Item 1A. Risk Factors.
Investing in our common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described below, together with all of the other information in this Annual Report on Form 10-K, including the sections titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes, before making a decision to invest in our common stock. Our business, financial condition, results of operations, or prospects could also be harmed by risks and uncertainties not currently known to us or that we currently do not believe are material. If any of the risks actually occur, our business, financial condition, results of operations, and prospects could be adversely affected. In that event, the market price of our common stock could decline, and you could lose part or all of your investment.
Risks Related to Our Business and Industry
Growth of the Company’s customer base could be limited by delays or difficulties in completing development and introduction of planned products or product enhancements. If the Company fails to enhance existing products, or to develop and achieve market acceptance for flat panel displays, flight management systems, autothrottle technology and other new products that meet customer requirements, its business, reputation and statements of income may be affected adversely.
The Company spends a large portion of its R&D efforts in developing and marketing the FPDS, FMS, ThrustSense® Autothrottle and complementary products. The Company’s ability to grow and diversify its operations through introduction and sale of new products is dependent upon its continued success in product development and engineering activities, its sales and marketing efforts, and its ability to obtain necessary regulatory approvals to sell such products. Sales growth will depend in part on market acceptance of and demand for the FPDS, FMS, ThrustSense® Autothrottle and future products. The Company cannot be certain that it will be able to develop, introduce or market its FPDS, FMS, ThrustSense® Autothrottle or other new products or product enhancements in a timely or cost-effective manner, or that any new products or product enhancements will receive market acceptance or necessary regulatory approval. In addition, the Company’s business is dependent upon maintaining its reputation and relationships with existing customers. If the Company’s performance or the performance of the Company’s products does not meet its customers’ expectations, the Company’s reputation and its relationships could be damaged, which may have a material adverse impact on the Company’s business and statements of income, including reductions in sales.
In seeking new customers, the Company may have difficulty in displacing the products of incumbent competitors. The Company cannot be assured that potential customers will accept its products or that existing customers will not abandon them.
16
Table of Contents
Contracts can be terminated by many of the Company’s customers at any time and, therefore, may not result in sales.
The Company’s contracts, including contracts with government agencies, include various terms and conditions that impose certain requirements on the Company, including the ability of the government agency or general contractor to alter the price, quantity or delivery schedule of the products. Additionally, government agencies and general contractors typically retain the right to terminate the contract at any time at their convenience. Upon alteration or termination of these contracts, the Company is entitled typically to an equitable adjustment to the contract price so that it would be compensated for delivered items and allowable costs incurred. However, because these contracts can be terminated for convenience, the Company cannot be assured that its backlog will result in sales.
The Company enters into fixed-price contracts or service arrangements to perform specified design and EDC services related to its products that could subject the Company to losses in the event the Company incurs cost overruns on its projects.
During fiscal year 2023, approximately 3.3% percent of the Company’s total sales were from fixed-price EDC arrangements with customers to perform specified design and EDC services related to its products. These arrangements allow the Company to benefit by recovering some of its product development costs, but it carries the risk of potential cost overruns. If the Company’s initial cost estimates are incorrect, it can incur potentially large one time charges and losses on these contracts. These EDC arrangements can expose the Company to potential losses because the customer may compel the Company to complete a project or, in the event of a termination for default, pay the incremental cost of its replacement by another provider. Because some of these projects involve new technologies and applications, and can last for more than a year, unforeseen events such as technological difficulties, fluctuations in the price of raw materials, problems with subcontractors, and cost overruns can result in the contractual price becoming less favorable or even unprofitable to the Company over time. Furthermore, if the Company does not meet project deadlines or if its products do not meet customer specifications, it may need to renegotiate contracts on less favorable terms, be forced to pay penalties or liquidated damages, or suffer losses if the customer exercises its right to terminate. The Company’s results of operations are dependent on its ability to maximize earnings from the EDC service arrangements. Lower earnings caused by cost overruns could have a negative impact on the Company’s financial condition, operating results and cash flows.
A portion of the Company’s sales come from government contracts, which could be adversely affected by continued high U.S. federal budget deficits. Government contracts are also subject to special risks as a result of the U.S. government’s audit practices.
A portion of the Company’s sales has been, and is expected to continue to be, from defense contractors or government agencies in connection with government aircraft retrofit or OEM contracts. Sales to government contractors and government agencies could decline as a result of DoD spending cuts and general budgetary constraints, which may become more severe as the federal budget deficit remains high.
In addition, the U.S. government regularly conducts investigations, inquiries and audits into its suppliers’ compliance with procurement regulations and performance under the relevant government contracts. If an investigation reveals or an audit finds that the Company violated applicable law or regulations, its government contracts could be terminated and it could be restricted from future procurement activities. Moreover, if an investigation, inquiry or audit finds that the Company acted improperly or was involved in illegal activities, the Company could be subject to civil penalties, criminal penalties, and administrative sanctions. As a result, the Company’s reputation could be harmed even if the allegations were later determined to be false.
Reductions in government expenditures could adversely affect the Company’s business.
Reductions in funding of the DoD and U.S. defense spending could have significant consequences to the Company’s business and industry. The impact of any such reductions in defense appropriations and/or reductions in U.S. defense spending could result in delays in procurement of products and services due to lack of funding, and negatively affect the Company’s revenues, financial condition and results of operations.
17
Table of Contents
The loss of a key customer or a significant deterioration in the financial condition of a key customer could have a material adverse effect on the Company’s results of operations.
The Company’s revenue is concentrated with a limited number of customers. During fiscal year 2023 the Company derived 54% of revenue from the top five customers. The Company continues to expect a relatively small number of customers to account for a majority of its revenues for the foreseeable future. As a result of the concentrated customer base, a loss of one or more of these customers or a dispute or litigation with one of these key customers could affect adversely its revenue and results of operations. The Company monitors and evaluates the credit status of its customers and attempts to adjust sales terms as appropriate. Despite these efforts, a significant deterioration in the financial condition or bankruptcy filing of a key customer could affect adversely the Company’s business, results of operations, and financial condition.
In addition, the Company is subject to credit risk associated with the concentration of accounts receivable from its key customers. If any of the Company’s top customers were to become bankrupt or insolvent or otherwise were unable to pay for the products and services provided by the Company, then the Company may incur significant write-offs of accounts receivable, incur other impairment charges or result in a significant loss of expected revenues, which may have a material adverse effect on the Company’s results of operations.
We self-insure a significant portion of our employee medical insurance program, which may expose us to unpredictable costs and negatively affect our financial performance.
We self-insure a significant portion of our employee medical insurance program and related benefit claims. The estimated liability for the self-funded portion of our insurance program is determined actuarially, based on claims filed historically, demographic factors and an estimate of claims incurred but not yet reported. We maintain stop loss insurance coverage to limit our exposure for the self-funded portion of our health insurance program both on a per employee and aggregate basis, and liabilities associated with these losses include estimates of both claims filed and losses incurred but not yet reported. Unanticipated changes in any applicable actuarial assumptions or management estimates underlying our recorded liabilities for these losses could result in materially different amounts of expense than expected under these programs, which could have a material adverse effect on our financial condition and results of operations. In addition, the premiums for this coverage could increase in the future, or we could be forced to raise our self-insured retention amounts. If these expenses increase, or if we experience a claim in excess of our reserve and/or coverage limits, it could also have a material adverse effect on our financial condition and results of operation.
We currently operate without a substantial backlog.
During periods of economic uncertainty, the rate of customer orders can quickly decrease, and a substantial backlog may help promote greater efficiency in production, facilitate business planning and improve revenue visibility. As of September 30, 2023, 8% of the Company’s backlog was expected to be filled beyond fiscal 2024, which is below the Company’s historical expectations and may result in lower revenues in future periods. As a result, future revenue will be dependent on orders booked and shipped in that quarter, and may not be predictable with any degree of certainty. Furthermore, certain contracts may represent a significant portion of our revenue and profits for a quarter such that the loss or deferral of even one such contract could adversely affect our revenue and profitability.
The Company has limited experience in marketing and distributing its products internationally.
The Company plans to derive increasing revenues from sales outside the United States, particularly in Europe and Asia. Risks inherent in doing business internationally include:
● differing regulatory requirements;
● legal uncertainty regarding liability and the enforceability of agreements;
● tariffs, trade and investment barriers, and other regulatory barriers;
● changes in diplomatic and trade relationships;
● difficulty with staffing and managing widespread operations;
● the impact of recessions in economies outside the United States; and
18
Table of Contents
● variances and unexpected changes in local laws and regulations.
Currently, all of the Company’s international sales are denominated in U.S. dollars. An increase in the dollar’s value compared to other currencies could render the Company’s products less competitive in the international markets. In the future, the Company may be required to conduct sales in the foreign country’s local currency, thus exposing it to fluctuations and volatility in exchange rates that could adversely affect its operating results. Further, as we pursue customers in Asia and other less developed markets throughout the world, our potential inability to ensure the creditworthiness of counterparties could impose additional risks and affect our overall profitability. Emerging market operations in particular can present many risks, including volatility in gross domestic product, economic and government instability, and the imposition of exchange controls and capital controls.
These factors and their impact are difficult to predict, and any one or more of them could have a material adverse effect on our competitive position, results of operations, cash flows or financial condition.
The Company’s competition includes other manufacturers of air data systems and flight information displays against whom it may not be able to compete successfully.
The markets for the Company’s products are intensely competitive and subject to rapid technological change. Competitors include Honeywell, Collins Aerospace, Thales Defense & Security, Inc., Garmin Ltd. and GE Aviation Systems. All these competitors have substantially greater financial, technical, and human capital resources than does the Company. In addition, these competitors have much greater experience in and resources for marketing their products. As a result, these competitors may be able to respond more quickly to new or emerging technologies and customer preferences, or to devote greater resources to development, promotion and sale of their products than the Company can. The Company’s competitors may have greater name recognition and more extensive customer bases. Such competition could result in price reductions, fewer customer orders, reduced gross margins, and loss of market share.
The Company relies on third-party suppliers for components of its products, including any necessary raw materials, and any interruption in the supply of these components could hinder its ability to deliver products on a timely basis.
The Company’s manufacturing process consists primarily of assembling components purchased from its supply chain. The suppliers may not continue to be available to the Company, or be able to perform or timely deliver our components. If the Company is unable to maintain relationships with key third-party suppliers, the development and distribution of its products could be delayed until equivalent components can be obtained and integrated into the products. In addition, substitution of certain components from other manufacturers may require product redesign or FAA, EASA or other approvals, which could delay the Company’s ability to ship products, and any increase in component costs, including the costs of any necessary raw materials, in the Company’s supply chain could adversely affect the Company’s results of operations.
19
Table of Contents
The Company depends on key personnel to manage its business effectively, and an inability to retain its key employees and plan for management succession could adversely impact the Company’s ability to compete.
The Company’s success depends on the efforts, abilities, and expertise of its senior management and other key personnel. There can be no assurance that the Company will be able to retain such employees, and the loss of some could damage its ability to execute its business strategy. The Company intends to continue hiring key management, engineering, and sales and marketing personnel. Competition for skilled personnel is intense, and the Company may not be able to attract or retain additional qualified personnel.
The Company’s future success will depend in part on its ability to implement and improve its operational, administrative and financial systems and controls and to manage, train and expand its employee base. The Company cannot provide assurance that current and planned personnel levels, systems, procedures and controls will be adequate to support its current and future customer base. In such a circumstance, the Company may not be able to fully capitalize on existing and potential market opportunities. Any delays or difficulties encountered could impair the Company’s ability to attract new customers or maintain its relationships with existing customers. In addition, effective succession planning is important to our long-term success. Failure to ensure effective transfer of knowledge and smooth transitions involving senior management and other key personnel could hinder our strategic planning and execution
The Company’s revenue and operating results may vary significantly from quarter to quarter, which may cause its stock price to decline.
The Company’s revenue and operating results may vary significantly from quarter to quarter because of a number of factors, including, but not limited to:
● demand for products and/or delivery schedule changes by its customers;
● delays in introducing or obtaining government approval for new products;
● new product introductions by competitors;
● costs related to possible acquisition of technologies or businesses.
If the Company is unable to respond to rapid technological change, its products could become obsolete and its reputation could suffer.
Future generations of flat panel displays, air data systems, engine and fuel displays, flight management systems and autothrottle technology which embody new technologies or new industry standards could render the Company’s products obsolete. The market for aviation products is subject to rapid technological change, new product introductions, changes in customer preferences, and evolving industry standards and government regulations. The Company’s future success will depend on its ability to:
● embrace rapidly changing technologies;
If the Company fails to modify or improve its products in response to evolving industry standards and government regulations, its products could rapidly become obsolete.
The Company’s products are currently subject to direct regulation by the FAA and other equivalent organizations. The Company’s products, as they relate to aircraft applications, must be approved by the FAA, EASA, or other equivalent organizations before they can be installed in an aircraft. To be certified, the Company must demonstrate that its products are accurate and able to maintain certain levels of repeatability over time. Although the certification requirements of the FAA and EASA are substantially similar, no formal reciprocity exists between the two regulators. Accordingly, even though the Company’s products are FAA approved, the Company may need to obtain approval from EASA or other appropriate organizations to have them certified for installation outside the United States.
20
Table of Contents
Significant delay in receiving certification for newly developed products or enhancements to the Company’s products, or the loss of certification for its existing products, could result in lost sales or delays in sales. Furthermore, new regulations or product standards, and changes to existing product standards could require the Company to change its products and underlying technology. The Company cannot ensure that it will receive regulatory approval on a timely basis or at all.
Inasmuch as the Company’s products utilize sophisticated technology and are deployed in complex aircraft cockpit environments, problems with these products may arise that could harm the Company’s reputation for quality assurance and, consequently, its business prospects.
The Company’s products use complex system designs and components that may contain errors, omissions, or defects, particularly when the Company incorporates new technologies into its products or when it releases new versions or enhancements of its existing products. Despite the Company’s quality assurance process, errors, omissions or defects could occur in its current products, in new products, or in new versions or enhancements of existing products. The Company may be required to redesign or recall those products or pay damages. Such an event could result in the following:
● delay or loss of revenues;
● cancellation of customer contracts;
● diversion of development resources;
● damage to the Company’s reputation;
● increased service and warranty costs; or
● litigation costs.
The Company’s product liability insurance, may not be adequate to cover its losses in the event of a large product liability claim. In addition, the Company may not be able to maintain such insurance in the future.
We may pursue strategic acquisitions, investments, strategic partnerships or other ventures, and our business could be materially harmed if we fail to successfully identify, evaluate, complete, and integrate such transactions. Acquisitions, including the Transaction, involve inherent risks that may adversely affect our operating results and financial condition. The Company may be unable to successfully integrate and realize the anticipated benefits of the Transaction.
Our growth strategy includes evaluating acquisition opportunities and opportunities to make investments in complementary businesses, technologies, services or products, or to enter into strategic partnerships with parties who can provide access to those assets, additional product or services offerings, additional distribution or marketing synergies or additional industry expertise. One example is the recent asset acquisition of certain inertial, communication and navigation product lines from Honeywell. We may not be able to identify suitable acquisition, investment or strategic partnership candidates, or if we do identify suitable candidates in the future, we may not be able to complete those transactions on commercially favorable terms, or at all.
Acquisitions, including the Transaction, involve various inherent risks, such as: our ability to assess accurately the value, strengths, weaknesses, internal controls, contingent and other liabilities and potential profitability of acquisition candidates; difficulties in integrating acquired businesses, including the potential loss of key personnel from an acquired business, our potential inability to achieve identified financial, operating and other synergies anticipated to result from an acquisition, and integration issues associated with internal controls of acquired businesses; the diversion of management’s attention from our existing businesses; the potential impairment of assets; potential unknown liabilities associated with a business that we acquire or in which we invest, including environmental liabilities; new and proposed regulations limiting the enforcement of noncompetition and nonsolicitation agreements; and production delays associated with consolidating acquired facilities and manufacturing operations. Any past or future acquisition, including the Transaction, could also result in such risks. Due diligence performed prior to closing acquisitions may not uncover certain risks or liabilities that could materially impact our business and financial results.
We may not successfully integrate business, operational, and financial activities such as internal controls, the Sarbanes-Oxley Act of 2002, as amended (the “Sarbanes-Oxley Act”) compliance, cyber security measures, the GDPR and other corporate governance and regulatory matters, operations, personnel or products related to acquisitions we may make in the future. We closed the Transaction in June 2023 and are working to integrate the Honeywell product lines into our business. The success of the Transaction, including anticipated benefits and potential additional revenue opportunities, will depend, in part, on the Company’s ability to successfully integrate the Honeywell product lines in a manner that results in various benefits, including, among other things, enhancing the Company’s current offerings in the air transport, military and business aviation markets, creating potential cost synergies, accelerating the Company’s growth and enhancing its global reputation. The ongoing process of integrating the Transaction could result in a loss of
21
Table of Contents
key personnel, cause an interruption of, or loss of momentum in, the activities of one or more of the Company’s businesses or inconsistencies in standards, controls, procedures and policies that adversely affect the ability of the Company to maintain relationships with customers and employees. The diversion of management’s attention and any delays or difficulties encountered in connection with the integration of the Transaction could have an adverse effect on the business, financial condition, operating results and prospects of the Company. If the Company experiences difficulties in the integration process, including those listed above, the Company may fail to realize the anticipated benefits of the Transaction in a timely manner or at all. Failure to achieve these anticipated benefits could result in increased costs, decreases in the amount of expected revenues, lost cost savings and revenue opportunities and diversion of management’s time and energy, and could have an adverse effect on the Company’s business, financial condition, operating results and prospects. If we fail to successfully integrate such transaction, or any future transactions, our business could be materially harmed. In connection with our acquisitions, including those acquisitions that we do not complete, we may incur significant transaction costs. We are required to expense such transaction costs as incurred, which may have a material adverse impact on our financial results.
Risks Related to Intellectual Property, Privacy, Cybersecurity, and Technical Infrastructure
The Company’s success depends on its ability to protect its proprietary rights against potential risk of infringement. If the Company is unable to protect and enforce its intellectual property rights, it may be unable to compete effectively.
The Company’s success and ability to compete will depend in part on its ability to obtain and maintain patent or other protection for its technology and products, both in the United States and internationally. In addition, the Company must operate without infringing the proprietary rights of others.
22
Table of Contents
As of September 30, 2023, the Company holds 32 U.S. patents and has three U.S. patent applications pending relating to its technology. In addition, the Company holds 85 international patents and has six international patent applications pending. The Company cannot be certain that patents will be issued on any of its present or future applications. In addition, existing patents or future patents may not adequately protect the Company’s technology if they are not broad enough or are successfully challenged, or if other entities are able to develop competing methods without violating its patents. If the Company is not successful in protecting its intellectual property, competitors could begin to offer products that incorporate its technology. Patent protection involves complex legal and factual questions, and, therefore, is highly uncertain. Litigation relating to intellectual property is often very time consuming and expensive. If a successful claim of patent infringement were made against the Company, and if the Company were unable to develop non-infringing technology, or to license the infringed or similar technology on a timely and cost-effective basis, the Company might not be able to produce and sell some of its products. Further, the Company has incurred, and may continue to incur, significant legal and other costs in defense of its intellectual property.
A cyber security incident or other technology disruption could have a negative impact on our business.
We face certain security threats and technology disruptions, including threats to our information technology (“IT”) infrastructure, attempts to gain access to our or our customers’ proprietary or classified information, threats of terrorism events, and failures of our technology tools and systems. Our IT networks and related systems are critical to the operation of our business and essential to our ability to successfully perform day-to-day operations. We are also involved with IT systems for certain customers and other third parties, for which we face similar security threats as for our own, in particular the DoD. In particular, cybersecurity threats—which include, but are not limited to, computer viruses, spyware and malware, attempts to access information, denial of service attacks and other electronic security breaches—are persistent and evolve quickly. In general, such threats have increased in frequency, scope and potential impact in recent years. Further, a variety of technological tools and systems, including both company-owned IT and technological services provided by outside parties, support our critical functions. These technologies, as well as our products, are subject to failure and the user’s inability to have such technologies properly supported, updated, expanded or integrated into other technologies and, in certain cases, may contain open source and third-party software which may unbeknownst to us contain defects or viruses that pose unintended risks. These risks, if not effectively mitigated or controlled, could materially harm our business or reputation. There can be no assurance that actions we have taken to implement appropriate measures and controls will be sufficient to prevent disruptions to critical systems, unauthorized release of confidential information or corruption of data.
The security measures we have implemented may become subject to third-party security breaches, employee error, malfeasance, faulty password management or other irregularities. For example, third parties may attempt to fraudulently induce employees or customers into disclosing user names, passwords or other sensitive information, which may in turn be used to access our IT systems. These security systems cannot provide absolute security. To the extent we were to experience a breach of our systems and were unable to protect sensitive data, such a breach could materially damage business partner and customer relationships, and curtail or otherwise impact the use of our IT systems. Moreover, if a security breach of our IT systems affects our computer systems or results in the release of personally identifiable or other sensitive information of customers, business partners, employees and other third parties, our reputation and brand could be materially damaged, use of our products and services could decrease, and we could be exposed to a risk of loss, litigation and potential liability.
Such an event could require significant management attention and resources, negatively impact our reputation among our customers and the public and challenge our eligibility for future work on sensitive or classified systems, which could have a material adverse effect on our business, financial condition and results of operations.
Legal and Regulatory Risks
Litigation with customers, employees and others could harm our reputation and impact operating results.
In the ordinary course of business, we may be involved in lawsuits and regulatory actions with customers, employees and others. Additionally, we may be subject to employment-related claims alleging discrimination, harassment, wrongful termination and wage issues, including those relating to overtime compensation. We are susceptible to claims filed by customers alleging responsibility for breaches of contract or from product defects, and we are also subject to lawsuits filed by patent holders alleging patent infringement. These types of claims, as well as other types of lawsuits to which we are subject from time to time, can distract management’s attention from core business operations and impact operating results, particularly if a lawsuit results in an unfavorable outcome, or could harm the Company’s reputation with customers, employees, investors and others.
23
Table of Contents
Tax changes could affect the Company’s effective tax rate and future profitability.
The Company’s future results could be affected negatively by changes in the effective tax rate due to changes in the Company’s overall profitability, changes to statutory tax rates in the United States and in other jurisdictions, changes in tax legislation, and the results of audits and examinations of previously filed tax returns. In addition, adverse changes in the underlying profitability and financial outlook of our operations or future changes in tax law could lead to changes in the value of tax assets or liabilities that we currently or in the future may hold, which could materially affect our results of operations. Further, the nature and impact of any future changes to tax law, and the resulting impact on our business, financial condition and results of operations, are uncertain.
The Company is subject to various laws and regulations. Changes to, or failure by the Company to comply with, these laws and regulations could have a significant impact on the Company’s business and operations.
The Company is subject to, and must comply with, various laws and regulations, including, but not limited to, the product-related and other regulations of the FAA and the EASA, U.S. government procurement regulations, the rules and regulations of the SEC, and local, state, federal, and international tax codes, import and export controls and customs laws, employment and employment-related laws, environmental laws, intellectual property laws, and consumer protection statutes. Failure to comply with all applicable laws could result in investigation and remediation costs to the Company and could adversely impact the operations and profits of the Company. In addition, the evolving and at times overlapping regulatory regimes to which the Company is subject may change at any time. Any changes to existing laws or regulations, or the adoption of new laws or regulations, could increase our compliance costs and operating costs. In addition, failure to timely comply with regulatory changes could cause payments to be withheld and/or an impact on future business.
If the Company fails to maintain an effective system of internal control over financial reporting, it may not be able to accurately report its financial condition, results of operations or cash flows, which may adversely affect investor confidence in the Company and, as a result, the value of the Company’s common stock.
The Sarbanes-Oxley Act requires, among other things, that the Company maintain effective internal control over financial reporting and disclosure controls and procedures. Under Section 404 of the Sarbanes-Oxley Act, the Company is required to furnish a report by management on, among other things, the effectiveness of the Company’s internal control over financial reporting. This assessment must include disclosure of any material weaknesses identified by management in the Company’s internal control over financial reporting. A material weakness is a control deficiency, or combination of control deficiencies, in internal control over financial reporting that results in more than a reasonable possibility that a material misstatement of annual or interim financial statements will not be prevented or detected on a timely basis. Section 404 of the Sarbanes-Oxley Act also generally requires an attestation from the Company’s independent registered public accounting firm on the effectiveness of the Company’s internal control over financial reporting.
The Company’s compliance with Section 404 requires that it compile the system and process documentation necessary to perform an appropriate evaluation. During the evaluation and testing process, if the Company identifies one or more material weaknesses in its internal control over financial reporting, it will be unable to assert that its internal control over financial reporting is effective. The Company cannot assure you that there will not be material weaknesses or significant deficiencies in its internal control over financial reporting in the future. Any failure to maintain internal control over financial reporting could severely inhibit the Company’s ability to accurately report its financial condition, results of operations or cash flows. If the Company is unable to conclude that its internal control over financial reporting is effective, or if its independent registered public accounting firm determines the Company has a material weakness or significant deficiency in its internal control over financial reporting once that firm begin its reviews, the Company could lose investor confidence in the accuracy and completeness of its financial reports, the market price of its common stock could decline, and it could be subject to sanctions or investigations by NASDAQ, the SEC or other regulatory authorities. Failure to remedy any material weakness in the Company’s internal control over financial reporting, or to implement or maintain other effective control systems required of public companies, could also restrict the Company’s future access to the capital markets.
Risks Related to Our Common Stock, Capital Markets and Indebtedness
Our common stock may be affected by limited trading volume and may fluctuate significantly.
Our common stock is traded on NASDAQ. Although an active trading market has developed for our common stock, there can be no assurance that an active trading market for our common stock will be sustained. Failure to maintain an active trading market for our common stock may adversely affect our shareholders’ ability to sell our common stock in short time periods, or at all. Our common
24
Table of Contents
stock has experienced, and may experience in the future, significant price and volume fluctuations, which could adversely affect the market price of our common stock.
Our common stock has experienced and may continue to experience price fluctuations, which could cause you to lose a significant portion of your investment and interfere with our efforts to grow our business.
Stock markets are subject to significant price fluctuations that may be unrelated to the operating performance of particular companies, and accordingly the market price of our common stock may frequently and meaningfully change. In addition, the market price of our common stock has fluctuated and may continue to fluctuate substantially due to a variety of other factors. Possible exogenous incidents and trends may also impact the capital markets generally and our common stock prices specifically. For example, the war in the Middle East and the war between Russia and Ukraine and resulting economic sanctions imposed by many countries on Russia have led to disruption, instability and volatility in the U.S. and global markets and industries and are expected to have a negative impact on the U.S. and broader global economies. The timing of your purchase and sale of our common stock relative to fluctuations in its trading price may result in you losing a significant portion of your investment.
Because we do not intend to declare cash dividends on our shares of common stock in the foreseeable future, shareholders must rely on appreciation of the value of our common stock for any return on their investment.
We currently anticipate that we will retain future earnings for the development, operation and expansion of our business and do not anticipate declaring or paying any cash dividends in the foreseeable future. In addition, the terms of any future debt agreements may preclude us from paying dividends. As a result, we expect that only appreciation of the price of our common stock, if any, will provide a return to investors in this offering for the foreseeable future.
Volatility and weakness in capital markets may adversely affect credit availability and related financing costs, which could adversely affect the Company.
Bank and capital markets can experience periods of volatility and disruption. During these periods of volatility and disruption, risks to the Company include:
● reduced access to credit sources; and
There are risks associated with our outstanding and future indebtedness.
On June 28, 2023, the Company and one of its subsidiaries entered into an Amendment to Loan Documents (the “Loan Amendment”) with PNC Bank, National Association (“PNC”), which amends certain terms of that certain Loan Agreement entered into by the parties on May 11, 2023 (the “Loan Agreement” and, as amended, the “Amended Loan Agreement”) and (ii) a corresponding Term Note in favor of PNC (the “Term Note”), which together provide for a senior secured term loan in an aggregate principal amount of $20.0 million, with a maturity date of June 28, 2028 (the “Term Loan”). In addition to providing for the Term Loan, the Loan Agreement, together with a corresponding Revolving Line of Credit Note in favor of PNC, executed May 11, 2023 (“Line of Credit Note”), provides for a senior secured revolving line of credit in an aggregate principal amount of $10.0 million, with an expiration date of May 11, 2028 (the “Revolving Line of Credit”). As of September 30, 2023, the balance of the Term Loan amounted to $19.5 million. There was no balance drawn on the Revolving Line of Credit as of September 30, 2023.
We may incur additional indebtedness in the future under these existing credit facilities and/or enter into new financing arrangements. We may fail to pay these or additional future obligations, as and when required. Specifically, if we are unable to generate sufficient cash flows from operations or to borrow sufficient funds in the future to service or refinance our debt, our business, operating results, financial condition and cash flows will be harmed. Any downgrades from credit rating agencies such as Moody’s Investors Service or Standard & Poor’s Rating Services may adversely impact our ability to obtain additional financing or the terms of such financing and reduce the market capacity for our commercial paper. Furthermore, if prevailing interest rates or other factors result in higher interest rates upon any potential future financing, then interest expense related to the refinance indebtedness would increase.
25
Table of Contents
In addition, all the agreements governing our indebtedness subject us to continued compliance with certain financial and negative covenants. The Company was in compliance with all applicable covenants throughout and at September 30, 2023. If we are unable to meet our debt service obligations or should we fail to comply with our financial and other negative covenants contained in the agreements governing our indebtedness, we may be required to refinance all or part of our debt, sell strategic assets at unfavorable prices, incur additional indebtedness or issue common stock or other equity securities. We may not be able to, at any given time, refinance our debt, sell assets, incur additional indebtedness or issue equity securities on terms acceptable to us, in amounts sufficient to meet our needs. If we are able to raise additional funds through the issuance of equity securities, such issuance would also result in dilution to our shareholders. Our inability to service our obligations or refinance our debt could have a material and adverse effect on our business, financial condition or operating results.
On December 19, 2023, the Company and PNC entered into an Amendment to Loan Documents (the “Restated Loan Amendment”) and a corresponding Amended and Restated Revolving Line of Credit Note (“Restated Line of Credit Note”) and Amended and Restated Line of Credit and Investment Sweep Rider (the “Restated Rider”), to increase the aggregate principal amount available under the Company’s senior secured revolving line of credit from $10,000,000 to $30,000,000 and extend the maturity date until December 19, 2028. The proceeds of the Restated Line of Credit Note will be used for working capital and other general corporate purposes, for acquisitions as permitted under the Restated Loan Amendment, and to pay off and close the loan evidenced by that certain Term Note executed in favor of PNC, dated June 28, 2023, which provides for a senior secured term loan in an aggregate principal amount of $20,000,000, with a maturity date of June 28, 2023.
The interest rate applicable to loans outstanding under the Restated Line of Credit is a rate per annum equal to the sum of (A) Daily SOFR (as defined in the Restated Line of Credit Note) plus (B) an unadjusted spread of Applicable SOFR Margin (as defined in the Restated Line of Credit Note) plus (C) a SOFR adjustment of ten basis points. The Applicable SOFR Margin ranges from 1.5% to 2.5% depending on the Company’s funded debt to EBITDA ratio.
The foregoing descriptions of the Restated Loan Amendment, Restated Line of Credit Note and Restated Rider do not purport to be complete and are qualified in their entirety by reference to the full text of the Restated Loan Amendment, Restated Line of Credit Note and Restated Rider, which are filed as Exhibit 10.1, Exhibit 10.2 and Exhibit 10.3, respectively, to the Current Report on Form 8-K filed December 22, 2023 and are incorporated therein by reference.
Item 1B. Unresolved Staff Comments.
None
Item 2. Properties.
In fiscal 2001, the Company purchased 7.5 acres of land in the Eagleview Corporate Park in Exton, Pennsylvania. Shortly thereafter, the Company constructed a 45,000 square foot design, manufacturing and office facility on this site. Land development approval allows for expansion of up to 20,400 square feet. Such expansion would provide for a 65,400 square foot facility which the Company believes is adequate to meet the needs of the Company for the foreseeable future.
The Company leased two separate hangars to house the Company’s airplanes in New Castle County, Delaware under month-to-month leases. One hangar lease expired with the sale of the Pilatus PC-12 airplane during the quarter ended September 30, 2022. The annual lease expense for both hangars was approximately $52,000. On November 30, 2023, the Company sold its King Air aircraft. and cancelled the remaining month-to-month hangar lease.
Item 3. Legal Proceedings.
In the ordinary course of business, the Company is at times subject to various legal proceedings and claims. 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.
26
Table of Contents
Item 4. Mine Safety Disclosures.
Not applicable.
PART II
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities.
Market Information
The Company’s common stock has been traded on the NASDAQ Global Select Market® tier of the NASDAQ Stock Market, LLC under the symbol “ISSC” since its initial public offering on August 4, 2000.
Holders of Common Stock
As of January 8, 2024, there were approximately seven registered holders of the Company’s common stock. A substantially greater number of holders of the Company’s common stock are beneficial holders, whose shares of record are held by banks, brokers and other financial institutions in “street name.”
Dividends
The Company’s Board of Directors (the “Board”) previously declared special cash dividends in the amount of $0.65 per share in fiscal 2020 and $0.50 per share in fiscal 2021. The Company did not pay cash dividends in fiscal years 2022 and 2023. The Company intends to retain future earnings, if any, to finance the development and growth of its business and does not anticipate paying any cash dividends in the foreseeable future. The declaration and payment of any dividend in the future will be at the discretion of the Board and will depend on then-existing conditions, including our operating results, financial condition, business prospects and other factors the Board may deem relevant.
27
Table of Contents
Item 6. Selected Consolidated Financial Data.
The following tables present portions of the Company’s consolidated financial statements. The following selected consolidated financial data set forth below should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes to the consolidated financial statements appearing elsewhere herein. The selected statements of operations data for the fiscal years ended September 30, 2023, 2022 and 2021 and the balance sheet data as of September 30, 2023 and 2022 are derived from the Company’s audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The selected statements of operations data for the fiscal years ended September 30, 2020 and 2019 and the balance sheet data as of September 30, 2021, 2020 and 2019 are extracted from the Company’s audited consolidated financial statements that are not included in this Annual Report on Form 10-K.
Fiscal year ended September 30,
Statements of Operations Data:
Interest expense (393,281) — — — —
Net income per common share:
Cash dividends declared per common share $ — $ — $ 0.50 $ 0.65 $ —
Weighted average shares outstanding:
As of September 30,
Balance Sheet Data:
Restricted cash — — — 11,180,900 —
28
Table of Contents
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Objective
The following discussion provides an analysis of the Company’s financial condition, cash flows and results of operations from management’s perspective and should be read in conjunction with “Selected Consolidated Financial Data” and the consolidated financial statements and related notes included in this Annual Report on Form 10-K. Our objective is to also provide discussion of events and uncertainties known to management that are reasonably likely to cause reported financial information not to be indicative of future operating results or of future financial condition and to offer information that provides understanding of our financial condition, cash flows and results of operations.
Overview
The Company 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, autothrottles and cockpit display systems for retrofit applications and OEMs. The Company supplies integrated FMS, FPDS, FPDS with autothrottle, air data equipment, integrated standby units, integrated standby units with autothrottle and advanced GPS receivers that enable reduced carbon footprint navigation, communication and navigation products and inertial reference units.
The Company has continued to position itself as a system integrator, which provides the Company with the capability and potential to generate more substantive orders over a broader product base. This 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, the DoD/governmental and foreign military markets. This approach, combined with the Company’s industry experience, is designed to enable the Company to develop high-quality products and systems, to reduce product time to market and to achieve cost advantages over products offered by its competitors.
The Company sells to both the OEM and the retrofit markets. Customers include various OEMs, commercial air transport carriers and corporate/general aviation companies, the DoD and its commercial contractors, aircraft operators, aircraft modification centers, government agencies and foreign militaries. Occasionally, the Company sells its products directly to the 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 termination and other provisions of government contracts are applicable to these contracts. The Company’s retrofit projects are generally pursuant to either a direct contract with a customer or a subcontract with a general contractor to a customer (including government agencies).
In June 2023, the Company entered into an Asset Purchase and License Agreement (the “Honeywell Agreement”) with Honeywell International, Inc. (“Honeywell”) pursuant to which Honeywell sold, assigned or licensed certain assets related to its inertial, communication and navigation product lines, including a sale of certain inventory, equipment and customer-related documents, an assignment of certain contracts and a grant of exclusive and non-exclusive licenses to use certain Honeywell intellectual property related to its inertial, communication and navigation product lines to repair, overhaul, manufacture sell, import, export and distribute certain products to the Company for cash consideration of $35.9 million (the “Transaction”).
The exclusive licensing of these product lines from Honeywell is a unique opportunity for the Company that enhances its current offerings in the air transport, military and business aviation markets. In addition, there are potential cost synergies from better utilization of the Company’s skilled engineering team and its existing operational capacity. The Company believes the Honeywell Agreement will help to accelerate the Company’s growth and enhance its global reputation for delivering some of the industry’s best price-for-performance value propositions.
Cost of sales related to product and service sales comprises materials, components and third-party avionics purchased from suppliers, direct labor and overhead costs. Many of the components are standard, although certain parts are manufactured to meet the Company’s specifications. The overhead portion of cost of sales primarily comprises salaries and benefits, building occupancy costs, supplies and outside service costs related to production, purchasing, material control and quality control. Cost of sales also includes warranty costs.
Cost of sales related to EDC sales comprises 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 reimbursement accounted for as a sale in accordance with the percentage-of-completion method or
29
Table of Contents
completed contract method of accounting. Company funded R&D expenditures relate to internally-funded efforts for the development of new products and the improvement of existing products. These costs are expensed as 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 to expense associated R&D costs as they are incurred.
Selling, general and administrative (“SG&A”) expenses consist of sales, marketing, business development, professional services, salaries and benefits for executive and administrative personnel, facility costs, recruiting, legal, accounting and other general corporate expenses.
The Company sells its products to agencies of the United States and foreign governments, aircraft operators, aircraft modification centers and OEMs. Customers have been and may continue to be affected by changes in economic conditions both in the United States and abroad. Such changes 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, inflation, public health crises and pandemics, including the COVID-19 pandemic, and other macroeconomic factors that affect spending behavior. Furthermore, spending by government agencies may be reduced in the future. 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. For example, in the 2020 fiscal year, certain of the Company’s customers temporarily suspended product deliveries as a result of the COVID-19 pandemic, and while these deliveries subsequently resumed, there is a possibility that the COVID-19 or similar pandemics will result in other suspensions, delays or order cancellations by the Company’s customers or suppliers.
30
Table of Contents
Results of Operations
The following table sets forth statements of operations data expressed as a percentage of total net sales for the fiscal years indicated:
Twelve Months Ending September 30,
Net sales:
Engineering development contracts 3.3 % 1.7 % 1.2 %
Cost of sales:
Customer service 9.7 % 5.4 % 6.5 %
Engineering development contracts 1.1 % 0.6 % 0.3 %
Operating expenses:
Research and development 9.0 % 9.8 % 11.4 %
Selling, general and administrative 31.1 % 24.3 % 27.1 %
Total operating expenses 40.1 % 34.1 % 38.5 %
Interest expense (1.1) % 0.0 % 0.0 %
Interest income 1.5 % 0.2 % 0.0 %
Other income 0.4 % 0.2 % 0.3 %
Income before income taxes 21.9 % 26.4 % 17.3 %
Income tax expense (benefit) 4.6 % 6.5 % (4.7) %
31
Table of Contents
Fiscal Year Ended September 30, 2023 Compared to Fiscal Year Ended September 30, 2022
Net sales. Net sales in fiscal 2023 increased $7.1 million, or 25.5%, to $34.8 million from $27.7 million in fiscal 2022. Product sales in fiscal 2023 increased $0.2 million compared to fiscal 2022. EDC sales increased $0.7 million, or 146.8% compared to fiscal 2022, reflecting increased EDC business. Customer service sales increased $6.2 million, or 127.2% from fiscal 2022. The increase in customer service sales primarily reflects customer service sales of $5.8 million due to the Honeywell Agreement. The increase in product sales primarily reflects increased shipments of displays to general aviation customers and commercial transport customers of $0.7 million and $0.6 million, respectively. Military product sales decreased $1.1 million due to reduced business volume.
Cost of sales. Cost of sales was $13.5 million, or 38.8% of net sales, in fiscal 2023 compared to $11.1 million, or 39.9% of net sales, in fiscal 2022. The increase in cost of sales was primarily the result of an increase in customer service sales volume. The Company’s overall gross margin in fiscal 2023 was 61.2% compared to 60.1% in fiscal 2022. The fiscal 2023 gross margin percentage increase was primarily attributable to increased customer service sales that typically generate higher gross margins than manufactured products.
Research and development. R&D expenses were $3.1 million in fiscal 2023 and $2.7 million in fiscal 2022. R&D expense decreased to 9.0% of net sales in fiscal 2023 compared to 9.8% of net sales in fiscal 2022. The increase in R&D expense resulted primarily from increased personnel and related benefits, offset by the increase of EDC contract activity whose costs are reflected in cost of sales rather than R&D expense.
Selling, general, and administrative. SG&A expenses increased $4.0 million or 60.2%, to $10.8 million from $6.8 million in fiscal 2022. SG&A expenses in fiscal 2022 were reduced by inclusion of a gain of $1.2 million from the sale of the PC-12 aircraft. The increase in SG&A expense in fiscal 2023 was primarily the result of increased stock compensation expense and legal fees, professional fees, audit fees and amortization expense primarily related to the Transaction and increased board director fees.
Interest income. Interest income of $0.5 million in fiscal 2023 increased by $0.4 million as compared to interest income in fiscal 2022 of $0.1 million. The increase in interest income was primarily the result of the increase in the average cash balance in fiscal 2023 and a general increase in interest rates as compared to fiscal 2022.
Other income. Other income was $0.2 million in fiscal 2023, an increase of $.01 million in fiscal 2022.
Income taxes. Income tax expense was $1.6 million in fiscal 2023 as compared to income tax expense of $1.8 million in fiscal 2022. The effective tax rate in fiscal 2023 was 21.1% as compared to 24.8% in fiscal 2022. The higher tax and effective tax rate in fiscal 2022 as compared to fiscal 2023 primarily reflects higher state tax due to tax on the gain from the sale of the PC-12 aircraft.
Net income. As a result of the factors described above, the Company’s net income in fiscal 2023 was $6.0 million compared to net income of $5.5 million in fiscal 2022. On a fully diluted basis, net income per share was $0.35 in fiscal 2023, compared to a net income of $0.32 per share in fiscal 2022.
Fiscal Year Ended September 30, 2022 Compared to Fiscal Year Ended September 30, 2021
Net sales. Net sales for fiscal 2022 increased $4.7 million, or 20.4%, to $27.7 million from $23.0 million for fiscal 2021. For fiscal 2022, product sales increased $3.7 million, or 19.6% and customer service sales increased $0.8 million, or 21.0%, from fiscal 2021. This increase in product sales primarily reflects increased shipments of aftermarket retrofit displays to commercial customers. OEM sales to general aviation customers were relatively flat compared to fiscal 2021 at $10.4 million. Military sales were up slightly from fiscal 2021 at $2.8 million, which was up $0.3 million, or a 13.5% increase. The increase in customer service revenue was mainly due to increases in repair work for the Department of Defense.
Cost of sales. Cost of sales was $11.1million, or 39.9% of net sales, for fiscal 2022 compared to $10.3 million, or 44.5% of net sales, in fiscal 2021. The increase in cost of sales was primarily the result of an increase in product sales volume. The Company’s overall gross margin in fiscal 2021 was 60.1% compared to 55.5% in fiscal 2021. The fiscal 2022 gross margin percentage increase was attributable to operating leverage achieved due to increased sales that resulted in increased cost absorption, as well as a favorable product mix.
Research and development. R&D expense was $2.7 million for fiscal 2022 and $2.6 million for fiscal 2021. R&D expense decreased to 9.8% of net sales in fiscal 2022 compared to 11.4% of net sales in fiscal 2021. This decrease in R&D expense as a percent of net
32
Table of Contents
sales was due to lower salaries and benefits due to lower headcount, along with fewer R&D related projects, including STC certifications.
Selling, general, and administrative. SG&A expense increased $0.5 million or 7.9% to $6.8 million from $6.3 million in fiscal 2021. The increase in SG&A expense was primarily the result of increased legal, and professional fees, with an offset due to a gain on the sale of a PC-12 aircraft.
Interest income. Interest income of $61,051 in fiscal 2022 increased by $59,817 as compared to fiscal 2021 interest income of $1,234. The increase in interest income was primarily the result of the increase in the cash balance in fiscal 2022 and a general increase in interest rates as compared to fiscal 2021.
Other income. Other income was flat at $0.1 million for both fiscal 2022 and fiscal 2021.
Income taxes. Income tax expense was $1.8 million for fiscal 2022 as compared to an income tax benefit of $1.1 million in fiscal 2021. The effective tax rate benefit for fiscal 2021 was 27.4% and differs from the statutory rate primarily due to the release of the valuation allowance for all federal and state deferred tax assets. This release both increased the deferred tax asset and removed the valuation allowance. Fiscal 2022 income tax expense of $1.8 million represents income taxes due based on an effective tax rate of 24.7% with no related allowances.
Net income. As a result of the factors described above, the Company’s net income for fiscal 2022 was $5.5 million compared to net income of $5.1 million for fiscal 2021. On a fully diluted basis, net income per share was $0.32 for fiscal 2022, compared to a net income of $0.29 per share for fiscal 2021.
33
Table of Contents
Liquidity and Capital Resources
Sources of Liquidity
The following table highlights key financial measurements of the Company:
September 30, September 30,
Twelve Months Ended September 30,
Cash flow activities:
(2) Calculated as: current assets divided by current liabilities
The Company’s principal source of liquidity for operations has been cash flows from current year operations and cash accumulated from prior years’ operations. Cash is used principally to finance inventory, accounts receivable, contract assets, and payroll, as well as the Company’s known contractual and other commitments (including those described in Note 19, “Lease Recognition.”
Debt Facility
In connection with the Transaction, the Company entered into the Term Loan with PNC for $20.0 million to fund a portion of the Transaction (see Note 20, “Loan Agreement” for further details). In addition to providing for the Term Loan, the Loan Agreement, together with a corresponding Line of Credit Note in favor of PNC, executed on May 11, 2023, provides for the senior secured Revolving Line of Credit in an aggregate principal amount of $10,000,000, with an expiration date of May 11, 2028.
On December 19, 2023, the Company and PNC entered into an Amendment to Loan Documents and a corresponding Amended and Restated Revolving Line of Credit Note and Amended and Restated Line of Credit and Investment Sweep Rider. See Note 21, “Subsequent Events”.
Stifel Sales Agreement
On September 22, 2023, the Company entered into an at-the-market equity offering Sales Agreement (the “ATM Sales Agreement”) with Stifel, Nicolaus & Company, Incorporated (the “Sales Agent”), pursuant to which the Company may offer and sell from time to time through the Sales Agent up to $40 million of shares of its common stock. The shares will be offered and sold pursuant to the Company’s shelf registration statement on Form S-3 (File No. 333-267595), which was declared effective by the SEC on October 14, 2022. The Company filed a prospectus supplement, dated September 22, 2023, with the SEC in connection with the offer and sale of the shares. Subject to the terms and conditions of the ATM Sales Agreement, the Sales Agent will use commercially reasonable efforts to sell shares of the Company’s common stock from time to time, based upon the Company’s instructions. The Company is not obligated to sell any shares under the ATM Sales Agreement, and the Company or the Sales Agent may at any time suspend solicitation and offers under the ATM Sales Agreement or terminate the ATM Sales Agreement. The Company has provided the Sales Agent with customary indemnification rights, and the Sales Agent will be entitled to compensation for its services of up to 3.0% of the gross sales price per share of the shares of the Company’s common stock sold through the Sales Agent. Sales of the shares of the Company’s common stock, if any, under the ATM Sales Agreement may be made in transactions that are deemed to be “at the market offerings” as defined in Rule 415 under the Securities Act, including sales made directly on or through NASDAQ or any other existing
34
Table of Contents
trading market for the Company’s common stock, in negotiated transactions at market prices prevailing at the time of sale or at prices related to such prevailing market prices and/or any other method permitted by law.
During the year ended September 30, 2023, we did not sell any shares of common stock under the ATM Sales Agreement.
Future Funding Requirements
The Company’s existing cash balances, anticipated cash flows from operations and current banking facility are expected to be adequate to satisfy the Company’s liquidity needs for at least the next 12 months.
Apart from what has been disclosed above, management is not aware of any trends, events or uncertainties that have had or are likely to have a material impact on our liquidity, financial condition and capital resources.
The Board previously declared special cash dividends in the amount of $0.65 per share in fiscal 2020 and $0.50 per share in fiscal 2021. The Company did not pay cash dividends in fiscal 2022 or 2023. The Company intends to retain future earnings, if any, to finance the development and growth of its business and does not anticipate paying any cash dividends in the foreseeable future. The declaration and payment of any dividend in the future will be at the discretion of the Company’s Board of Directors and will depend on then-existing conditions, including our operating results, financial condition, business prospects and other factors the Board may deem relevant.
Operating Activities
The Company generated $2.1 million of cash from operating activities during fiscal 2023, as compared to cash generated of $6.1 million during fiscal 2022. The cash generated by operating activities for the year ended September 30, 2023 was primarily generated by net income of $6.0 million, increase in non-cash compensation expenses for stock options and stock awards of $0.8 million and $0.7 million, respectively, and depreciation and amortization expense of $0.7 million, partially offset by increases to accounts receivable of $5.4 million and an increase in inventories of $0.8 million.
The Company generated $6.1 million of cash in operating activities during fiscal 2022, as compared to cash generated of $4.6 million during fiscal 2021. The cash generated by operating activities for the year ended September 30, 2022 was primarily generated by net income of $5.5 million, increase in accrued expenses of $1.3 million and a decrease in deferred income tax assets of $1.0 million, partially offset by the gain on sale of the Company’s Pilatus PC-12 airplane of $1.2 million and an increase in inventories of $0.7 million.
Investing Activities
Cash used in investing activities was $36.2 million for fiscal year 2023. On June 30, 2023, the Company entered into the Honeywell Agreement with Honeywell for cash consideration of $35.9 million whereby Honeywell sold the Company certain assets and granted perpetual license rights to manufacture and sell licensed products related to its inertial, communication and navigation product lines to the Company. The Transaction involved a sale of certain inventory, equipment and customer-related documents; an assignment of certain customer contracts; and a grant of exclusive and non-exclusive licenses to use certain Honeywell intellectual property related to its inertial, communication and navigation product lines to repair, overhaul, manufacture sell, import, export and distribute certain products to the Company. The Transaction enhances the Company’s current offerings in the air transport, military and business aviation markets. In addition, there are potential cost synergies from better utilization of the Company’s skilled engineering team and its existing operational capacity. The Company believes this agreement can help to accelerate the Company’s growth and enhance its global reputation for delivering some of the industry’s best price-for-performance value propositions. In addition, the Company spent $0.3 million for the purchase of test equipment and computer hardware. The Company plans to continue investing in capital equipment to support engineering development efforts and operations.
In connection with the Transaction, the Company entered into the Term Loan with PNC for $20.0 million to fund a portion of the Transaction (see Note 20, “Loan Agreement” for further details). The preliminary purchase consideration was $35.9 million in cash.
Cash provided by investing activities was $2.6 million for fiscal year 2022 and consisted primarily of proceeds from the sale of the Company’s Pilatus PC-12 airplane offset by spending of $0.2 million primarily for quality test equipment and computer hardware. The Company plans to continue investing in capital equipment to support engineering development efforts and operations.
35
Table of Contents
Financing Activities
Cash provided by financing activities was $19.9 million for fiscal year 2023 and primarily consisted of proceeds from the Term Loan with PNC for $20.0 million to fund a portion of the Honeywell Agreement with Honeywell, proceeds from the exercise of stock options for $0.4 million and the paydown of the Term Loan for $0.5 million.
Cash provided by financing activities was $0.3 million for fiscal year 2022 and consisted of proceeds from employees’ exercise of stock options.
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. The Company has experienced increases in expenditures since its inception and anticipates that expenditures will remain relatively constant with the levels experienced in fiscal 2023 and fiscal 2022. The Company believes that its cash and cash equivalents and current banking facility will provide sufficient capital to fund operations for at least the next twelve months. Furthermore, the Company may need to develop and introduce new or enhanced products to respond to competitive pressures, to invest in or acquire businesses or technologies or to respond to unanticipated requirements or developments. If insufficient funds are available, the Company may not be able to introduce new products or to compete effectively.
Inflation
The Company does not believe inflation had a material effect on its financial position or results of operations during the past three years; however, it cannot predict future effects of inflation.
Environmental, Social and Governance Considerations
In recent years, environmental, social and governance (“ESG”) issues have become an increasing area of focus for some of our shareholders, customers and suppliers. Management and the Board are committed to identifying, assessing and understanding the potential impact of ESG issues and related risks on the Company’s business model, as well as potential areas for ESG related improvements.
We are committed to recruiting, motivating and developing a diversity of talent. We are an equal opportunity employer and a Vietnam Era Veterans’ Readjustment Assistance Act federal contractor. All qualified applicants receive consideration for employment without regard to race, color, religion, sex, sexual orientation, gender identity, national origin, disability status, protected veteran status or any other characteristic protected by law.
The nature of our business also supports long-term sustainability. Historically, a majority of the Company’s sales have come from the retrofit market, in which the Company, by making upgrades to improve the functionality and safety of existing machinery, facilitates the re-use and recycling of aircraft and equipment that might otherwise be scrapped as obsolete. The Company’s GPS receivers also facilitate reduced carbon footprint navigation. The Company also plans to enhance its focus on the environmental impact of its operations.
Critical Accounting Policies and Estimates
The discussion and analysis of financial condition and consolidated results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”). The preparation of these 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. Management has determined that the most critical accounting policies and estimates are those related to revenue recognition, inventory valuation and valuation of tangible and intangible assets acquired. On an ongoing basis, the Company’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.
36
Table of Contents
Revenue recognition
The Company enters into sales arrangements with customers that, in general, provide for the Company to design, develop, manufacture and deliver large flat-panel display systems, flight information computers, autothrottles 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.
Revenue from Contracts with Customers
The Company accounts for revenue in accordance with Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers (“ASC 606”). The core principle of ASC 606 is that an entity recognizes revenue when a customer obtains control of promised goods or services. The amount of revenue recognized reflects the consideration to which the Company expects to be entitled to receive in exchange for these goods or services. To achieve this core principle, the Company applies the following five steps:
1) Identify the contract with a customer
The Company’s contract with its customers typically is in the form of a purchase order issued to the Company by its customers and, to a lesser degree, in the form of a purchase order issued in connection with a formal contract executed with a customer. For the purpose of accounting for revenue under ASC 606, a contract with a customer exists when (i) the Company enters into an enforceable contract with a customer that defines each party’s rights regarding the goods or services to be transferred and identifies the payment terms related to these goods or services, (ii) the contract has commercial substance and (iii) the Company determines that collection of substantially all consideration for goods or services that are transferred is probable based on the customer’s intent and ability to pay the promised consideration. Payment terms are defined by when payment is typically due. The Company applies judgment in determining the customer’s ability and intention to pay, which is based on a variety of factors including the customer’s historical payment experience or, in the case of a new customer, published credit and financial information pertaining to the customer.
2) Identify the performance obligations in the contract
Performance obligations promised in a contract are identified based on the goods or services that will be transferred to the customer that are both capable of being distinct, whereby the customer can benefit from the good or service either on its own or together with other resources that are readily available from third parties or from the Company, and are distinct in the context of the contract, whereby the transfer of the goods or services is separately identifiable from other promises in the contract. Most of our revenue is derived from purchases under which we provide a specific product or service and, as a result, there is only one performance obligation. In the event that a contract includes multiple promised goods or services, such as an EDC contract, which includes both engineering services and a resulting product shipment, the Company must apply judgment to determine whether promised goods or services are capable of being distinct in the context of the contract. In these cases, the Company considers whether the customer could, on its own, or together with other resources that are readily available from third parties, produce the physical product using only the output resulting from the Company’s completion of engineering services. If the customer cannot produce the physical product, then the promised goods or services are accounted for as a combined performance obligation.
3) Determine the transaction price
The transaction price is determined based on the consideration to which the Company will be entitled in exchange for transferring goods or services to the customer. To the extent the transaction price includes variable consideration, the Company estimates the amount of variable consideration that should be included in the transaction price utilizing either the expected value method or the most likely amount method depending on the nature of the variable consideration. Variable consideration is included in the transaction price if, in the Company’s judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur.
4) Allocate the transaction price to performance obligations in the contract
If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. The Company determines standalone selling price based on the price at which the performance obligation is sold separately. If the standalone selling price is not observable through past transactions, the Company estimates the standalone selling price by taking into account available information such as market conditions as well as the cost of the goods or services and the Company’s normal margins for similar performance obligations.
37
Table of Contents
5) Recognize revenue when or as the Company satisfies a performance obligation
The Company satisfies performance obligations either over time or at a point in time as discussed in further detail below. Revenue is recognized at the time the related performance obligation is satisfied by transferring a promised good or service to a customer. Historically, the Company has also recognized revenue from EDC contracts and is recognized over time using an input measure (e.g., costs incurred to date relative to total estimated costs at completion) to measure progress. Contract costs include material, components and third-party avionics purchased from suppliers, direct labor and overhead costs.
Contract Balances
Contract assets consist of the right to consideration in exchange for product offerings that we have transferred to a customer under the contract. Contract liabilities primarily relate to consideration received in advance of performance under the contract.
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 are included in product and service sales and product and service cost of sales, respectively, on the accompanying consolidated statements of operations.
Acquisitions
The Company accounts for business acquisitions using the acquisition method of accounting. Under this method of accounting, assets acquired and liabilities assumed are recorded at their respective fair values at the date of the acquisition. When determining the fair values of assets acquired and liabilities assumed, management makes significant estimates and assumptions. The Company’s estimates of fair value are based upon assumptions believed to be reasonable but that are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Any excess of the purchase price over the fair value of the net assets acquired is recognized as goodwill. The Company also uses best estimates and assumptions to determine the useful lives of those acquired intangible assets that have a finite life.
Critical estimates in valuing certain of the intangible assets and goodwill acquired include:
● future expected cash flows from customer contracts and license agreements;
● discount rates.
Inventory valuation
The Company values inventory at the lower of cost (first-in, first-out) or net realizable value. Inventories are written down for estimated obsolescence equal to the difference between inventory cost and estimated net realizable value based on a combination of historical usage and assumptions based on expected usage related to estimated future customer and market demands. The Company’s method of valuing inventory contains uncertainties because the calculation requires management to consider inventory aging, to make assumptions regarding expected usage and to apply judgments on forecasted future demand, market conditions and technological obsolescence. If actual future demand or market conditions are less favorable than those projected by management, additional inventory write-down may be required.
New Accounting Pronouncements
In June 2016, Financial Accounting Standards Board (“FASB”) issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instrument (“ASU 2016-13”). ASU 2016-13 replaces the incurred loss impairment methodology in current U.S. GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. ASU 2016-13 is effective for SEC small business filers for fiscal years beginning after December 15, 2022. The adoption of this standard is not expected to have a material impact on our condensed consolidated financial statements or related disclosures.
As new accounting pronouncements are issued, we will adopt those that are applicable.
38
Table of Contents
Business Segments
The Company operates in one business segment as a systems integrator that designs, develops, manufactures, sells and services flight guidance and cockpit display systems for OEMs and retrofit applications. Customers include various OEMs, commercial air transport carriers and corporate/general aviation companies, the DoD and its commercial contractors, aircraft operators, aircraft modification centers, government agencies and foreign militaries. The Company currently derives the majority of its revenues from the sale and service of this equipment and related EDC services. Most of the Company’s sales, operating results and identifiable assets are generated in the United States. In fiscal years 2023, 2022 and 2021 net sales outside the United States amounted to $15.5 million, $11.1 million and $8.4 million, respectively.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The Company’s operations are exposed to market risks primarily as a result of changes in interest rates. The Company does not use derivative financial instruments for speculative or trading purposes. The Company’s exposure to market risk for changes in interest rates relates to its cash equivalents. The Company’s cash equivalents consist of funds invested in money market funds, which bear interest at a variable rate. The Company does not participate in interest rate hedging. A change in interest rates earned on the Company’s cash equivalents would impact interest income and cash flows but would not impact the fair market value of the underlying instruments. Assuming that the balances during fiscal 2023 were to remain constant and that 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 $99,000. This would have resulted in a net impact on cash of approximately $99,000 for fiscal 2023.
Item 8. Financial Statements and Supplementary Data.
The financial statements of the Company listed in the index appearing under Item 8 herein are filed as part of this Annual Report on Form 10-K.
39
Table of Contents
Innovative Solutions and Support, Inc.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Independent Registered Public Accounting Firm PCAOB ID Number 248 41
Consolidated Balance Sheets 43
Consolidated Statements of Operations 44
Consolidated Statements of Shareholders’ Equity 45
Consolidated Statements of Cash Flows 46
Notes to Consolidated Financial Statements 47-69
40
Table of Contents
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Innovative Solutions & Support, Inc.
Opinion on the financial statements
We have audited the accompanying consolidated balance sheets of Innovative Solutions & Support, Inc. (a Pennsylvania corporation) and subsidiaries (the “Company”) as of September 30, 2023 and 2022, the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended September 30, 2023, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 2023 and 2022, and the results of its operations and its cash flows for each of the three years in the period ended September 30, 2023, in conformity with accounting principles generally accepted in the United States of America.
Basis for opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical audit matters
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Fair Value of Acquired License Agreements and Customer Relationships
As described further in Note 4 to the financial statements, on June 30, 2023, the Company entered into an Asset Purchase and License Agreement with Honeywell International, Inc., whereby Honeywell sold certain assets and granted perpetual license rights to manufacture and sell licensed products related to its inertial, communication and navigation product lines to the Company. The acquisition was accounted for as a business combination. The Company accounts for acquisitions of entities or asset groups that qualify as businesses using the acquisition method of accounting. Accordingly, the purchase consideration was allocated to the tangible and intangible assets acquired and liabilities assumed based on the estimated fair values as of the acquisition date, which are measured in accordance with fair value measurement principles. The allocation of the total purchase consideration to the estimated fair values of the acquired license agreements and customer relationships were $5.7 million and $10.7 million, respectively.
Management estimated the fair value of the acquired license agreements using the relief from royalty method, and estimated the fair value of the acquired customer relationships using the multi-period excess earnings method. The significant assumptions include: (i)
41
Table of Contents
future expected cash flows from customer contracts and license agreements, (ii) historical and expected customer attrition rates, and (iii) discount rates.
We identified the fair value of the acquired license agreements and customer relationships intangible assets as a critical audit matter because of the significant estimates and assumptions management made to determine the fair value of these assets. This required a high degree of auditor judgment and an increased extent of effort, including the need to involve our valuation specialists, when performing audit procedures to evaluate the reasonableness of management’s estimates and assumptions.
Our audit procedures related to the fair value of the acquired license agreements and customer relationships intangible assets included the following, among others.
•Utilized valuation specialists to evaluate the reasonableness of the discount rates used in the valuation.
/s/ GRANT THORNTON LLP
We have served as the Company’s auditor since 2014.
Philadelphia, Pennsylvania
January 12, 2024
42
Table of Contents
INNOVATIVE SOLUTIONS AND SUPPORT, INC.
CONSOLIDATED BALANCE SHEETS
September 30, September 30,
ASSETS
Current assets
Assets held for sale 2,063,818 —
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities
Current portion of long-term debt $ 2,000,000 $ —
Commitments and contingencies (See Note 16)
Shareholders’ equity
The accompanying notes are an integral part of these statements.
43
Table of Contents
INNOVATIVE SOLUTIONS AND SUPPORT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Fiscal Year Ended September 30,
Net Sales:
Cost of sales:
Operating expenses:
Interest expense (393,281) — —
Net income per common share:
Weighted average shares outstanding:
The accompanying notes are an integral part of these statements.
44
Table of Contents
INNOVATIVE SOLUTIONS AND SUPPORT, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(Accumulated
Additional Deficit)
Common Paid-In Retained Treasury
Stock Capital Earnings Stock Total
Share-based compensation — 181,350 — — 181,350
Exercise of stock options 5 17,005 — — 17,010
Share-based compensation — 166,617 — — 166,617
Issuance of stock to directors 27 173,298 — — 173,325
Issuance of stock to directors 33 326,453 — — 326,486
The accompanying notes are an integral part of these statements.
45
Table of Contents
INNOVATIVE SOLUTIONS AND SUPPORT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Fiscal Year Ended September 30,
CASH FLOWS FROM OPERATING ACTIVITIES:
Share-based compensation expense
Impairment of long-lived assets 44,400 — —
Gain on disposal of property and equipment — (1,191,743) —
Excess and obsolete inventory cost (recovery) 44,308 — (100,446)
(Increase) decrease in:
Other non-current assets (101,356) — —
Increase (decrease) in:
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the sale of property and equipment — 2,750,576 —
Acquisition of a business (35,860,000) — —
CASH FLOWS FROM FINANCING ACTIVITIES:
Debt payments (500,000) — —
Dividend paid — — (19,788,092)
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
The accompanying notes are an integral part of these statements.
46
Table of Contents
INNOVATIVE SOLUTIONS AND SUPPORT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Background
Innovative Solutions and Support, Inc. (the “Company,” “IS&S,” “we” or “us”) 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”), FPDS with Autothrottle, air data equipment, Integrated Standby Units (“ISU”), ISU with Autothrottle and advanced GPS receivers that enable reduced carbon footprint navigation, communications, navigation and inertial reference products.
The Company has continued to position itself as a system integrator, which provides the Company with the capability and potential to generate more substantive orders over a broader product base. This 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, 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 various OEMs, commercial air transport carriers and corporate/general aviation companies, DoD and its commercial contractors, aircraft operators, aircraft modification centers, government agencies and foreign militaries.
On June 30, 2023 (the “Acquisition Date”), the Company entered into an Asset Purchase and License Agreement (the “Honeywell Agreement”) with Honeywell International, Inc. (“Honeywell”) whereby Honeywell sold certain assets and granted perpetual license rights to manufacture and sell licensed products related to its inertial, communication and navigation product lines (the “Product Lines”) to the Company (the “Transaction”). The Transaction involved a sale of certain inventory, equipment and customer-related documents; an assignment of certain customer contracts; and a grant of exclusive and non-exclusive licenses to use certain Honeywell intellectual property related to its inertial, communication and navigation product lines to repair, overhaul, manufacture sell, import, export and distribute certain products to the Company. See Note 4, “Acquisition” for more details.
On September 22, 2023, the Company entered into an at-the-market equity offering Sales Agreement (the “ATM Sales Agreement”) with Stifel, Nicolaus & Company, Incorporated (the “Sales Agent”), pursuant to which the Company may offer and sell from time to time through the Sales Agent up to $40 million of shares of its common stock. The shares will be offered and sold pursuant to the Company’s shelf registration statement on Form S-3 (File No. 333-267595), which was declared effective by the SEC on October 14, 2022. The Company filed a prospectus supplement, dated September 22, 2023, with the SEC in connection with the offer and sale of the shares. Subject to the terms and conditions of the ATM Sales Agreement, the Sales Agent will use commercially reasonable efforts to sell shares of the Company’s common stock from time to time, based upon the Company’s instructions. The Company is not obligated to sell any shares under the ATM Sales Agreement, and the Company or the Sales Agent may at any time suspend solicitation and offers under the ATM Sales Agreement or terminate the ATM Sales Agreement. The Company has provided the Sales Agent with customary indemnification rights, and the Sales Agent will be entitled to compensation for its services of up to 3.0% of the gross sales price per share of the shares of the Company’s common stock sold through the Sales Agent. Sales of the shares of the Company’s common stock, if any, under the ATM Sales Agreement may be made in transactions that are deemed to be “at the market offerings” as defined in Rule 415 under the Securities Act, including sales made directly on or through NASDAQ or any other existing trading market for the Company’s common stock, in negotiated transactions at market prices prevailing at the time of sale or at prices related to such prevailing market prices and/or any other method permitted by law.
During fiscal 2023, we did not sell any shares of common stock under the ATM Sales Agreement.
2. Concentrations
Major Customers and Products
In fiscal 2023, 2022 and 2021, the Company derived 54%, 58% and 59%, respectively, of total sales from five customers, although not all the same customers in each year. Accounts receivable and contract assets related to those top five customers was $3.5 million, $3.3 million and $2.1 million as of September 30, 2023, 2022 and 2021, respectively.
47
Table of Contents
In fiscal year 2023, the three largest customers, Pilatus, ATSG and Textron accounted for 23%, 12% and 10% of total revenue, respectively. In fiscal year 2022, the three largest customers, Pilatus, ATSG and Textron accounted for 22%, 11% and 11% of total revenue, respectively. In fiscal year 2021, the two largest customers, Pilatus and Textron accounted for 20% and 17% of total revenue, respectively.
Flat panel product sales were 99%, 98% and 88% of total product sales in the years ended September 30, 2023, 2022 and 2021, respectively. Product sales of air data systems and components were 1%, 2% and 12% of total product sales for the years ended September 30, 2023, 2022 and 2021, respectively. Product sales to government contractors and agencies accounted for approximately 9%, 14% and 18% of total product sales during fiscal years 2023, 2022 and 2021, respectively. The government agency or general contractor typically retains the right to terminate the contract at any time at its convenience. Upon alteration or termination of these contracts, IS&S is typically entitled to an equitable adjustment to the contract price so that it would be compensated for delivered items and allowable costs incurred. Accordingly, because these contracts can be terminated, the Company cannot be assured that its backlog will result in sales.
Major Suppliers
The Company buys several of its components from sole source suppliers. Although there are a limited number of suppliers of particular components, management believes other suppliers could provide similar components on comparable terms.
During fiscal 2023, the Company had four suppliers that accounted for 49.0% of the Company’s total inventory related purchases. During fiscal 2022, the Company had three suppliers that accounted for 33.7% of the Company’s total inventory related purchases. During fiscal 2021, the Company had one supplier that accounted for 14.9% 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 major 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 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 significant credit risks.
3. Summary of Significant Accounting Policies
Principles of Consolidation
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.
Reclassification
The Company presented intangible assets, net, separately in the consolidated balance sheet as of September 30, 2023. In order to conform to the presentation of the consolidated balance sheet as of September 30, 2023, the Company reclassified $60,348 from other assets to intangible assets, net, in the consolidated balance sheet as of September 30, 2022. This reclassification has no impact on the Company’s net income for the years ended September 30, 2023 and 2022.
Use of Estimates
The financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”), which require management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from those estimates. Estimates are used in accounting for, among other items, valuation of tangible and intangible assets acquired, long term contracts, evaluation of allowances for doubtful accounts, inventory obsolescence, product warranty cost liabilities, income taxes, engineering and material costs on EDC programs, percentage of completion on EDC contracts, the useful lives of long-lived assets for depreciation and amortization, the recoverability of long-lived assets, evaluation of goodwill impairment and contingencies. Estimates and assumptions are reviewed periodically, and the effects of changes, if any, are reflected in the consolidated statements of operations in the period they are determined.
48
Table of Contents
Acquisitions
The Company evaluates each of its acquisitions in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, Business Combinations (“ASC 805”), to determine whether the transaction is a business combination or an asset acquisition. In determining whether an acquisition should be accounted for as a business combination or an asset acquisition, the Company first performs a screening test to determine whether substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets. If this is the case, the acquired set is not deemed to be a business and is instead accounted for as an asset acquisition. If this is not the case, the Company then further evaluates whether the acquired set includes, at a minimum, an input and a substantive process that together significantly contribute to the ability to create outputs. If so, the Company concludes that the acquired set is a business.
The Company accounts for business acquisitions using the acquisition method of accounting. Under this method of accounting, assets acquired and liabilities assumed are recorded at their respective fair values at the date of the acquisition. When determining the fair values of assets acquired and liabilities assumed, management makes significant estimates and assumptions. The Company’s estimates of fair value are based upon assumptions believed to be reasonable, but these assumptions are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Any excess of the purchase price over the fair value of the net assets acquired is recognized as goodwill.
During the measurement period, which may be up to one year from the Acquisition Date, the Company adjusts the provisional amounts of assets acquired and liabilities assumed with the corresponding offset to goodwill to reflect new information obtained about facts and circumstances that existed as of the Acquisition Date that, if known, would have affected the measurement of the amounts recognized as of that date. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded within the Company’s consolidated statements of operations.
Intangible Assets
The Company’s identifiable intangible assets primarily consist of license agreements and customer relationships. Intangible assets acquired in a business combination are recognized at fair value using generally accepted valuation methods deemed appropriate for the type of intangible asset acquired and are reported separately from any goodwill recognized.
Intangible assets with a finite life are amortized over their estimated useful life and are reported net of accumulated amortization. They are assessed for impairment in accordance with the Company’s policy on assessing long-lived assets for impairment described below.
Indefinite-lived intangible assets are not amortized, but are subject to an annual impairment test, or when events or circumstances dictate, more frequently. The impairment review for indefinite-lived intangible assets can be performed using a qualitative or quantitative impairment assessment. The quantitative assessment consists of a comparison of the fair value of the indefinite-lived intangible asset with its carrying amount. If the carrying amount exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. If the fair value exceeds its carrying amount, the indefinite-lived intangible asset is not considered impaired.
Goodwill
Goodwill represents the future economic benefit arising from other assets acquired that could not be individually identified and separately recognized. The recorded amounts of goodwill from business combinations are based on management’s best estimates of the fair values of assets acquired and liabilities assumed at the date of acquisition. Goodwill is assigned to the reporting units that are expected to benefit from the synergies of the business combination that generated the goodwill. The Company’s goodwill impairment test is performed at the reporting unit level. Reporting units are determined based on an evaluation of the Company’s operating segments and the components making up those operating segments.
Goodwill is tested for impairment annually or in an interim period if certain changes in circumstances indicate a possibility that an impairment may exist. Factors to consider that may indicate an impairment may exist are: the macroeconomic conditions, industry and market considerations such as a significant adverse change in the business climate, cost factors, overall financial performance such as current-period operating results or cash flow declines combined with a history of operating results or cash flow declines or a projection/forecast that demonstrates continuing declines in the cash flow or the inability to improve the operations to forecasted levels, and any entity-specific events.
49
Table of Contents
If the Company determines that it is more likely than not that the fair value of the reporting unit is below the carrying amount as part of its qualitative assessment, a quantitative assessment of goodwill is required. In the quantitative evaluation, the fair value of the reporting unit is determined and compared to the carrying value. If the fair value is greater than the carrying value, then the goodwill is deemed not to be impaired and no further action is required. If the fair value is less than the carrying value, goodwill is considered impaired and a charge is reported as impairment of goodwill in the consolidated statements of operations.
Cash and Cash Equivalents
Highly liquid investments, purchased with an original maturity of three months or less, are classified as cash equivalents. Cash equivalents at September 30, 2023 and 2022 consist of cash on deposit and cash invested in money market funds with financial institutions. Due to the short maturity of these instruments, the carrying values on our consolidated balance sheets approximate fair value.
Inventory Valuation
Inventories are stated at the lower of cost (first-in, first-out) or net realizable value, net of write-downs for excess and obsolete inventory, and consists of the following:
September 30, September 30,
Assets Held for Sale
Asset to be disposed of by sale (“disposal groups”) are reclassified into “assets held for sale” if their carrying amounts are principally expected to be recovered through a sale transaction rather than through continuing use. The reclassification occurs when the disposal group is available for immediate sale and the sale is probable. These criteria are generally met when an agreement to sell exists, or management has committed to a plan to sell the assets within one year. Disposal groups are measured at the lower of carrying amount or fair value less costs to sell and are not depreciated or amortized. When the net realizable value of a disposal group increases during a period, a gain can be recognized to the extent that it does not increase the value of the disposal group beyond its original carrying value when the disposal group was reclassified as held for sale. The fair value of a disposal group, less any costs to sell, is assessed each reporting period it remains classified as held for sale and any remeasurement to the lower of carrying value or fair value less costs to sell is reported as an adjustment to the carrying value of the disposal group.
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 lease term), except for the manufacturing facility and the corporate airplanes, which are depreciated using the straight-line method over their estimated useful lives of thirty-nine years and ten years, respectively. Major additions and improvements are capitalized, while maintenance and repairs that do not improve or extend the life of assets are charged to expense as incurred.
Long-Lived Assets
The Company assesses the impairment of long-lived assets in accordance with FASB ASC Topic 360-10, “Property, Plant and Equipment.” This statement requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. In addition, long-lived assets to be disposed of should be reported at the lower of the carrying amount or fair value less cost to sell. The Company considers historical performance and future estimated results in its evaluation of potential impairment and then compares the carrying amount of the asset to estimated future cash flows expected to result from use of the asset. If the carrying amount of the asset exceeds the estimated expected undiscounted future cash flows, the Company measures the amount of the impairment by comparing the carrying amount of the asset to its fair value. The estimation of fair value is generally measured by discounting expected future cash flows.
50
Table of Contents
Revenue Recognition