Employer

of Incorporation or Organization)

 

Identification No.)

 

720 Pennsylvania Drive, Exton, Pennsylvania

 

19341

(Address of Principal Executive Offices)

 

(Zip Code)

 

(610) 646-9800

(Registrant’s Telephone Number, Including Area Code)

 

Indicate by check mark whether the registrantRegistrant (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 registrantRegistrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x     No o

 

Indicate by check mark whether the registrantRegistrant has submitted electronically and posted on its corporate Website, 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 registrantRegistrant was required to submit and post such files). Yes x     No o

 

Indicate by check mark whether the registrantRegistrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”filer,” “smaller reporting company” and “smaller reporting“emerging growth company” in Rule 12b-2 of the Exchange Act.

 

o Large accelerated filer

 

o Accelerated filer

 

 

 

o Non-accelerated filer (Do not check if a smaller reporting company)

 

x Smaller reporting company

(Do not check if a smaller reporting company)

o Emerging growth company

 

 

 

If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

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

 

As of July 29, 2016,28, 2017, there were 16,908,84916,783,129 shares of the Registrant’s Common Stock, with par value of $.001 per share, outstanding.

 

 

 



Table of Contents

 

INNOVATIVE SOLUTIONS AND SUPPORT, INC.

FORM 10-Q June 30, 20162017

 

INDEX

 

 

 

Page No.

 

 

 

PART I.

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Condensed Consolidated Balance Sheets — June 30, 20162017 (unaudited) and September 30, 20152016

1

 

 

 

 

Condensed Consolidated Statements of Operations — Three and Nine months endedMonths Ended June 30, 20162017 and 20152016 (unaudited)

2

 

 

 

 

Condensed Consolidated Statements of Cash Flows — Nine months endedMonths Ended June 30, 20162017 and 20152016 (unaudited)

3

 

 

 

 

Notes to Condensed Consolidated Financial Statements (unaudited)

4 16

 

 

 

Item 2.

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

17 23

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

24

 

 

 

Item 4.

Controls and Procedures

24

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

25

 

 

 

Item 1A.

Risk Factors

25

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

2625

 

 

 

Item 3.

Defaults upon Senior Securities

2625

 

 

 

Item 4.

Mine Safety Disclosures

2625

 

 

 

Item 5.

Other Information

2625

 

 

 

Item 6.

Exhibits

2625

 

 

 

SIGNATURES

2726

 



Table of Contents

PART I—FINANCIAL INFORMATION

 

Item 1- Financial Statements

 

INNOVATIVE SOLUTIONS AND SUPPORT, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

 

 

June 30,

 

September 30,

 

 

June 30,

 

September 30,

 

 

2016

 

2015

 

 

2017

 

2016

 

 

(unaudited)

 

 

 

 

(unaudited)

 

 

 

ASSETS

ASSETS

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

17,530,210

 

$

16,282,039

 

 

$

24,981,341

 

$

18,767,661

 

Accounts receivable

 

5,838,818

 

2,394,695

 

 

2,073,268

 

4,511,091

 

Unbilled receivables, net

 

1,611,357

 

3,920,209

 

 

1,600,034

 

1,597,672

 

Inventories

 

4,008,114

 

4,597,316

 

 

4,533,039

 

3,645,828

 

Deferred income taxes

 

741,109

 

933,499

 

Prepaid expenses and other current assets

 

1,136,268

 

1,221,717

 

 

1,002,622

 

847,207

 

 

 

 

 

 

 

 

 

 

 

Total current assets

 

30,865,876

 

29,349,475

 

 

34,190,304

 

29,369,459

 

 

 

 

 

 

 

 

 

 

 

Property and equipment, net

 

7,014,638

 

7,095,330

 

 

6,762,897

 

6,962,562

 

Other assets

 

156,948

 

168,948

 

 

200,274

 

156,948

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

38,037,462

 

$

36,613,753

 

 

$

41,153,475

 

$

36,488,969

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

1,849,274

 

$

1,435,981

 

 

$

1,021,572

 

$

1,503,771

 

Accrued expenses

 

2,295,897

 

2,568,531

 

 

1,955,031

 

1,889,908

 

Deferred revenue

 

299,052

 

756,745

 

 

314,702

 

179,585

 

 

 

 

 

 

 

 

 

 

 

Total current liabilities

 

4,444,223

 

4,761,257

 

 

3,291,305

 

3,573,264

 

 

 

 

 

 

 

 

 

 

 

Non-current deferred income taxes

 

576,629

 

507,184

 

Other liabilities

 

2,930

 

2,826

 

Deferred income taxes

 

67,745

 

67,701

 

 

 

 

 

 

 

 

 

 

 

Total liabilities

 

5,023,782

 

5,271,267

 

 

3,359,050

 

3,640,965

 

 

 

 

 

 

 

 

 

 

 

Commitments and contingencies (See Note 6)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 June 30, 2016 and September 30, 2015

 

 

 

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 June 30, 2017 and September 30, 2016

 

$

 

$

 

 

 

 

 

 

 

 

 

 

 

Common stock, $.001 par value: 75,000,000 shares authorized, 18,812,465 and 18,756, 089 issued at June 30, 2016 and September 30, 2015, respectively

 

18,813

 

18,756

 

Common stock, $.001 par value: 75,000,000 shares authorized, 18,879,580 and 18,812,465 issued at June 30, 2017 and September 30, 2016, respectively

 

18,880

 

18,813

 

 

 

 

 

 

 

 

 

 

 

Additional paid-in capital

 

51,400,058

 

51,148,722

 

 

51,583,840

 

51,392,159

 

Retained earnings

 

2,408,440

 

818,768

 

 

7,560,242

 

2,805,569

 

Treasury stock, at cost, 1,903,616 and 1,846,451 shares at June 30, 2016 and September 30, 2015, repectively

 

(20,813,631

)

(20,643,760

)

Treasury stock, at cost, 2,096,451 shares at June 30, 2017 and September 30, 2016

 

(21,368,537

)

(21,368,537

)

 

 

 

 

 

 

 

 

 

 

Total shareholders’ equity

 

33,013,680

 

31,342,486

 

 

37,794,425

 

32,848,004

 

 

 

 

 

 

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

38,037,462

 

$

36,613,753

 

 

$

41,153,475

 

$

36,488,969

 

 

The accompanying notes are an integral part of these statements.

INNOVATIVE SOLUTIONS AND SUPPORT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

 

 

Three Months Ended June 30,

 

Nine Months Ended June 30,

 

 

Three Months Ended June 30,

 

Nine Months Ended June 30,

 

 

2016

 

2015

 

2016

 

2015

 

 

2017

 

2016

 

2017

 

2016

 

Net sales:

 

 

 

 

 

 

 

 

 

Sales:

 

 

 

 

 

 

 

 

 

Product

 

$

6,376,042

 

$

4,114,837

 

$

20,771,687

 

$

12,152,290

 

 

$

4,476,717

 

$

6,376,042

 

$

12,566,311

 

$

20,771,687

 

Engineering development contracts

 

128,550

 

804,852

 

977,465

 

4,777,705

 

 

64,704

 

128,550

 

550,889

 

977,465

 

Returns and allowances

 

 

 

(556,009

)

 

Total net sales

 

6,504,592

 

4,919,689

 

21,749,152

 

16,929,995

 

 

4,541,421

 

6,504,592

 

12,561,191

 

21,749,152

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of sales:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product

 

2,490,681

 

2,300,470

 

8,461,419

 

6,918,457

 

 

2,074,500

 

2,490,681

 

5,996,291

 

8,461,419

 

Engineering development contracts

 

130,335

 

687,574

 

185,000

 

3,734,692

 

 

89,640

 

130,335

 

298,332

 

185,000

 

Total cost of sales

 

2,621,016

 

2,988,044

 

8,646,419

 

10,653,149

 

 

2,164,140

 

2,621,016

 

6,294,623

 

8,646,419

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

3,883,576

 

1,931,645

 

13,102,733

 

6,276,846

 

 

2,377,281

 

3,883,576

 

6,266,568

 

13,102,733

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

1,405,158

 

799,340

 

3,674,374

 

2,101,812

 

 

1,236,184

 

1,405,158

 

3,391,181

 

3,674,374

 

Selling, general and administrative

 

2,246,074

 

1,397,165

 

7,531,633

 

4,911,546

 

 

1,682,286

 

2,246,074

 

2,025,952

 

7,531,633

 

Total operating expenses

 

3,651,232

 

2,196,505

 

11,206,007

 

7,013,358

 

 

2,918,470

 

3,651,232

 

5,417,133

 

11,206,007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

232,344

 

(264,860

)

1,896,726

 

(736,512

)

Operating (loss) income

 

(541,189

)

232,344

 

849,435

 

1,896,726

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

9,092

 

6,372

 

24,458

 

18,269

 

 

7,682

 

9,092

 

27,505

 

24,458

 

Other income

 

12,457

 

11,173

 

71,490

 

31,405

 

 

15,628

 

12,457

 

4,174,953

 

71,490

 

Income (loss) before income taxes

 

253,893

 

(247,315

)

1,992,674

 

(686,838

)

(Loss) income before income taxes

 

(517,879

)

253,893

 

5,051,893

 

1,992,674

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

27,096

 

3,284,658

 

403,002

 

2,615,484

 

Income tax (benefit) expense

 

(537,099

)

27,096

 

297,220

 

403,002

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

226,797

 

$

(3,531,973

)

$

1,589,672

 

$

(3,302,322

)

Net income

 

$

19,220

 

$

226,797

 

$

4,754,673

 

$

1,589,672

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) per common share:

 

 

 

 

 

 

 

 

 

Net income per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.01

 

$

(0.21

)

$

0.09

 

$

(0.20

)

 

$

0.00

 

$

0.01

 

$

0.28

 

$

0.09

 

Diluted

 

$

0.01

 

$

(0.21

)

$

0.09

 

$

(0.20

)

 

$

0.00

 

$

0.01

 

$

0.28

 

$

0.09

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

16,941,707

 

16,910,475

 

16,925,688

 

16,930,522

 

 

16,755,082

 

16,941,707

 

16,735,533

 

16,925,688

 

Diluted

 

17,059,546

 

16,910,475

 

17,027,216

 

16,930,522

 

 

16,870,404

 

17,059,546

 

16,847,305

 

17,027,216

 

 

The accompanying notes are an integral part of these statements.

INNOVATIVE SOLUTIONS AND SUPPORT, INC.


CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


(unaudited)

 

 

For the Nine Months Ended June 30,

 

 

For the Nine Months Ended June 30 ,

 

 

2016

 

2015

 

 

2017

 

2016

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

1,589,672

 

$

(3,302,322

)

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

 

 

 

 

 

Net income

 

$

4,754,673

 

$

1,589,672

 

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

 

 

 

 

 

Depreciation and amortization

 

355,930

 

430,525

 

 

332,323

 

355,930

 

Share-based compensation expense:

 

 

 

 

 

 

 

 

 

 

Stock options

 

68,172

 

259,582

 

 

 

68,172

 

Stock awards

 

183,222

 

149,952

 

 

191,748

 

183,222

 

Tax adjustment from share-based compensation

 

 

(54,055

)

Recovery of loss on unbilled receivables

 

 

(62,159

)

(Gain) loss on disposal of property and equipment

 

(563

)

(56,824

)

Excess and obsolete inventory cost

 

 

246,663

 

Gain on disposal of property and equipment

 

 

(563

)

Deferred income taxes

 

261,835

 

2,837,888

 

 

44

 

261,835

 

(Increase) decrease in:

 

 

 

 

 

 

 

 

 

 

Accounts receivable

 

(3,444,668

)

516,769

 

 

2,437,823

 

(3,444,668

)

Unbilled receivables, net

 

2,308,852

 

2,622,729

 

 

(2,362

)

2,308,852

 

Inventories

 

589,202

 

1,085,418

 

 

(887,211

)

589,202

 

Prepaid expenses and other current assets

 

85,449

 

97,287

 

 

(51,097

)

85,449

 

Other non-current assets

 

 

(75,300

)

 

(45,926

)

 

Increase (decrease) in:

 

 

 

 

 

 

 

 

 

 

Accounts payable

 

413,293

 

(2,043,154

)

Accounts payable, net

 

(482,199

)

413,293

 

Accrued expenses

 

(272,634

)

(1,593,150

)

 

65,123

 

(272,634

)

Income taxes payable/receivable

 

104

 

(359,491

)

 

(104,318

)

104

 

Deferred revenue

 

(457,694

)

213,218

 

 

135,117

 

(457,694

)

Net cash provided by operating activities

 

1,680,172

 

913,576

 

 

6,343,738

 

1,680,172

 

 

 

 

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

 

 

 

 

 

Purchases of property and equipment

 

(263,238

)

(171,474

)

 

(130,058

)

(263,238

)

Proceeds from the sale of property and equipment

 

1,108

 

57,000

 

 

 

1,108

 

Net cash (used in) investing activities

 

(262,130

)

(114,474

)

 

(130,058

)

(262,130

)

 

 

 

 

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

 

 

 

 

 

Purchase of Company’s stock

 

(169,871

)

(254,170

)

 

 

(169,871

)

Net cash (used in) financing activities

 

(169,871

)

(254,170

)

 

 

(169,871

)

 

 

 

 

 

 

 

 

 

 

Net increase in cash and cash equivalents

 

1,248,171

 

544,932

 

 

6,213,680

 

1,248,171

 

Cash and cash equivalents, beginning of year

 

16,282,039

 

15,214,584

 

 

18,767,661

 

16,282,039

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents, end of period

 

$

17,530,210

 

$

15,759,516

 

 

$

24,981,341

 

$

17,530,210

 

 

 

 

 

 

 

 

 

 

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

 

 

 

 

 

 

 

 

 

 

Cash paid for income tax

 

$

135,000

 

$

191,000

 

 

$

400,000

 

$

135,000

 

 

The accompanying notes are an integral part of these statements.

INNOVATIVE SOLUTIONS AND SUPPORT, INC.


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

1. Summary of Significant Accounting Policies

 

Description of the Company

 

Innovative Solutions and Support, Inc. (the “Company” or “IS&S”) was incorporated in Pennsylvania on February 12, 1988. The Company operates in one business segment as a systems integrator that designs, manufactures, sells, and services air data equipment, engine display systems, standby equipment, primary flight guidance, and cockpit display systems for retrofit applications and original equipment manufacturers (“OEMs”). The Company supplies integrated Flight Management Systems (“FMS”), Flat Panel Display Systems (“FPDS”), Integrated Standby Units (“ISU”) and, advanced Global Positioning System (“GPS”) receivers that enable reduced carbon footprint navigation.navigation and an Autothrottle, which allows a pilot to automatically control the power setting of the engine and is designed to reduce pilot workload and enhance safety.

 

The Company has continued to position itself as a system integrator, which capability provides the Company with the potential to generate more substantive orders over a broader product base. The strategy, as both a manufacturer and integrator, is designed to leverage the latest technologies developed for the computer and telecommunications industries into advanced and cost-effective solutions for the general aviation, commercial air transport, United States Department of Defense (“DoD”)/governmental, and foreign military markets. This approach, combined with the Company’s industry experience, is designed to enable IS&S to develop high-quality products and systems, to reduce product time to market, and to achieve cost advantages over products offered by its competitors. Customers include commercial air transport carriers and corporate/general aviation companies, the DoD and its commercial contractors, aircraft operators, aircraft modification centers, foreign militaries, and various OEMs.

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements are presented pursuant to the rules and regulations of the United States Securities and Exchange Commission (the “SEC”) in accordance with the disclosure requirements for the quarterly report on Form 10-Q and, therefore, do not include all of the information and footnotes required by generally accepted accounting principles in the United States (“GAAP”) for complete annual financial statements. In the opinion of Company management, the unaudited condensed consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) necessary to state fairly the results for the interim periods presented. The condensed consolidated balance sheet as of September 30, 20152016 is derived from the audited financial statements of the Company. Operating results for the three and nine months ended June 30, 20162017 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2016.2017. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes of the Company included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2015.2016.

 

The Company’s condensed consolidated financial statements include the accounts of its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

 

Use of Estimates

 

Preparation ofThe Company prepares its condensed consolidated financial statements in conformity with GAAP, which 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 net sales and expenses during the reporting period. Estimates are used in accounting for, among other items, long term contracts, allowance for doubtful accounts, inventory obsolescence, product warranty cost liabilities, income taxes, engineering and material costs on Engineering Development Contracts (“EDC”) programs, percentage-of-completion on EDC, recoverability of long-lived assets, stock-based compensation expense, self-insurance reserves, 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 June 30, 20162017 and September 30, 20152016 consist of funds invested in money market funds with financial institutions.

 

Property and Equipment

 

Property and equipment are stated at cost. Depreciation is provided using an accelerated method over the estimated useful lives of the assets (the lesser of three to seven years or over the related lease term), except for the manufacturing facility and the corporate airplane. The building is being depreciated on a straight linestraight-line basis over 39 years. During the nine months ended June 30, 2017 and 2016, no depreciation was provided for the airplane because it had been depreciated to its estimated salvage value. Major additions and improvements are capitalized. Maintenancecapitalized, while maintenance and repairs that do not improve or extend the life of assets are charged to expense as incurred.  The airplane was depreciated on a straight-line basis over its estimated useful life of ten years; however, because the airplane had been depreciated previously to its estimated salvage value, no depreciation expense was recorded for this asset during the nine months ended June 30, 2016 or 2015, respectively.

Fair Value of Financial Instruments

 

The net carrying amounts of cash and cash equivalents, accounts receivable, and accounts payable approximate their fair value because of the short-term nature of these instruments. For financial assets and liabilities measured at fair value on a recurring basis, fair value is the price 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 fair value 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 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 June 30, 20162017 and September 30, 2015,2016, according to the valuation techniques the Company used to determine their fair values.

 

 

Fair Value Measurement on June 30, 2016

 

 

Fair Value Measurement on June 30, 2017

 

 

Quoted Price in

 

Significant Other

 

Significant

 

 

Quoted Price in

 

Significant Other

 

Significant

 

 

Active Markets for

 

Observable

 

Unobservable

 

 

Active Markets for

 

Observable

 

Unobservable

 

 

Identical Assets

 

Inputs

 

Inputs

 

 

Identical Assets

 

Inputs

 

Inputs

 

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

16,414,873

 

$

 

$

 

 

$

23,893,711

 

$

 

$

 

 

 

 

 

Fair Value Measurement on September 30, 2015

 

 

Quoted Price in

 

Significant Other

 

Significant

 

 

Active Markets for

 

Observable

 

Unobservable

 

 

Identical Assets

 

Inputs

 

Inputs

 

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Assets

 

 

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

 

 

Money market funds

 

$

14,410,806

 

$

 

$

 

 

 

Fair Value Measurement on September 30, 2016

 

 

 

Quoted Price in

 

Significant Other

 

Significant

 

 

 

Active Markets for

 

Observable

 

Unobservable

 

 

 

Identical Assets

 

Inputs

 

Inputs

 

 

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Assets

 

 

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

 

 

Money market funds

 

$

16,414,873

 

$

 

$

 

 

Long-Lived Assets

 

The Company assesses the impairment of long-lived assets in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 360-10, Property, Plant and Equipment” (“ASC Topic 360-10”).Equipment.” This statement requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances, known as triggering events, indicate the carrying amount of an asset may not be recoverable. In addition, long-lived assets to be disposed of mustshould 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 recordedtriggering events occurred during the nine months ended June 30, 20162017 or 2015.2016.

Revenue Recognition

 

The Company enters into sales arrangements with customers that, in general, provide for the Company to design, develop, manufacture and deliver air data equipment, large FPDS, flight information computersflat-panel display systems, and advanced monitoring systems that measure and display critical flight information, including data relative to aircraft separation, airspeed, altitude, and engine and fuel data measurements. The Company’s sales arrangements may include multiple deliverables as defined in FASB ASC Topic 605-25 “Multiple-Element Arrangements”Multiple-Element Arrangements (“ASC Topic 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 EDC sales and any functional upgrade and product elements in product sales inon the accompanying consolidated statements 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 2009-14, Revenue Arrangements That Include Software ElementsElements” (“ASU 2009-14”),; and FASB Accounting Standards Update 2009-13, Multiple-Deliverable Revenue Arrangements—aArrangements-a consensus of the FASB Emerging Issues Task ForceForce” ” (“(“ASU 2009-13”),; and FASB ASC Topic 605, Revenue RecognitionRecognition” ” (“(“ASC Topic 605”).

 

To the extent that an arrangement contains software components, which may include functional upgrades that the Company sellsare sold on a standalone basis and which itthe 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 sales to each deliverable (if more than one) based on that deliverable’s fair value.selling price. The Company then considers the appropriate recognition method for each deliverable. The Company’s multiple element arrangements can include defined design and development activities, functional upgrades, and product sales.

 

The Company utilizes the selling price hierarchy that has been established by FASB 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 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 EDC activities as an identified deliverables anddeliverable in addition to products (resulting in a multiple element arrangement), the Company recognizes as EDC sales 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 Topic 605-35”) under the percentage-of-completion method.. To the extent that multiple element arrangements include product sales, sales are generally recognized once revenue recognition criteria for the product deliverables have been met based on the provisions of ASC Topic 605. The Company includes any design and engineering services elements in EDC sales and any functional upgrade and product elements in “product”product sales on the accompanying consolidated statements of operations.

 

Single Element Arrangements -

 

Products

 

To the extent that a single element arrangement provides for product sales and repairs, the Company recognizes salesrevenue when revenue recognition criteria for the product deliverablesdeliverable have been met based on the provisions of ASC Topic 605. In addition, the Company receives orders for equipment and parts.  Generally,parts, and recognizes revenue fromat either the sale of such products is recognizedshipping point or upon shipmentreceipt by the customer. Prior to the customer.quarter ended December 31, 2016, the Company had not experienced significant returns of its products. During the nine months ended June 30, 2017, the Company negotiated with two customers to reconfigure their avionics system. In connection with this change, the Company agreed to allow the return of products previously sold and, accordingly, net sales and net accounts receivable reflect reductions of $0.6 million for the value of products returned by the customers.

 

The Company offers its customers extended warranties for additional fees. These warranty sales are recordedfees, which it records as deferred revenue and recognizedrecognizes as sales on a straight-line basis over the warranty period.periods.

Engineering Development Contracts

 

The Company may enter into contracts to perform specified design and EDC services related to its products. The Company recognizes revenue from these arrangements as EDC sales,revenue, following the guidance included in ASC Topic 605-35, and considers the nature of these contracts (including term, size of contract, and level of effort) when determining the appropriate accounting treatment for a particular contract. CertainFor contracts that are long-term in nature, the Company believes that the use of these contracts are accounted for under the percentage-of-completion method of accounting when

is appropriate as the Company determines thathas the ability to make reasonably dependable estimates of the extent of progress towardtowards completion, is reasonablecontract revenues, and reliably estimable, andcontract costs. In certain circumstances, the contract is long-term in nature. The Company uses the completed contract method for all other contracts because these contracts are short-term in nature and meet the criteria set forth in ASC Topic 605-35.contracts. Sales and profit margins 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).method.

 

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 marginmargins requires the Company to make projections of the total sales to be generated and the total costs that will be incurred under eacha contract. The 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. Contracts sometimes 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 estimated 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.

 

The Company reviews estimates of profit margins for contracts on a quarterly basis. 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 because of either revisions in revenuesales and cost estimates or to the exercise of contract options may result in profit margins being recognized unevenly over a contract asbecause such changes are accounted for on a cumulative basis in the period in which 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 operationsoperation in the period in which the revised estimate is made. Cumulative catch-up adjustments (loss contracts) resulting from changes in estimates are disclosed in the notes to the consolidated financial statements of the Company.

 

Customer Service Revenue

 

The Company enters into sales arrangements with customers for the repair or upgrade of its various products that are not under warranty. The Company’s customer service revenue and cost of sales for the three and nine months ended June 30, 20162017 and 2015,2016 respectively are as follows:

 

 

For the Three Months Ended June 30,

 

For the Nine Months Ended June 30,

 

 

For the Three Months Ended June 30,

 

For the Nine Months Ended June 30,

 

 

2016

 

2015

 

2016

 

2015

 

 

2017

 

2016

 

2017

 

2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Customer Service Sales

 

$

1,023,302

 

$

772,385

 

$

2,702,956

 

$

1,928,966

 

 

$

827,046

 

$

1,023,302

 

$

2,228,934

 

$

2,702,956

 

Customer Service Cost of Sales

 

357,390

 

266,789

 

935,995

 

823,190

 

 

367,697

 

357,390

 

1,001,046

 

935,995

 

Gross Profit

 

$

665,912

 

$

505,596

 

$

1,766,961

 

$

1,105,776

 

 

$

459,349

 

$

665,912

 

$

1,227,888

 

$

1,766,961

 

 

Income Taxes

 

Income taxes are recorded in accordance with FASB ASC Topic 740, “Income“Income Taxes” (“ASC Topic 740”), 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 losses (“NOL”) 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. At the end of each interim and year-end reporting period, the Company prepares an estimate of the annual effective income tax rate and applies that annual effective income tax rate to ordinary year-to-date pre-tax income or loss for the interim period. Specific tax items discrete to a particular quarter are recorded in income tax expense for that quarter. The estimated annual effective tax rate used in providing for income taxes on a year-to-date basis may change in subsequent interim periods.

 

Deferred tax assets are reduced by a valuation allowancesallowance 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 objectively verified, and significant management judgment is required in determining any valuation allowancesallowance recorded against net deferred tax

assets. The Company evaluates deferred income taxes on a quarterly basis to determine if a valuation allowances areallowance is required by considering available evidence. Deferred tax assets are recognized 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,carryforwards, taxable income in carry-back years, and tax planning strategies.

Instrategies which are both prudent and feasible. The Company’s current balance of the period ended June 30, 2015, adeferred tax valuation allowance wasis recorded on aagainst the majority of the Company’s federal and state deferred tax assets, net of liabilities, due to uncertainty with respect to the Company’s ability to generate sufficient future taxable income to realize such deferred tax assets. The remaining amount of the Company’s recognized deferred tax assets were related to tax planning strategies and the ability to carry-back federal tax losses to claim a tax refund.

For the nine months ended June 30, 2016, the valuation allowance was reduced due to the current year profitability of the Company which represents an additional source of taxable income to realize certainits federal and state deferred tax assets. However, the Company will continue to maintain a valuation allowance until the Company generates a sufficient level of profitability to warrant a conclusion that it is no longer more likely than not that the entirety of these net federal and state deferred tax assets will not be realized in future periods. The Company will also continue to assess all available evidence during future periods to evaluate any changes to the realization thereof.of its deferred tax assets.

 

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 the Company’s tax return. To the extent that the 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 associated with uncertain tax positions 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 as thea result of ongoing examinations by and settlements with the various taxing authorities, and changes in tax laws, regulations and precedent. The consolidated tax provision of any given year includes adjustments to prior years’ income tax accruals that are considered appropriate, and any related estimated interest. Management believes that it has made 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 the Company’s consolidated financial position, but could possibly be material to its consolidated results of operations or cash flow of any one period.

 

Engineering Development

 

The Company invests a large percentage of its sales inon engineering development, both research and development (“R&D”) and EDC. At June 30, 2016,2017, approximately 38%34% of the Company’s employees were engineers engaged in various engineering development projects. Total engineering development expense is comprised of both designinternally funded R&D and EDCproduct development and design charges related to specific customer contracts and R&D.  EDCcontracts. Engineering development expense consists primarily of payroll-related expenses of employees engaged in EDC 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. EDCProduct development and design charges related to specific customer arrangementscontracts are charged to cost of sales-EDC based on the method of contract accounting (either percentage-of-completion or completed-contract)completed contract) applicable to such contracts.

 

Treasury Stock

 

Treasury stock is recorded at acquisition cost. Gains and losses on disposition are recorded as increases or decreases to additional paid-in capital with losses in excess of previously recorded gains charged directly to retained earnings. When treasury shares are retired and returned to authorized but unissued status, the carrying value in excess of par is allocated to additional paid-in capital and retained earnings on a pro rata basis.

 

Comprehensive Income

 

Pursuant to FASB ASC Topic 220, “Comprehensive Income” (“ASC Topic 220”), the Company is required to classify items of other comprehensive income by their nature in the balance sheet and to display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of its condensed consolidated balance sheets. For the three and nine months ended June 30, 20162017 and 2015,2016, respectively, comprehensive income consisted of net income only. Thereonly, and there were no items of other comprehensive income or accumulated other comprehensive income balances in the equity accounts for any of the periods presented.

 

Share-Based Compensation

 

The Company accounts for share-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” (“ASC Topic 718”), which require the Company to measure the cost of employee or non-employee director 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. ThatThe Company recognizes such cost is recognized over the period during which an employee or non-employee director is required to provide service in exchange for the award.

Warranty

 

The Company offers warranties on some products of various lengths;lengths, however the standard warranty is twenty-four months. At the time of shipment, the Company establishes a reserve for estimated costs of warranties based on its 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 affect warranty cost. If actual warranty costs are higher thandiffer from the Company’s estimated amounts, future results of operations could be affected adversely. Warranty cost is recorded as cost of sales, and the reserve balance is recorded as an accrued expense. AlthoughWhile the Company maintains product quality programs and processes, its warranty obligations areobligation 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 the estimated warranty liability accordingly.

 

Self-Insurance Reserves

 

BeginningSince January 1, 2014, the Company began self-insuringhas self-insured a significant portion of its employee medical insurance. The Company maintains a stop-loss insurance policy that limits its losses both on a per employee basis and an aggregate basis. Liabilities associated with the risks that are retained by the Company are estimated based upon actuarial assumptions includingsuch as historical claimclaims experience, demographic factors and demographic factors.other actuarial assumptions. The Company has estimated the total medical claims incurred but not reported and the Company believes that it has adequate reserves for these claims at June 30, 2017 and September 30, 2016. However, the actual value of such claims could be significantly affected if future occurrences and claims differ from these assumptions. At June 30, 20162017 and September 30, 2015,2016, the estimated liability for medical claims incurred but not reported was $53,000$50,000 and $80,000,$52,600 respectively. The Company has recorded the excess of funded premiums over estimated claims incurred but not reported in the amounts of $272,000$268,000 and $119,000$253,000 as a current asset in the accompanying condensed consolidated balance sheets as of June 30, 20162017 and September 30, 2015,2016, respectively.

 

Concentrations

 

Major Customers and Products

 

For the three months ended June 30, 2016,2017, two customers, Kanematsu Aerospace (“Kanematsu”) and Sierra Nevada Corporation (“Sierra Nevada”), accounted for 30% and 15% of net sales, respectively. During the nine months ended June 30, 2017, three customers, Sierra Nevada, DHL Aviation Services (“DHL”) and Kanematsu accounted for 20%, 13% and 11% of net sales, respectively.

For the three months ended June 30, 2016, two customers, Sierra Nevada and iAccess Technologies, Inc. (“iAccess”), accounted for 45% and 12% of net sales, respectively. During the nine months ended June 30, 2016, three customers, Jet2.com Limited (“Jet2”), Sierra Nevada and DHL Aviation Services (“DHL”) accounted for 16%, 15% and 14% of net sales, respectively.

For the three months ended June 30, 2015, three customers, Eclipse Aerospace, Inc. (“Eclipse”), American Airlines, Inc. (“American”) and Pilatus Aircraft Limited (“Pilatus”), accounted for 23%, 20% and 11% of net sales, respectively.  During the nine months ended June 30, 2015, three customers, Pilatus, Eclipse and the DoD accounted for 23%, 18% and 11% of net sales, respectively.

 

Major Suppliers

 

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

 

For the three and nine months ended June 30, 2016,2017, the Company had one supplierzero and two suppliers respectively that waswere individually responsible for greater than 10% of the Company’s total inventory related purchases.

 

For the three and nine months ended June 30, 2015,2016, the Company had, five and two suppliers respectivelyin each case, one supplier that werewas individually responsible for greater than 10% of the Company’s total inventory related purchases.

 

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 primary consideration. Cash balances are maintained with two major banks. Balances on deposit with certain money market accounts and operating accounts may exceed the Federal Deposit Insurance Corporation (“FDIC”) limits. The Company’s customer base consists principally of companies within the aviation industry. The Company requests advance payments and/or letters of credit from customers that it considers to be credit risks.

 

As of June 30, 2016, theThe Company had allowances for doubtful accounts for unbilled receivables in the amount of $3.6 million related to the Delta contract (see “Note 6, Contingencies” for a description of the Delta contract). Asas of September 30, 2015, the Company had allowances for doubtful accounts for unbilled receivables of $1.3 million related to a certain customer contract and $3.6 million

related to the Delta contract. In January 2016 the Company negotiated changes to its agreement with a customer whereby $1.3 million of unbilled receivables previously charged to bad debt expense in the quarter ended September 30, 2015 were cancelled. (See Unbilled Receivables below under Note 2. Supplemental Balance Sheet Disclosures).

Recent Accounting Pronouncements

 

In March 2016, the Financial Accounting Standards Board (“FASB”)FASB issued ASU 2016-09, Compensation - Stock Compensation - Improvements to EmployeeEmployer Share-Based Payment Accounting” (“ASU 2016-09”),Account, which involves several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Under the new standard, income tax benefits and deficiencies are to be recognized as income tax expense or benefit in the income statement andsimplifies the tax effectstreatment of exercised or vested awards should be treated as discrete items in the reporting period in which they occur. An entity should also recognizestock “shortfalls” and “windfalls.” Previous guidance required excess tax benefits regardless(“windfalls”) to be recorded in equity. Tax deficiencies (“shortfalls”) were recorded in equity to the extent of whetherprevious windfalls then to the benefit reduces taxes payable inincome statement. The new guidance simplifies this treatment by having all “windfalls” and “shortfalls” recorded through the current period. Excess tax benefits should be classified along with other income tax cash flows as an operating activity. In regards to forfeitures, the entity may make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest or account for forfeitures when they occur. This ASUstatement. The updated standard is effective for fiscal yearsthe Company beginning after December 15, 2016, includingwith early adoption permitted as of the beginning of any interim periods within thator annual reporting period. Early adoption is permitted. The Company is assessing the impact the adoption of ASU 2016-09 will have on its financial statements.

 

In February 2016, the FASB issued ASU 2016-02, Leases” (“ASU 2016-02”) (Topic 842). The new standard establishes aUnder this guidance, an entity is required to recognize right-of-use (“ROU”) model that requires a lessee to record an ROU assetassets and a lease liabilityliabilities on theits balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. A modified retrospective transition approach is requiredand disclose key information about leasing arrangements. This guidance offers specific accounting guidance for lessees, for capital and operating leases existing at, or entered into after, the beginninglessors, including with respect to sale and leaseback transactions. Lessees and lessors are required to disclose qualitative and quantitative information about leasing arrangements to enable a user of the earliest comparative period presented in the financial statements with certain practical expedients available. The new standardto assess the amount, timing and uncertainty of cash flows arising from leases. This guidance is effective for fiscal yearsannual reporting periods beginning after December 15, 2018, including interim periods within those fiscal years. Earlythat reporting period, and requires a modified retrospective adoption, iswith early adoption permitted. The Company is assessingcurrently evaluating the impact theimpacts of adoption of ASU 2016-02 will have on its financial statements.this guidance.

 

In November 2015, the FASB issued guidance regardingASU 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. CurrentTaxes, which simplifies balance sheet presentation of deferred income taxes. Previous guidance requiresrequired an entity to separate deferred income tax liabilities and assets into current and noncurrent amounts in a classified statement of financial position. However,position; however, the new guidance requires that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The guidanceupdated standard is effective for the Company beginning October 1, 2017. Early2017, with early adoption is permitted.permitted as of the beginning of any interim or annual reporting period. The Company is currently assessing the impactearly adopted this standard retrospectively and reclassified its current deferred tax balances to noncurrent deferred tax for all periods presented. The adoption of this guidance did not have a material impact on itsthe Company’s consolidated financial statements disclosure.statements.

 

In July 2015, the FASB issued guidance regarding Simplifying the Measurement of Inventory. This guidance requires entities to measure most inventory “at the lower of cost and net realizable value,” thereby simplifying the current guidance under which an entity must measure inventory at the lower of cost or market (market in this context is defined as one of three different measures). The guidance will not apply to inventories that are measured by using either the last-in, first-out (“LIFO”) method or the retail inventory method (“RIM”). The guidance is effective for the Company beginning October 1, 2017. Early adoption is permitted. The Company is currently assessing the impact of this guidance on its financial statements disclosure.

 

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40) (“ASU 2014-15”) (ASU 2014-15). The objective of ASU 2014-15 is to define management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and provide related disclosures. Currently, GAAP does not provide guidance to evaluate whether there is substantial doubt regarding an organization’s ability to continue as a going concern. This ASU 2014-15 provides guidance to an organization’s management, with principles and definitions to reduce diversity in the timing and content of financial statement disclosures commonly provided by organizations. ASU 2014-15 is effective for periods ending after December 15, 2016 and interim periods within annual periods beginning after December 15, 2016. Early adoption is permitted. The Company does not believe that ASG 2014-15 will have a material effect on the accompanying financial statements.

In June 2014, the FASB issued ASU No. 2014-12, “Compensation - Stock Compensation (ASC Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period” (“ASU 2014-12”). The amendments in ASU 2014-12 require that a performance target that affects vesting and that could be achieved after the requisite service period to be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant date fair value of the award. This ASU further clarifies that compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered.  The amendments in ASU 2014-12 are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015.  Early adoption is permitted. The Company does not believe that ASG 2014-12 will have a material effect on the accompanying financial statements.

 

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (ASC(ASC Topic 606)” (“ASU 2014-09”). ASU 2014-09 will supersede existing revenue recognition guidance and require revenue to be recognized when promised goods or services are transferred to customers in amounts that reflect the consideration to which the company expects to be entitled in exchange for those goods or services. The new standard wasstandards are scheduled to be effective for reporting periods beginning after December 15, 2017. Additionally, during 2016,

and early adoption is not permitted. However, on July 9, 2015, the FASB decided to delay the effective dateissued ASU Nos. 2016-08, “Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Gross versus Net)”, ASU 2016-10, “Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing”, and ASU 2016-12, “Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients”, all of the new revenue standard by one year, but reporting entities may choose to adopt the standard as of the original effective date.which should be adopted concurrent with ASU 2014-09. Adoption of the new rules could affect the timing of revenue recognition for certain transactions. The guidance permits two implementation approaches, one requiring retrospective application of the new standard with restatement of prior years and one requiring retrospective application of the new standard with the cumulative effect of applying the new standard as of the date of initial application recognized and disclosure of results under old standards. The FASB has recently issued an Exposure DraftBased on the nature of a proposedthe Company’s business, the adoption of ASU that would delay by one yearNo. 2014-09, or any of the effective datesubsequent related ASU’s, is not expected to impact financial reporting with respect to the majority of this standard.its revenue streams. The Company is currently in the process of evaluating current accounting policies to identify potential differences for each of its revenue streams, and there is the impactspotential for some changes to revenue recognition practices for multiple-element arrangements. In addition, the Company is currently determining the transition method and disclosure requirements, and plans on finishing its analysis by the end of adoption and the implementation approach to be used.fiscal 2017.

 

As new accounting pronouncements are issued, the Companywe will adopt those that are applicable under the circumstances.applicable.

2. Supplemental Balance Sheet Disclosures

 

Unbilled Receivables

 

Unbilled receivables principally represent sales recorded under the percentage-of-completion method of accounting that have not been billed to customers in accordance with applicable contract terms, have not been billed to customers.  terms. Unbilled receivables, net of progress payments were $1.6 million at June 30, 2017 and an impairmentSeptember 30, 2016. The unbilled balance of $1.6 million at September 30, 2016 reflects a reserve of $3.6 million related to the Delta contract atcontract. On February 21, 2017 the Company entered into a settlement agreement with Delta. Under the terms of the settlement, Delta paid the Company $7.75 million resulting in the reversal of the $3.6 million reserve and the collection of the unbilled receivable in the nine month period ended June 30, 2016 were $1.6 million.  Unbilled receivables, net2017. The reversal of progress paymentsthe reserve is reflected in the selling, general and an impairmentadministrative expenses in the Condensed Consolidated Statements of $1.3 million related to a certain customer and an impairmentOperations in the nine month period ended June 30, 2017. The remainder of $3.6 million relatedthe amount paid to the Delta contract, at SeptemberCompany, approximately $4.1 million is reflected in other income for the nine month period ended June 30, 2015 were $3.9 million. The Company negotiated changes to its agreement with a customer in January 2016 whereby the $1.3 million of unbilled receivables previously charged to bad debt expense in the quarter ended September 30, 2015 were cancelled.2017.

 

Significant changes in estimates related to accounting for long-term contracts under the percentage-of-completion method may have a material effect on the Company’s results of operations in the period in which the revised estimates are made. Cumulative catch-up adjustments resulting from changes in estimates decreased operating income by $45,000 for the three months ended June 30, 2017 and increased operating income by $76,000 for the nine months ended June 30, 2017. Cumulative catch-up adjustments resulting from changes in estimates decreased operating income by $120,000 for the three months ended June 30, 2016 and increased operating income by $232,000 for the nine months ended June 30, 2016. These increases to operating income are primarily related to reversals of loss accruals due to the cancellation of certain product deliverables as negotiated with a certain customer in January 2016.  Cumulative catch-up adjustments resulting from changes in estimates decreased operating income by $125,000 for the three months ended June 30, 2015 and increased operating income by $595,000 for the nine months ended June 30, 2015.

 

Inventories

 

Inventories are stated at the lower of cost (first-in, first-out) or market, net of reservewrite-downs for excess and obsolete inventory, and consist of the following:

 

 

 

June 30,

 

September 30,

 

 

 

2016

 

2015

 

 

 

 

 

 

 

Raw materials

 

$

3,151,301

 

$

3,346,778

 

Work-in-process

 

474,767

 

745,311

 

Finished goods

 

382,046

 

505,227

 

 

 

$

4,008,114

 

$

4,597,316

 

 

 

June 30,

 

September 30,

 

 

 

2017

 

2016

 

 

 

 

 

 

 

Raw materials

 

$

3,296,928

 

$

2,966,891

 

Work-in-process

 

901,076

 

500,869

 

Finished goods

 

335,035

 

178,068

 

 

 

$

4,533,039

 

$

3,645,828

 

Prepaid expenses and other current assets

 

Prepaid expenses and other current assets consist of the following:

 

 

 

June 30,

 

September 30,

 

 

 

2016

 

2015

 

 

 

 

 

 

 

Prepaid insurance

 

$

434,017

 

$

290,543

 

Income tax refund receivable

 

380,806

 

386,869

 

Other

 

321,445

 

544,305

 

 

 

$

1,136,268

 

$

1,221,717

 

 

 

June 30,

 

September 30,

 

 

 

2017

 

2016

 

 

 

 

 

 

 

Prepaid insurance

 

$

425,837

 

$

386,212

 

Income tax refund receivable

 

209,791

 

106,932

 

Other

 

366,994

 

354,063

 

 

 

$

1,002,622

 

$

847,207

 

Property and equipment

 

Property and equipment, net consists of the following:

 

 

June 30,

 

September 30,

 

 

June 30,

 

September 30,

 

 

2016

 

2015

 

 

2017

 

2016

 

 

 

 

 

 

 

 

 

 

 

Land

 

$

1,021,245

 

$

1,021,245

 

 

$

1,021,245

 

$

1,021,245

 

Computer equipment

 

2,260,506

 

2,270,799

 

 

2,260,561

 

2,208,398

 

Corporate airplane

 

3,194,571

 

3,128,504

 

 

3,194,571

 

3,194,571

 

Furniture and office equipment

 

1,052,284

 

1,056,486

 

 

1,052,284

 

1,052,284

 

Manufacturing facility

 

5,733,313

 

5,733,313

 

 

5,733,312

 

5,733,313

 

Equipment

 

5,358,315

 

5,165,190

 

 

5,504,804

 

5,435,949

 

 

18,620,234

 

18,375,537

 

 

18,766,777

 

18,645,760

 

Less: accumulated depreciation and amortization

 

(11,605,596

)

(11,280,207

)

 

(12,003,880

)

(11,683,198

)

 

$

7,014,638

 

$

7,095,330

 

 

$

6,762,897

 

$

6,962,562

 

 

Depreciation and amortization related to property and equipment was approximately $117,000$111,000 and $138,000$117,000 for the three months ended June 30, 20162017 and 2015,2016, respectively. The corporate airplane is utilized primarily in support of product development and has been depreciated to its estimated salvage value.

 

Depreciation and amortization related to property and equipment was approximately $344,000$330,000 and $413,000$344,000 for the nine months ended June 30, 20162017 and 2015,2016, respectively.

 

Other assets

 

Other assets consist of the following:

 

 

June 30,

 

September 30,

 

 

June 30,

 

September 30,

 

 

2016

 

2015

 

 

2017

 

2016

 

Intangible assets, net of accumulated amortization of $529,037 and $517,037 at June 30, 2016 and September 30, 2015

 

$

71,200

 

$

83,200

 

Intangible assets, net of accumulated amortization of $531,637 and $529,037 at June 30, 2017 and September 30, 2016

 

$

68,600

 

$

71,200

 

Other non-current assets

 

85,748

 

85,748

 

 

131,674

 

85,748

 

 

$

156,948

 

$

168,948

 

 

$

200,274

 

$

156,948

 

 

Intangible assets consist of licensing and certification rights which are amortized over a defined number of units. No impairment charges were recorded in the nine months ended June 30, 20162017 and 2015.2016.

 

Total amortizationAmortization expense was approximately $7,200$200 and $5,000$7,200 for the three and months ended June 30, 2017 and 2016, and 2015, respectively. Total amortization

Amortization expense was approximately $12,000$2,600 and $17,000$12,000 for the nine months ended June 30, 20162017 and 2015,2016, respectively.

 

The timing of future amortization expense is not determinable because the intangible assets are being amortized over a defined number of units.

Accrued expenses

 

Accrued expenses consist of the following:

 

 

June 30,

 

September 30,

 

 

June 30,

 

September 30,

 

 

2016

 

2015

 

 

2017

 

2016

 

 

 

 

 

 

 

 

 

 

 

Warranty

 

$

950,432

 

$

878,901

 

 

$

1,036,950

 

$

1,009,368

 

Salary, benefits and payroll taxes

 

451,910

 

537,451

 

 

468,612

 

267,323

 

Professional fees

 

689,453

 

353,012

 

 

272,370

 

308,905

 

Other, including losses on contracts

 

204,102

 

799,167

 

 

177,099

 

304,312

 

 

$

2,295,897

 

$

2,568,531

 

 

$

1,955,031

 

$

1,889,908

 

 

Other accrued expense at June 30, 20162017 and September 30, 20152016 includes $0approximately $20,000 and $0.6 million$77,000 of EDC program costs, respectively.

 

Warranty cost and accrual information for the three and nine months ended June 30, 20162017 is highlighted below:

 

 

Three Months Ending

 

Nine Months Ending

 

 

 

June 30, 2016

 

June 30, 2016

 

 

 

 

 

 

 

Warranty accrual, beginning of period

 

$

996,660

 

$

878,901

 

Accrued expense

 

35,890

 

308,200

 

Warranty cost

 

(82,118

)

(236,669

)

Warranty accrual, end of period

 

$

950,432

 

$

950,432

 

 

 

Three Months Ending

 

Nine Months Ending

 

 

 

June 30, 2017

 

June 30, 2017

 

 

 

 

 

 

 

Warranty accrual, beginning of period

 

$

1,054,499

 

$

1,009,368

 

Accrued expense

 

28,168

 

171,737

 

Warranty cost

 

(45,717

)

(144,155

)

Warranty accrual, end of period

 

$

1,036,950

 

$

1,036,950

 

 

3. Income Taxes

 

The income tax expensebenefit for the three and nine months ended June 30, 20162017 was $27,000 and $403,000, respectively,$537,000 as compared to an income tax expense of $3.3 million and $2.6 million respectively,$27,000 for the three and nine months ended June 30, 2015.2016.

 

The effective tax rate benefit for the three months ended June 30, 2017 was 103.7%. The effective tax rate benefit for the three months ended June 30, 2017 differs from the statutory tax rate primarily due to the change in the anticipated profitability in the current year partially offset by the reduction in the utilization of certain R&D tax credits in the period resulting in an increase in the valuation allowance of approximately $0.5 million.

The effective tax rate for the three months ended June 30, 2016 was 10.7%. The effective tax rate for the three months ended June 30, 2016 differs from the statutory rate primarily due to a reduction in the valuation allowance of approximately $150,000 included in ourthe current year estimated annual effective tax rate that is attributable to the anticipated profitability in the current year.

 

The effectiveincome tax rate expense for the threenine months ended June 30, 20152017 was (1,328.1%)$297,000 as compared to an income tax expense of $403,000 for the nine months ended June 30, 2016.

The effective tax rate for the nine months ended June 30, 2017 was 5.9%. The effective tax rate for the threenine months ended June 30, 20152017 differs from the statutory rate primarily becausedue to a change in the valuation allowance of approximately $1.4 million included in the current year estimated annual effective tax rate that is attributable to the anticipated profitability in the current year. The majority of this change is a result of the Company recorded a valuation allowance againstbad debt reserve reversal being deductible for tax purposes and the deferredutilization of certain R&D tax assets of $3.3 million reflecting only those deferred tax assets that could be realized.credits in the period.

 

The effective tax rate for the nine months ended June 30, 2016 was 20.2%.  The effective tax rate for the nine months ended June 30, 2016 differs from the statutory rate primarily due to a reduction in the valuation allowance of approximately $150,000 included in ourthe current year estimated annual effective tax rate that is attributable to the anticipated profitability in the current year.

The effective tax benefit rate for the nine months ended June 30, 2015 was (380.8%).  The effective tax rate for the nine months ended June 30, 2015 differs from the statutory rate primarily because of the $3.3 million valuation allowance recorded against the deferred tax assets in the three months ended June 30, 2015.

On December 18, 2015, the Protecting Americans from Tax Hikes (PATH) Act of 2015 was enacted. This legislation retroactively extended various temporary tax provisions which expired on December 31, 2014, including the permanent extension of the R&D Tax Credit. No income tax benefit was recorded in the period on the retroactive benefit for the period from January 1, 2015 to September 30, 2015 due to the uncertainty on the Company’s ability to generate future taxable income.

In the period ended June 30, 2015, a valuation allowance was recorded on a majority of the Company’s federal and state deferred tax assets, net of liabilities, due to the uncertainty on the Company’s ability to generate sufficient future taxable income to realize such deferred tax assets. The remaining amount of the deferred tax assets recognized were attributable to tax planning strategies and the ability to carry-back federal tax losses to claim a tax refund.

For the nine months ended June 30, 2016, the valuation allowance was reduced due to the current year profitability of the Company which represented an additional source of taxable income to realize certain federal and state deferred tax assets.  However the Company will continue to maintain a valuation allowance until the Company generates a sufficient level of profitability to warrant a conclusion that it no longer is more likely than not that these net federal and state deferred tax assets will not be realized in future periods.

On September 13, 2014, the U.S. Treasury Department and the IRS issued final regulations that addressed cost incurred in acquiring, producing, or improving tangible property (the “tangible property regulations”). The tangible property regulations were generally effective for tax years beginning on or after January 1, 2014 and required the Company to make additional tax accounting method changes as of October 1, 2014. However, the impact of these changes to the Company’s consolidated financial statements was immaterial as of and for the three and nine months ended June 30, 2016 and 2015.

4. Shareholders’ Equity and Share-based Payments

 

At June 30, 2016,2017, the Company’s Amended and Restated Articles of Incorporation provides the Company authority to issue 75,000,000 shares of common stock and 10,000,000 shares of preferred stock.

 

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 fair value method for expensing stock options and stock awards.

Total share-based compensation expense was $0 for each of the three months ended June 30, 2017 and 2016. The income tax effect recognized as a credit to additional paid-in capital related to share-based compensation arrangements was $0 for the three months ended June 30, 2017 and 2016, respectively.

Total share-based compensation expense was approximately $0 and $59,000$68,000 for the threenine months ended June 30, 20162017 and 2015,2016, respectively. The income tax effect recognized as a (charge) to additional paid-in capital related to share-based compensation arrangements was ($0) and ($7,000) for the three months ended June 30, 2016 and 2015, respectively.

Total share-based compensation expense was approximately $68,000 and $409,000$0 for the nine months ended June 30, 20162017 and 2015, respectively.  The income tax effect recognized as a (charge) to additional paid-in capital related to share-based compensation arrangements was approximately ($0) and ($54,000) for the nine months ended June 30, 2016, and 2015, 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;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”). The Company’s shareholders approved , each of these plans.which the shareholders approved. 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 be awarded under the Restricted Plan.

 

1998 Stock Option Plan

 

The 1998 Plan authorizedallowed the grantgranting 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.  There was no compensation expense associated with awards under the 1998 Plan for the nine months ended June 30, 2016 and 2015.

plan. Incentive stock options granted under the 1998 Plan have exercise prices that must beare at least equal to the fair value of the common stock on the grant date. Nonqualified stock options granted under the 1998 Planplan have exercise prices that may beare less than, equal to or greater than the fair value of the common stock on the date of grant. The Company reserved 3,389,000 shares of common stock for awards under the 1998 Plan.plan. On November 13, 2008, the 1998 Plan expired and no additional shares were granted under the 1998 Plan after that date.

 

2003 Restricted Stock Plan

The Restricted Plan for non-employee directors was approved by shareholders at the Company’s February 26, 2004 Annual Meeting of Shareholders. It provided for an annual award of non-vested shares of commonTotal compensation expense associated with stock having a fair market value of $40,000 at close of business on October 1 of each year for each eligible non-employee director. The shares of common stock were awarded in four quarterly installments during the fiscal year if the director was still serving on the board on the quarterly issue date. The lastoption awards to employees under the Restricted1998 Plan were made in 2010, and the Company has awarded all available shares under the Restricted Plan. However, the Company has continued to make an annual grant of shares to eligible non-employee directors under the 2009 Plan.

There was no compensation expense under the Restricted Plan$0 for the three and nine monthsmonth periods ended June 30, 2017 and 2016, and 2015.respectively.

 

2009 Stock-Based Incentive Compensation Plan

 

The 2009 Plan authorizes the grant of Stock Appreciation Rights (“SARs”), Restricted Stock, Options,stock appreciation rights, restricted stock, options, RSUs and other equity-based awards (collectively referred to as “Awards”). Options granted under the 2009 Plan may be either “Incentive Stock Options”“incentive stock options” as defined in section 422 of the Internal Revenue Code of 1986, as amended (the “Code”), or “Nonqualified Stock Options”nonqualified stock options, as determined by the Compensation Committee of the Company’s Board of Directors (the “Compensation Committee”).

 

Subject to an adjustment required because ofnecessary upon a stock dividend, recapitalization, forward split or reverse split, reorganization, merger, consolidation, spin-off, combination, repurchase or share exchange, extraordinary or unusual cash distribution, or other similar corporate transaction or event, the maximum number of shares of common stock available for Awards under the 2009 Plan isshall be 1,200,000, all of which may be issued pursuant to Awards of Incentive Stock Options.incentive stock options. In addition, the 2009 Plan provides that no more than 300,000 shares of common stock per year may be awarded to any employee as a performance-based Award under Section 162(m) of the Code. At June 30, 2016,2017 there were 268,439259,598 shares of common stock available for Awardsawards under the 2009 Plan.plan.

 

If any Award is forfeited, or if any Optionoption terminates, expires or lapses without being exercised, the related shares of common stock subject to such Award will again be available for future grant. Any shares tendered by a participant in payment of the exercise price of an Optionoption 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 must adjust proportionately and equitably adjust the number and kind of shares of common stock which may be issued in connection with future Awards, the number and type of shares of common stock covered by Awards then outstanding under the 2009 Plan, the number and type of shares of common stock available under the 2009 Plan, the exercise or grant price of any Award, or if deemed appropriate, make provision for a cash payment with respect to any outstanding Award, provided that no adjustment may be made that would adversely affect adversely 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 adversely 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.

 

On April 17, 2014, the Board of Directors resolved to revise the valuation date and the timing of the issuance of the awards of non-vested shares of common stock to each eligible non-employee director under the 2009 Plan. Effective January 1, 2015, the awards had a fair market value of $40,000 each at the close of business on the first business day after January 1 of each calendar year and will be issued on the first business day after January 1 of the followingnext year. If any non-employee director resigns from the Board of Directors prior to December 31 of such calendar year, the Company will issue to such non-employee director a pro-rata number of shares through the date of resignation. On November 12, 2015, the Board of Directors resolved that effective January 1, 2016, such awards would be in the form of restricted stock units (“RSUs”) with a fair market value of 40,000 each at the close of business on the first business day after January 1 of the calendar year of service, which RSU’s shall vest in full on the first business day of the calendar year following the year of service.

 

Total compensation expense related to Options issued to employees under the 2009 Plan was approximately $0 and $59,000 for each of the three months ended June 30, 20162017 and 2015, respectively;2016; and $68,000$0 and $259,000approximately $68,000 for the nine months ended June 30, 20162017 and 2015,2016, respectively. The expense under the 2009 Plan related to shares issued to non-employee members of the Company’s Board of Directors as compensation was approximately $0 for the three months ended June 30, 20162017 and 2015, respectively,2016. Directors’ compensation was approximately $192,000 and $183,000 and $150,000 for each of the nine months ended June 30, 20162017 and 2015, respectively.2016. Total compensation expense associated with the 2009 Plan was approximately $0 and $59,000 for each of the three months ended June 30, 20162017 and 2015, respectively;2016; and $251,000approximately $192,000 and $409,000$251,000 for the nine months ended June 30, 2017 and 2016, and 2015, respectively.

Restricted Stock Units

During fiscal 2016, the Company’s Board of Directors (the “Board”) approved grants of RSUs to the non-employee directors on the Board as compensation for their services during calendar year 2016. Under the terms of the awards, at the conclusion of the vesting period on January 2, 2017, the grants of RSUs were settled in shares of the Company’s common stock at a rate of one share of stock for each unit. Directors that did not serve for the entirety of calendar year 2016 received a pro rata portion of such award for time served. As of June 30, 2017, there were no unvested restricted stock units outstanding under the 2009 Plan.

 

Stock repurchase program

 

On April 14, 2016, the Company’s Board of Directors approved the extension of the currentCompany’s share repurchase program (originally approved on April 29, 2013 and previously extended in each of April 2014 and April 2015) which allowsallowed the Company to acquire up to 250,000 shares of its outstanding common stock for one year beginning May 1, 2016. Under the share repurchase program, the Company maywas permitted to purchase shares of its common stock through open market transactions, 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 onwas subject to market conditions, and corporate and regulatory considerations. The program may be discontinuedCompany was also permitted to discontinue or suspendedsuspend the program at any time. The Company anticipates funding for this program to comewas derived from available corporate funds, including cash on hand and future cash flow.flows from operations. During the three monthsyear ended JuneSeptember 30, 2016, the Company purchased 57,165250,000 shares of its common stock under the program. The aggregate cost of the shares purchased in the three months ended June 30, 2016 was $169,871$724,776 at an average cost per share of $2.97. As of June$2.90. The program expired pursuant to its terms on April 30, 2016, the number of2017, and no shares that may yetare available to be purchased under the current share repurchase program was 192,835 shares.program.

5. Earnings Per Share

 

 

Three Months Ended June 30,

 

Nine Months Ended June 30,

 

 

Three Months Ended June 30,

 

Nine Months Ended June 30,

 

 

2016

 

2015

 

2016

 

2015

 

 

2017

 

2016

 

2017

 

2016

 

Numerator:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

226,797

 

$

(3,531,973

)

$

1,589,672

 

$

(3,302,322

)

Net income

 

$

19,220

 

$

226,797

 

$

4,754,673

 

$

1,589,672

 

Denominator:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic weighted average shares

 

16,941,707

 

16,910,475

 

16,925,688

 

16,930,522

 

 

16,755,082

 

16,941,707

 

16,735,533

 

16,925,688

 

Dilutive effect of share-based awards

 

117,839

 

 

101,528

 

 

 

115,322

 

117,839

 

111,772

 

101,528

 

Diluted weighted average shares

 

17,059,546

 

16,910,475

 

17,027,216

 

16,930,522

 

 

16,870,404

 

17,059,546

 

16,847,305

 

17,027,216

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic EPS

 

$

0.01

 

$

(0.21

)

$

0.09

 

$

(0.20

)

 

$

0.00

 

$

0.01

 

$

0.28

 

$

0.09

 

Diluted EPS

 

$

0.01

 

$

(0.21

)

$

0.09

 

$

(0.20

)

 

$

0.00

 

$

0.01

 

$

0.28

 

$

0.09

 

 

Earnings per share (“EPS”) are calculated pursuant to FASB ASC Topic 260, Earnings“Earnings Per ShareShare” (“ASC Topic 260”). Basic EPS excludes 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.

 

The number of incremental shares from the assumed exercise of stock options is calculated by using the treasury stock method. As of June 30, 20162017 and 2015,2016, there were 590,168586,834 and 667,168590,168 options to purchase common stock outstanding, respectively. The average outstanding diluted shares calculation excludes options with an exercise price that exceeds the average market price of shares during the period.

 

For the three months ended June 30, 2017 and 2016, respectively, 336,834 and 2015, respectively, 340,586 and 400,641 diluted weighted —average-weighted-average shares outstanding were excluded from the computation of diluted EPS because the effect would be anti-dilutive.

 

For the nine months ended June 30, 2017 and 2016, respectively, 337,003 and 2015, respectively, 359,571 and 402,063 diluted weighted- average-weighted-average shares outstanding were excluded from the computation of diluted EPS because the effect would be anti-dilutive.

 

6. Contingencies

 

The CompanyOn February 23, 2017, IS&S announced a settlement of its previously announced thatdisclosed lawsuit with Delta AirlinesAir Lines, Inc. (“Delta”) purported. The lawsuit related to terminate itsDelta’s October 2014 termination of a contract with the Companyfor IS&S to develop, manufacture and install new cockpit displays and certain navigationupgraded flight management systems with RNP, RTA, and GPS capabilities on Delta’s fleet of approximately 182 MD88McDonnell Douglas 88 and MD9090 aircraft. The Company initiated and engaged in a non-binding mediation with Delta on February 25, 2015. The mediation session did not resolve the dispute. On February 25, 2015, the Company filed a complaint against Delta in the United States District Court for the Eastern District of Pennsylvania for breach of contract. The Company has alleged in the case, captioned Innovative Solutions & Support, Inc. v. Delta Airlines, Inc. E.D. Pa. Civ. No. 15-959, that Delta’s purported termination of the contract was wrongful and in breach ofUnder the terms of settlement, Delta paid IS&S $7.75 million and the contract,parties dismissed their respective claims and is seeking monetary damages. On March 20, 2015, Delta answered the Company’s complaint and filed counterclaims against each other and exchanged releases, bringing the lawsuit to an end.

The Company for breach of contract and breachreversed the $3.6 million unbilled receivable reserve in the nine month period ended June 30, 2017. The effect of the duty of good faithreversal is reflected in selling, general and fair dealing, also seeking monetary damages. The parties have completed discovery and have each filed motions for summary judgment. The outcome of the litigation is not determinable at this time.administrative expenses. The Company had $3.6 million of unbilled receivables and $0.2 million of inventory on its balance sheet relating to the Delta program at September 30, 2015 both2016. The remainder of which are fully reserved.

On January 17, 2007the amount paid to the Company, filed suitapproximately $4.1 million is reflected in other income for 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 secrets and proprietary information in assisting J2 and Kollsman in developing the J2/Kollsman Air Data Computer. The case has not been resolved as of the date of the filing of this Form 10-Q.nine month period ended June 30, 2017.

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

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

This report contains forward-lookingforward looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These forward-lookingforward looking statements are based largely on current expectations and projections about future events and trends affecting the business.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 likely,“would,“is likely” and similar expressions, as they relate to the business or to its management, are intended to identify forward-lookingforward 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-lookingforward 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 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 Innovative Solutions and Support, Inc.’s (the “Company” or “IS&S”)this Annual Report on Form 10-K for the fiscal year ended September 30, 2015 filed with the United States Securities and Exchange Commission (the “SEC”) on January 14, 2016 and the following factors:

 

·market acceptance of the Company’s flat panel display systems, or COCKPIT/IP® or other planned products or product enhancements;

·continued market acceptance of the Company’s air data systems and products;

·the competitive environment and new product offerings from competitors;

·difficulties in developing and producing the Company’s COCKPIT/IP®Flat Panel Display System or other planned products or product enhancements;

·the deferral or termination of programs or contracts for convenience by customers;

·                  the availability of government funding;

·                  the impact of general economic trends on the Company’s business;

·                  the deferral or termination of programs or contracts for convenience by customers;

·difficulties in developing and producing the Company’s COCKPIT/IP® Flat Panel Display System or other planned products or product enhancements;

·market acceptance of the Company’s flat panel display systems, or COCKPIT/IP® or other planned products or product enhancements;

·continued market acceptance of the Company’s air data systems and products;

·the loss, bankruptcy or insolvency of one or more key customers;

·the loss of, or a dispute or litigation with, any of our key customers;

·the ability to gain regulatory approval of products in a timely manner;

·                  failure to retain/recruit key personnel;

·delays in receiving components from third-partythird party suppliers;

·                  the competitive environment and new product offerings from competitors;bankruptcy or insolvency of one or more key customers;

·                  protection of intellectual property rights;

·failure to retain/recruit key personnel;

·                  a cyber security incident;

·                  the ability to service the international market;

·risks related to our self-insurance program;

·                  potential future acquisitions; and

·                  other factors disclosed from time to time in the Company’s filings with the SEC.United States Securities and Exchange Commission (the “SEC”).

 

Except as expressly required by the federal securities laws, the 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. Results of operations in any past period should not be considered indicative of the results to be expected for future periods. Fluctuations in operating results may result also in fluctuations in the price of the Company’s common stock.

 

Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Form 10-Q. The Company does not undertake any obligation to release publicly any revisions to these forward-looking statements to reflect events, circumstances, or changes in expectations after the date of this Form 10-Q, 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 the Company, from time to time, communicates with securities analysts, it is against its policy to disclose any material non-public information or other confidential commercial information. Accordingly, shareholders should not assume that the Company agrees with any statement or report issued by any analyst irrespective of the content of the statement or report. Furthermore, the 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 are not the responsibility of the Company.

Company Overview

 

Innovative Solutions and Support, Inc. (the “Company” or “IS&S”) was incorporated in Pennsylvania on February 12, 1988. The Company operates in one business segment as a systems integrator that designs, develops, manufactures, sells, and services air data equipment, engine display systems, standby equipment, primary flight guidance, and cockpit display systems for retrofit applications and original equipment manufacturers (“OEMs”). The Company supplies integrated Flight Management Systems (“FMS”), Flat Panel Display Systems (“FPDS”), Integrated Standby Units (“ISU”) and, advanced Global Positioning System (“GPS”) receivers that enable reduced carbon footprint navigation.navigation and an Autothrottle, which allows a pilot to automatically control the power setting of the engine and is designed to reduce pilot workload and enhance safety.

 

The Company has continued to position itself as a system integrator, which capability provides the Company with the potential to generate more substantive orders over a broader product base. The strategy, as both a manufacturer and integrator, is designed to leverage the latest technologies developed for the computer and telecommunications industries into advanced and cost-effective solutions for the general aviation, commercial air transport, United States Department of Defense (“DoD”)/governmental, and foreign military markets. This approach, combined with the Company’s industry experience, is designed to enable IS&S to develop high-quality products and systems, to reduce product time to market, and to achieve cost advantages over products offered by its competitors.

 

For several years the Company has been working with advances in technology to provide pilots with more information to enhance both the safety and efficiency of flying, and has developed its COCKPIT/IP® Cockpit Information Portal (“CIP”) product line that incorporates proprietary technology, low cost, reduced power consumption, decreased weight, and increased functionality. The Company believes the CIP product line is suited to address market demand that will be driven by regulatory mandates, new technologies, and the high cost of maintaining aging/obsolete equipment on airplanes that have been in service for up to fifty years. The Company has also incorporated Electronic Flight Bag (“EFB”) functionality, such as charting and mapping systems, in its FPDS product line.

 

More recently, theThe Company has developed an FMS that combines the savings long associated with in flight fuel optimization in enroute flight management combined with the precision of satellite-based navigation required to comply with the regulatory environments of both domestic and international markets. The Company believes that the FMS coupled with its FPDS product line is well suited to address market demand driven by further regulatory mandates, new technologies, and the high cost of maintaining aging and obsolete equipment on aircraft that will be in service for up to fifty years. The shift in the regulatory and technological environment is illustrated by the dramatic increase in the number of Space Based Augmentation System (“SBAS”) or Wide Area Augmentation System (“WAAS”) approach qualified airports, particularly as realized through Localizer Performance with Vertical guidance (“LPV”) navigation procedures. Aircraft equipped with the Company’s FMS and FPDS product line (equipped with a SBAS/WAAS/LPV enabled navigator) will be qualified to land at such airports and to comply with upcoming Federal Aviation Administration (“FAA”) mandates for Required Navigation Performance (“RNP”) and Automatic Dependent Surveillance-Broadcast (“ADS-B”) navigation, a fact which IS&S believes will further increase the demand for the Company’s products. The Company’s FMS/FPDS product line is designed for new production and retrofit applications into general aviation, commercial air transport and military transport aircraft. In addition, the Company offers an innovative ISU, integrating the full functionality of the primary and navigation displays into a small backup-powered unit. This ISU builds on the Company’s legacy air data computer to form a complete next-generation cockpit display and navigation upgrade offering to the commercial and military markets.

 

More recently, the Company has continued to expand its product portfolio with receipt of a FAA Supplemental Type Certificate (“STC”) for its Autothrottle (Patent Pending Design). This certified Autothrottle is uniquely applicable to Non-Full Authority Digital Engine Control for retrofit in the Pilatus PC-12 aircraft. In addition, the Company is currently developing the Autothrottle for the King Air 200 and 350 aircraft.

IS&S sells to both the OEM and retrofit market. Customers include various OEMs, commercial air transport carriers and corporate/general aviation companies, DoD and its commercial contractors, aircraft operators, aircraft modification centers and foreign militaries. Occasionally, IS&S sells its products directly to DoD; however, the Company sells its products primarily to commercial customers for end use in DoD programs. Sales to defense contractors are generally made on commercial terms, although some of the terminationgovernment terms are flowed down and other provisions of government contracts are applicable to these contracts.

 

Customers have been and may continue to be affected by the uncertain economic conditions that currently exist both in the United States and abroad. Such conditions may cause customers to curtail or delay their spending on both new and existing aircraft. Factors that can impact general economic conditions and the level of spending by 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 factors that affect spending behavior.  In addition, the Budget Control Act of 2011 (the “Budget Act”) triggered substantial, automatic reductions in both defense and discretionary spending.  The automatic across-the-board sequestration cuts are in addition to reductions already reflected in defense funding over a ten-year period. Furthermore, spending by government agencies may be reduced in the future if tax revenues decline. If customers curtail or delay their spending or are forced to declare bankruptcy or liquidate their operations because of adverse economic conditions, the Company’s revenues and results of operations would be affected adversely. However, the Company believes that, in an uncertain economic environment, customers that may have otherwise elected to purchase newly manufactured aircraft may be interested instead in retrofitting existing aircraft as a cost-effective alternative, thereby creating a market opportunity for IS&S.

Cost of sales related to product sales is comprised of material components and third-party avionics purchased from suppliers, direct in-house assembly labor, and overhead costs. Many of the components are standard, although certain parts are manufactured to meet IS&S specifications. The overhead portion of cost of sales is comprised primarily of salaries and benefits, building occupancy costs, supplies, and outside service costs related to production, management, purchasing, material control, and quality control. Cost of sales includes warranty costs.

 

Cost of sales related to engineering development contracts (“EDC”) sales is comprised of engineering labor, consulting services, and other costs associated with specific design and development projects. These costs are incurred pursuant to contractual arrangements and are accounted for typically as contract costs within cost of sales with the payment from customers under such contractsreimbursement accounted for as a sale in accordance with the percentage-of-completion method of accounting. Company funded research and development (“R&D”) expenditures relate to internally-funded efforts towards the development of new products and the improvement of existing products, and theseproducts. These costs are expensed as incurred.incurred and reported as R&D expenses. The Company intends to continue investing in the development of new products that complement current product offerings and will continue to expense associated R&D costs as they are incurred.

 

Selling, general and administrative expense consistsexpenses consist of sales, marketing, business development, professional services, salaries and benefits for executive and administrative personnel, facility costs, recruiting, legal, accounting, bad debt expense and other general corporate expenses.

 

Critical Accounting Policies and Estimates

 

The discussion and analysis of financial condition and consolidated results of operations are based upon the Company’s condensed consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these condensed consolidated financial statements requires estimates and assumptions that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, IS&S management evaluates its estimates based upon historical experience and various other assumptions that it believes to be reasonable in the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

 

The Company believes that its critical accounting policies affect its more significant estimates and judgments used in the preparation of its consolidated financial statements. The Annual Report on Form 10-K for the fiscal year ended September 30, 20152016 contains a discussion of these critical accounting policies. There have been no significant changes in the Company’s critical accounting policies since September 30, 2015.2016. See also Note 1 to the unaudited condensed consolidated financial statements for the three and nine month periodsmonths period ending June 30, 20162017 as set forth herein.

RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED
June 30, 20162017 AND 20152016

 

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

 

 

Three Months Ended June 30,

 

Nine Months Ended June 30,

 

 

Three Months Ended June 30,

 

Nine Months Ended June 30,

 

 

2016

 

2015

 

2016

 

2015

 

 

2017

 

2016

 

2017

 

2016

 

Net sales:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product

 

98.0

%

83.6

%

95.5

%

71.8

%

 

98.6

%

98.0

%

95.6

%

95.5

%

Engineering development contracts

 

2.0

%

16.4

%

4.5

%

28.2

%

 

1.4

%

2.0

%

4.4

%

4.5

%

Total net sales

 

100.0

%

100.0

%

100.0

%

100.0

%

 

100.0

%

100.0

%

100.0

%

100.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of sales:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product

 

38.3

%

46.8

%

38.9

%

40.9

%

 

45.7

%

38.3

%

47.7

%

38.9

%

Engineering development contracts

 

2.0

%

14.0

%

0.9

%

22.0

%

 

2.0

%

2.0

%

2.4

%

0.9

%

Total cost of sales

 

40.3

%

60.8

%

39.8

%

62.9

%

 

47.7

%

40.3

%

50.1

%

39.8

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

59.7

%

39.2

%

60.2

%

37.1

%

 

52.3

%

59.7

%

49.9

%

60.2

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

21.6

%

16.2

%

16.9

%

12.4

%

 

27.2

%

21.6

%

27.0

%

16.9

%

Selling, general and administrative

 

34.5

%

28.4

%

34.6

%

29.0

%

 

37.0

%

34.5

%

16.1

%

34.6

%

Total operating expenses

 

56.1

%

44.6

%

51.5

%

41.4

%

 

64.3

%

56.1

%

43.1

%

51.5

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

3.6

%

(5.4

)%

8.7

%

(4.3

)%

Operating (loss) income

 

(11.9

)%

3.6

%

6.8

%

8.7

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

0.1

%

0.1

%

0.1

%

0.1

%

 

0.2

%

0.1

%

0.2

%

0.1

%

Other income

 

0.2

%

0.3

%

0.3

%

0.2

%

 

0.3

%

0.2

%

33.2

%

0.3

%

Income (loss) before income taxes

 

3.9

%

(5.0

)%

9.2

%

(4.0

)%

(Loss) income before income taxes

 

(11.4

)%

3.9

%

40.2

%

9.2

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income tax

 

0.4

%

66.8

%

1.9

%

15.4

%

Income tax (benefit) expense

 

(11.8

)%

0.4

%

2.4

%

1.9

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

3.5

%

(71.8

)%

7.3

%

(19.4

)%

Net income

 

0.4

%

3.5

%

37.8

%

7.3

%

Three Months Ended June 30, 20162017 Compared to the Three Months Ended June 30, 20152016

 

Net sales. Net sales were $4.5 million for the three months ended June 30, 2017 compared to $6.5 million for the three months ended June 30, 2016, compared to $4.9 million for the three months ended June 30, 2015, an increasea decrease of 32%30.2%. Product sales increased $2.3decreased $1.9 million in the three months ended June 30, 2016 to $6.4 million,2017 compared to $4.1 million in the three months ended June 30, 2015, and2016 primarily due to decreased shipments of displays for retrofit programs to commercial transport customers. EDC sales decreased $0.7 million, from $0.8 million to $0.1 million from the same period in the prior year.  Product sales increased from the same period in the prior year primarily because of increased shipments of displays for retrofit programs to the DoD and military subcontractors, which were partially offset by reduced general aviation and commercial transport business.  The decrease in EDC sales was primarily the result of less revenue being recognized as less cost was incurred on multi-yearfrom EDC projects awarded in prior years as these projects are nearing completion.completion and they have not been replaced by new EDC projects.

 

Cost of sales. Cost of sales decreased $0.4$0.5 million, or 12%17.4%, to $2.6$2.2 million, or 40%47.7% of net sales, in the three months ended June 30, 2016,2017, compared to $3.0$2.6 million, or 61%40.3% of net sales, in the three months ended June 30 2015.30, 2016. The decrease in cost of sales was primarily the result of a decrease in EDCproduct sales volume partially offset by higher manufacturing costs reflecting increased product sales for the three months ended June 30, 20162017 compared to the three months ended June 30, 2015.2016. The Company’s overall gross margin was 59.7%52.3% and 39.3%59.7% for the quarters ended June 30, 20162017 and 2015,2016, respectively. This increasedecrease in overall gross margin forreflects a lower product gross margin primarily the three months ended June 30, 2016 was primarilyresult of reduced coverage of fixed costs due to lower material costs and increased production volume relative to fixed costs.sales volume.

 

Research and development. R&D expense increaseddecreased by $0.6$0.2 million to $1.4$1.2 million for the three month periodperiods ended June 30, 2016 from $0.82017 versus $1.4 million for the three months ended June 30, 2015.2016. R&D expense represented 22%27.2% and 16%21.6% of net sales in such periods, respectively. The increasedecrease in R&D expense as a percentage of net sales resulted primarily from a higher proportion of engineering hours incurred on internal R&D projects rather than EDC programs, as certain EDC programs are nearing completion.reduced personnel and consultant costs.

 

Selling, general, and administrative. Selling, general and administrative expense increased by $0.8was $1.7 million in the three months ended June 30, 2017 as compared to an expense of $2.2 million in the three months ended June 30, 2016 from $1.4 million in the three months ended June 30, 2015.2016. The increasedecrease in selling, general, and administrative expense in the three month period was primarily the result of higherlower legal fees related to the litigation arising from the purported termination of the Delta contract and increased audit fees relativeoffset in part by an increase in commissions as compared to the prior year period. As a percentage of net sales, selling, general and administrative expenses were 35% and 28%37.0% of net sales in each of the three month periodsmonths ended June 30, 2016 and2017 from 34.5% of net sales in the three months ended June 30, 2015, respectively.2016.

 

Interest income. Interest income increaseddecreased to $8,000 in the three months ended June 30, 2017 from $9,000 in the three months ended June 30, 2016 from $6,000 in the three months ended June 30, 2015, mainly a result of higher average cash balances during the 2016 period.2016.

 

Other income. Other income was $12,000$16,000 in the three months ended June 30, 20162017 and $11,000$12,000 for the three months ended June 30, 2015.2016. Other income in each periodfor the three months ended June 30, 2016 is mainly composed of royalties earned.earned during the quarter.

 

Income tax expense. The income tax expensebenefit for the three months ended June 30, 20162017 was $27,000$0.5 million as compared to an income tax expense of $3.3 million$27,000 for the three months ended June 30, 2015.  2016. The effective tax rate benefit for the three months ended June 30, 2017 was 103.7%. The effective tax rate benefit for the three months ended June 30, 2017 differs from the statutory tax rate primarily due to the change in the anticipated profitability in the current year partially offset by the reduction in the utilization of certain R&D tax credits in the period resulting in an increase in the valuation allowance of approximately $0.5 million.

The effective tax rate for the three months ended June 30, 2016 was 10.7%. The effective tax rate for the three months ended June 30, 2016 differs from the statutory rate primarily due to a reduction in the valuation allowance of approximately $150,000 included in ourthe current year estimated annual effective tax rate that is attributable to the anticipated profitability in the current year.

 

The effective tax benefit rate for the three months ended June 30, 2015 was (1,328.1%).  The effective tax rate for the three months ended June 30, 2015 differs from the statutory rate primarily because the Company recorded a valuation allowance against the deferred tax asset of $3.3 million reflecting only those deferred tax assets that could be currently realized.

Net income (loss).. The Company reported net income for the three months ended June 30, 20162017 of $227,000$19,000 compared to a net lossincome of $3.5 million$227,000 for the three months ended June 30, 2015.2016. Net income was significantly impacted by the income tax benefit described above. On a diluted basis, the income per share was $0.00 for the three months ended June 30, 2017 compared to income per share of $0.01 for the three months ended June 30, 2016 compared to a loss per share of $0.21 for the three months ended June 30, 2015.2016.

Nine months endedMonths Ended June 30, 20162017 Compared to the Nine months endedMonths Ended June 30, 20152016

 

Net salessales.. Net sales were $12.6 million for the nine months ended June 30, 2017 compared to $21.7 million for the nine months ended June 30, 2016, an increasea decrease of 28% from $16.942.2%. Product sales decreased $8.8 million in the nine months ended June 30, 2015. For2017 compared to the nine months ended June 30, 2016 product sales increased $8.6 million and EDC salesprimarily due to decreased $3.8 million compared to the same period in the prior year.  The increase in product sales resulted primarily from increased shipments of displays for retrofit programs to commercial transport and DoD and military subcontractors customers partially offset by reduced general aviation business. Net product sales includes $0.7 million of previously deferred revenue as the Company negotiated changes in January 2016 to its arrangements with a certain customer whereby the Company’s obligation associated with certain product deliverables were cancelled. The decrease incustomers. EDC sales wasdecreased $0.4 million from the same period in the prior year primarily the result of less revenue being recognized as less cost was incurred on multi-yearfrom EDC projects awarded in prior years as these projects are nearing completion.completion and they have not been replaced by new EDC projects.

 

Cost of sales. Cost of sales wasdecreased $2.3 million, or 27.2%, to $6.3 million, or 50.1% of net sales, in the nine months ended June 30, 2017, compared to $8.6 million, or 39.8% of net sales, in the nine months ended June 30, 2016 compared to $10.7 million, or 62.9%2016. The decrease in cost of net sales in the same period in the prior year.  The decrease was primarily the result of thea decrease in EDCproduct sales volume for the nine months ended June 30, 20162017 compared to the nine months ended June 30, 2015 partially offset by higher manufacturing costs reflecting increased product sales for the nine months ended June 30, 2016. The Company’s overall gross margin was 60.2%49.9% and 37.1%60.2% for the nine monthsmonth period ended June 30, 20162017 and 2015,2016, respectively. This increase wasdecrease in overall gross margin reflects a lower product gross margin primarily the result of reduced coverage of fixed costs due to a gross margin on the EDC programs of 81% for the nine months ended June 30, 2016 versus a gross margin of 23% for the nine months ended June 30, 2015.lower sales volume. The EDC gross margin for the nine months ended June 30, 2016 reflects a reversal of a loss accrual in the amount of $0.5 million as the Company had negotiated changes in January 2016 to its arrangementsarrangement with a certain customer whereby the Company’s obligation associated with respect to certain product deliverables were cancelled. The improvement in product sales gross margin is due to the recognition of deferred revenue, lower material costs and increased production volume relative to fixed costs.

 

Research and developmentdevelopment.. R&D expenses wereexpense decreased by $0.3 million to $3.4 million for the nine month period ended June 30, 2017 versus $3.7 million and $2.1 million for the nine months ended June 30, 2016 and June 30, 2015, respectively.2016. R&D expense increased torepresented 27.0% and 16.9% of net sales in the nine months ended June 30, 2016 from 12.4% of net sales in the same period a year ago.such periods, respectively. The increase in R&D expense in the nine months ended June 30, 2016, as a percentage of net sales wasresulted primarily from lower sales volume in the result of a higher proportion of engineering hours incurred on internalnine month period ended June 30, 2017 as compared to the nine month period ended June 30, 2016. The decrease in R&D projects as certain EDC programs are nearing completion.expense resulted primarily from reduced personnel and consultant costs.

 

Selling, general, and administrative. Selling, general and administrative expenses were $7.5 million and $4.9expense was $2.0 million in the nine months ended June 30, 2016 and 2015, respectively.2017 as compared to an expense of $7.5 million in the nine months ended June 30, 2016. The increasedecrease in selling, general, and administrative expense in the 2016nine month period was primarily the result of higher legal fees related to the litigation arising fromreversal of the purported termination$3.6 million reserve of the Delta contractunbilled receivable due to the February 23, 2017 settlement with Delta and increased auditlower legal fees relativecompared to the prior year period. As a percentage of net sales, selling, general and administrative expenses increased towere 16.1% of net sales in the nine months ended June 30, 2017 from 34.6% of net sales in the nine months ended June 30, 2016 from 29% of net sales2016.

Interest income. Interest income increased to $28,000 in the nine months ended June 30, 2015.

Interest income. Interest income was2017 from $24,000 in the nine months ended June 30, 2016, compared to $18,000mainly a result of higher average cash balances in the nine months ended June 30, 2015.  The increase in interest income was primarily because of higher cash balances during the nine months ended June 30, 2016 compared to the prior year period.2017.

 

Other income. Other income for the nine month periods ended June 30, 2016 and 2015 was $71,000 and $31,000, respectively.  The increase in other income was primarily a result of higher royalties earned$4.2 million in the nine months ended June 30, 2016 compared2017 and $71,000 for the nine months ended June 30, 2016. The Delta settlement payment to the prior year period.Company of $7.75 million is reflected in the financial statements as payment of the $3.6 million unbilled receivable previously reserved which had been reversed in the period ended March 31, 2017 in selling, general and administrative expenses. The remainder of the settlement payment, approximately $4.1 million, is reflected as other income. Other income for the nine months ended June 30, 2016 is mainly composed of royalties earned during the nine months then ended.

 

Income tax expenseexpense. . The income tax expense for the nine months ended June 30, 20162017 was $403,000$297,000 as compared to an income tax expense of $2.6 million$403,000 for the nine months ended June 30, 2015.2016. The effective tax rate for the nine months ended June 30, 2017 was 5.9%. The effective tax rate for the nine months ended June 30, 2017 differs from the statutory rate primarily due to a reduction in the valuation allowance of approximately $1.4 million included in the current year estimated annual effective tax rate that is attributable to the anticipated profitability in the current year. The majority of this change is a result of the bad debt reserve reversal being deductible for tax purposes and the utilization of certain R&D tax credits in the period.

 

The effective tax rate for the nine months ended June 30, 2016 was 20.2%.  The effective tax rate for the nine months ended June 30, 2016 differs from the statutory rate primarily due to a reduction in the valuation allowance of approximately $150,000 included in ourthe current year estimated annual effective tax rate that is attributable to the anticipated profitability in the current year.

 

The effective tax rate benefit for the nine months ended June 30, 2015 was (380.8%).   The effective tax rate differs from the statutory rate primarily because of the $3.3 million valuation allowance recorded against the deferred tax assets in the three month period ended June 30, 2015.

Net income (loss).income. The Company reported net income for the nine months ended June 30, 20162017 of $1.6$4.8 million compared to a net lossincome of $3.3$1.6 million for the nine months ended June 30, 2015.2016. Net income per share was $0.09$0.28 on a diluted basis for the nine months ended June 30, 20162017 compared to a net lossincome of $0.20$0.09 per share for the nine months ended June 30, 2015.2016. The increases in net income and net income per share were primarily a result of the proceeds of the Delta settlement.

Liquidity and Capital Resources

 

The following table highlights key financial measurements of the Company:

 

 

June 30,

 

September 30,

 

 

2016

 

2015

 

 

June 30,
2017

 

September 30, 2016

 

Cash and cash equivalents

 

$

17,530,210

 

$

16,282,039

 

 

$

24,981,341

 

$

18,767,661

 

Accounts receivable

 

5,838,818

 

2,394,695

 

 

2,073,268

 

4,511,091

 

Current assets

 

30,865,876

 

29,349,475

 

 

34,190,304

 

29,369,459

 

Current liabilities

 

4,444,223

 

4,761,257

 

 

3,291,305

 

3,573,264

 

Deferred revenue

 

299,052

 

756,745

 

 

314,702

 

179,585

 

Other non-current liabilities (1)

 

579,559

 

510,010

 

Total debt and other non-current liabilities (1)

 

67,745

 

67,701

 

Quick ratio (2)

 

5.26

 

3.92

 

 

8.22

 

6.51

 

Current ratio (3)

 

6.95

 

6.16

 

 

10.39

 

8.22

 

 

 

 

 

 

 

 

Nine Months Ended June 30,

 

 

Nine Months Ended June 30,

 

 

2016

 

2015

 

 

2017

 

2016

 

Cash flow activites:

 

 

 

 

 

 

 

 

 

 

Net cash provided by (used in) operating activites

 

$

1,680,172

 

$

913,576

 

Net cash provided by operating activites

 

$

6,343,738

 

$

1,680,172

 

Net cash (used in) investing activites

 

(262,130

)

(114,474

)

 

(130,058

)

(262,130

)

Net cash (used in) provided by financing activites

 

(169,871

)

(254,170

)

Net cash (used in) financing activites

 

 

(169,871

)

 


(1)         Excludes deferred revenue

(2)         The sum of cash and cash equivalents plus accounts receivable, divided by current liabilities

(3)         Current assets divided by current liabilities

 

The Company’s principal source of liquidity has been from cash flows generated from current year operations and cash accumulated from prior years’ operations. Cash is used principally to finance inventory, accounts receivable, unbilled receivables, and payroll, which are all collectively leveraged to execute the Company’s growth strategies and to return value to its shareholders.

 

Operating activities

 

Cash generated for the nine months ended June 30, 2017 resulted primarily from net income of $4.8 million and the decrease of accounts receivable of $2.4 million which was partially offset by an increase in inventory of $0.9 million and a decrease in accounts payable of $0.5 million.

Cash generated for the nine months ended June 30, 2016 resulted primarily from net income of $1.6 million, the decreases of unbilled receivables of $2.3 million, which principally represent sales recorded under the percentage-of-completion method of accounting that have been billed to customers in accordance with applicable EDC terms, lower inventories of $0.6 million and an increase in accounts payable of $0.4 million partially offset by an increase in accounts receivable of $3.4 million.

 

Cash generated for the nine months ended June 30, 2015 resulted primarily from the net effect of decreases in unbilled receivables of $2.6 million which principally represent sales recorded under the percentage-of-completion method of accounting that have been billed to customers in accordance with applicable EDC terms, the collection of accounts receivable of $0.5 million, and lower inventories of $1.3 million, offset partially by decreases in accounts payable and accrued expenses of $3.6 million in the aggregate.

Investing activities

 

Cash used in investing activities was $0.3 and $0.1 million and $0.3 million for each of the nine months ended June 30, 20162017 and 2015,2016, respectively and consisted primarily of the purchase of production and laboratory test equipment.

 

Financing activities

 

Net cash used by financing activities was $0 and $0.2 million and $0.3 million for each of the nine months ended June 30, 2017 and 2016, and 2015, respectively, andrespectively. The financing activity in the nine month period ended June 30, 2016 consisted of the repurchase of shares of the Company’s common stock under the Company’s share repurchase program.

Summary

 

Future capital requirements depend upon numerous factors, including market acceptance of the Company’s products, the timing and

rate of expansion of business, acquisitions, joint ventures, and other factors. IS&S has experienced increases in expenditures since its inception and anticipates that expenditures will continue in the foreseeable future. The Company believes that its cash and cash equivalents will provide sufficient capital to fund operations for at least the next twelve months. However, IS&S may need to develop and introduce new or enhanced products, respond to competitive pressures, invest in or acquire businesses or technologies, or 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 compete effectively.

 

Backlog

 

Backlog activity for the three and nine months ended June 30, 2016 (in thousands):

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

June 30, 2016

 

 

 

 

 

 

 

Backlog, beginning of period

 

$

7,601

 

$

7,601

 

Bookings, net

 

5,258

 

20,502

 

Recognized in revenue

 

(6,505

)

(21,749

)

Backlog, end of period

 

$

6,354

 

$

6,354

 

At June 30, 2016 and September 30, 2015, the Company’s backlog was $6.4 million and $7.6 million, respectively. Backlog represents the value of contracts and purchase orders received, less sales recognized to date on those contracts and purchase orders. Backlog activity for the three and nine months ended June 30, 2017 (in thousands):

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

June 30, 2017

 

 

 

 

 

 

 

Backlog, beginning of period

 

$

5,882

 

$

4,569

 

Bookings, net

 

2,964

 

12,853

 

Recognized in revenue

 

(4,541

)

(13,117

)

Backlog, end of period

 

$

4,305

 

$

4,305

 

At June 30, 2017 and September 30, 2016, the Company’s backlog was $4.3 million and $4.6 million, respectively. The balance$0.3 million decrease in backlog was the result of $20.5$12.9 million in net new business orders, offset by $21.7$13.1 million of sales recognized for the nine months ended June 30, 2016.  Backlog includes large contracts with Pilatus and Eclipse but excludes potential future sole-source production orders from products currently in development under the Company’s EDC projects.2017. At June 30, 2016,2017, approximately 100% of the Company’s backlog is expected to be filled within the next twelve months. To the extent new business orders do not continue to equal or exceed sales recognized in the future from the Company’s existing backlog, future operating results may be impacted negatively.

 

Off-Balance Sheet Arrangements

 

IS&S has no relationships with unconsolidated entities or financial partnerships, such as Special Purpose Entities or Variable Interest Entities, established for the purpose of facilitating off-balance sheet arrangements or other limited purposes.

 

Item 3. 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. The Company does not participate in interest rate hedging. Cash balances are maintained with two major banks. Balances on deposit with certain money market accounts and operating accounts may exceed the Federal Deposit Insurance Corporation (“FDIC”) limits. A change in interest rates earned on the cash equivalents would impact interest income and cash flows, but would not impact the fair market value of the related underlying instruments. Assuming that the balances during the three and nine months ended June 30, 20162017 were to remain constant and the Company did not act to alter the existing interest rate sensitivity, a hypothetical 1% increase in variable interest rates would have affected interest income by approximately $40,000$59,000 and $121,000, respectively,$176,000 with a resulting impact on cash flows of approximately $40,000$59,000 and $121,000$176,000 for the three and nine months ended June 30, 2016,2017, respectively.

 

Item 4. Controls and Procedures

 

(a)         An           We carried out an evaluation was performed under the supervision and with the participation of the Company’sour management, including its Chief Executive Officer (“CEO”)our chief executive officer and Chief Financial Officer (“CFO”),chief financial officer, of the effectiveness of the Company’sdesign and operation of our disclosure

controls and procedures, as such term is defined under Rule 13a-15e13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of June 30, 2016.2017. Based on that evaluation, the Company’s management, including the CEOour chief executive officer and CFO,chief financial officer concluded that the Company’s disclosurethese controls and procedures arewere effective to provide reasonable assurance that information required to be disclosed by us in the Company in reports that it fileswe file or submitssubmit under the Exchange Act is (i) recorded, processed, summarized, and reported, aswithin the time periods specified in the SEC’s rules and forms of the Securities and that such information isExchange Commission and (ii) accumulated and communicated to the Company’sissuer’s management, including the CEOits principal executive and CFO,principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

 

(b)   As previously disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2015, management had concluded that there was a material weakness in its control over financial reporting as of such date, attributable to a lack of adequate controls over the percentage-of-completion accounting of fixed price contracts and allocation of related costs. Specifically, the Company did not design, implement and maintain effective controls to support the accurate reporting of revenue, receivables and project related costs with respect to revenue recognized using the percentage-of-completion method.

In response to this issue, during the nine months ended June 30, 2016, management (i) implemented procedures and controls to identify and evaluate customer contracts to ensure the accurate and timely reporting of revenue receivables and related project costs, (ii) strengthened the quarterly review processes to ensure proper recognition of revenue and (iii) utilize third-party accounting experts to assist the Company in the proper application of accounting principles to percentage-of-completion customer contracts.  However, the Company cannot assure you that it will be successful in pursuing these measures or that these measures will significantly improve or remediate the material weaknesses described above. The Company also cannot assure that it has identified all of its existing material weaknesses, or that it will not in the future have additional material weaknesses.

Other than as described above, there           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 havehas materially affected, or areis reasonably likely to

materially affect, the Company’s internal control over financial reporting.

 

PART II—OTHER INFORMATION

 

Item 1.   Legal Proceedings

 

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

The Company previously announced that Delta Airlines (“Delta”) purported to terminate its contract with the Company to develop, manufacture and install new cockpit displays and certain navigation capabilities on Delta’s fleet of approximately 182 MD88 and MD90 aircraft. The Company initiated and engaged in a non-binding mediation with Delta on February 25, 2015. The mediation session did not resolve the dispute. On February 25, 2015, the Company filed a complaint against Delta in the United States District Court for the Eastern District of Pennsylvania for breach of contract. The Company has alleged in the case, captioned Innovative Solutions & Support, Inc. v. Delta Airlines, Inc. E.D. Pa. Civ. No. 15-959, that Delta’s purported termination of the contract was wrongful and in breach of the terms of the contract, and is seeking monetary damages. On March 20, 2015, Delta answered the Company’s complaint and filed counterclaims against the Company for breach of contract and breach of the duty of good faith and fair dealing, also seeking monetary damages. The parties have completed discovery and have each filed motions for summary judgment. The outcome of the litigation is not determinable at this time. The Company had $3.6 million of unbilled receivables and $0.2 million of inventory on its balance sheet relating to the Delta program at September 30, 2015 both of which are fully reserved.

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 secrets and proprietary information in assisting J2 and Kollsman in developing the J2/Kollsman Air Data Computer. The case has not been resolved as of the date hereof.

 

Item 1A. Risk Factors

 

There are no material changes to the risk factors described under Item 1A of the Company’s Form 10-K for the year ended September 30, 2015.2016.

Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds

 

The table below provides information concerning the Company’s repurchases of shares of common stock during the quarter ended June 30, 2016 pursuant to the Company’s stock repurchase program.None

 

 

 

 

 

 

Total Number of

 

Number of

 

 

 

 

 

 

 

Shares Purchased as

 

Shares that May

 

 

 

 

 

 

 

Part of Publicly

 

Yet Be Purchased

 

 

 

Total Number of

 

Average Price Paid

 

Announced Plans or

 

Under the

 

Month Ended

 

Shares Purchased

 

per Share

 

Programs

 

Program

 

 

 

 

 

 

 

 

 

 

 

April 2016

 

 

 

 

250,000

 

May 2016

 

4,910

 

2.83

 

4,910

 

245,090

 

June 2016

 

52,255

 

2.96

 

52,255

 

192,835

 

 

 

57,165

 

$

2.95

 

57,165

 

 

 

See Note 4 to the Company’s condensed consolidated financial statements contained in this quarterly report on Form 10-Q for a more detailed discussion of the terms of the Company’s stock repurchase program.

 

Item 3.   Defaults upon Senior Securities

 

None

 

Item 4.   Mine Safety Disclosures

 

Not applicable

 

Item 5.   Other Information

 

None

 

Item 6. Exhibits

 

(a)   Exhibits

 

31.1

Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) (2)

 

 

31.2

Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) (2)

 

 

32.1

Certification Pursuant to U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (2)

 

 

101.INS

XBRL Instance Document (1)

101.SCH

XBRL Taxonomy Extension Scheme Document (1)

101.CAL

XBRL Taxonomy Extension Calculation Linkbase Document (1)

101.DEF

XBRL Taxonomy Extension Definition Linkbase Document (1)

101.LAB

XBRL Taxonomy Extension Label Linkbase Document (1)

101.PRE

XBRL Taxonomy Extension Presentation Linkbase Document (1)

 


(1)   Filed herewith

 

(2)   Furnished herewith

SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrantRegistrant has duly caused this report to be signed on its

behalf by the undersigned thereunto duly authorized.

 

 

INNOVATIVE SOLUTIONS AND SUPPORT, INC.

 

 

 

Date: August 12, 201611, 2017

By:

/s/ RELLAND WINAND

 

 

/s/ RELLAND WINAND

 

 

RELLAND WINAND

 

 

CHIEF FINANCIAL OFFICER

 

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