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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

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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.

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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) %

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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

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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.

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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

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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.

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.

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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.

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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.

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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.

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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.

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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

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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)

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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

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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.

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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.

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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.

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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.

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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.

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.

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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.

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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.

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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.

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Revenue Recognition

Revenue from Contracts with Customers

The Company accounts for revenue in accordance with 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. 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

4)Allocate the transaction price to performance obligations in the contract

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5)Recognize revenue when or as the Company satisfies a performance obligation

Contract Estimates

Accounting for performance obligations in long-term contracts that are satisfied over time involves the use of various techniques to estimate progress towards satisfaction of the performance obligation. The Company typically measures progress based on costs incurred compared to estimated total contract costs. Contract cost estimates are based on various assumptions to project the outcome of future events that often span more than a single year. These assumptions include the amount of labor and labor costs, the quantity and cost of raw materials used in the completion of the performance obligation and the complexity of the work to be performed.

As a significant change in one or more of these estimates could affect the profitability of our contracts, we review and update our contract-related estimates regularly. We recognize adjustments in estimated profit on contracts under the cumulative catch-up method. Under this method, the impact of the adjustment on profit recorded to date is recognized in the period the adjustment is identified. Revenue and profit in future periods of contract performance is recognized using the adjusted estimate. If at any time the estimate of contract profitability indicates an anticipated loss on the contract, we recognize the total loss in the quarter it is identified.

The impact of adjustments in contract estimates on our operating earnings can be reflected in either operating costs and expenses or revenue. The aggregate impact of adjustments in contract estimates did not change our revenue and operating earnings (and diluted earnings per share) for the fiscal years ended September 30, 2023 and 2022. Therefore, no adjustment on any contract was material to our consolidated financial statements for the fiscal years ended September 30, 2023 and 2022.

Contract Balances

Contract Contract

Assets Liabilities

Amount transferred to receivables from contract assets — —

Contract asset additions 324,397 —

Lease Recognition

The Company accounts for leases in accordance with ASU 2016-02, Leases (Topic 842). At the inception of an arrangement, the Company determines whether the arrangement is or contains a lease based on the unique facts and circumstances present in the arrangement. Leases with a term greater than one year are recognized on the balance sheet as right-of-use assets and short-term and long-term lease liabilities, as applicable. The Company does not have any financing leases that are material.

Income Taxes

Income taxes are recorded in accordance with ASC Topic 740, “Income Taxes” (“ASC Topic 740”), which utilizes a balance sheet approach to provide for income taxes. Under this method, the Company recognizes deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of the Company’s assets, liabilities and expected benefits of utilizing net operating losses (“NOL”) and tax credit carry-forwards. The impact on deferred taxes of changes in tax rates and laws, if

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any, are applied to the years during which temporary differences are expected to be settled and are reflected in the consolidated financial statements in the period of enactment. At the end of each interim reporting period, the Company prepares an estimate of the annual effective income tax rate and applies that annual effective income tax rate to ordinary year-to-date pre-tax income for the interim period. Specific tax items discrete to a particular quarter are recorded in income tax expense for that quarter. The estimated annual effective tax rate used in providing for income taxes on a year-to-date basis may change in subsequent periods.

Deferred tax assets are reduced by a valuation allowance if, based on the consideration of all available evidence, it is more likely than not that some portion of the deferred tax asset will not be realized. Significant weight is given to evidence that can be verified objectively, and significant management judgment is required in determining any valuation allowance recorded against net deferred tax assets. The Company evaluates deferred income taxes on a quarterly basis to determine if a valuation allowance is required by considering available evidence. Deferred tax assets are recognized when expected future taxable income is sufficient to allow the related tax benefits to reduce taxes that would otherwise be payable. The sources of taxable income that may be available to realize the benefit of deferred tax assets are future reversals of existing taxable temporary differences, future taxable income exclusive of reversing temporary differences and credit carryforwards, taxable income in carry-back years and tax planning strategies which are both prudent and feasible. For the year ended September 30, 2021, the valuation allowance was released against all federal and state deferred tax assets with the exception of certain state net operating losses due to positive evidence that the assets are more likely than not to be realized in future years. The Company will continue to assess all available evidence during future periods to evaluate any changes to the realization of its deferred tax assets. If the Company were to determine that it would be able to realize additional state deferred tax assets in the future, it would make an adjustment to the valuation allowance which would reduce the provision for income taxes.

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

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

In March 2020, in response to the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was signed into law to provide emergency assistance to affected individuals, families and businesses. The CARES Act provides numerous tax provisions and other stimulus measures, including temporary changes regarding the prior and future utilization of NOLs. The CARES Act amends the NOL provisions of the Tax Cuts and Jobs Act of 2017, thereby allowing for the carryback of losses arising in tax years beginning before December 31, 2017 to each of the two taxable years preceding the taxable year of loss. Approximately $1,500,000 of pre-tax NOL was carried back two years to fully offset taxable income. This carryback freed up previously utilized R&D credits which resulted in an estimated increase in the R&D credit carryforward of $196,000. The carryback created approximately $16,000 of AMT tax, which was refunded. The cash impact of this carryback was $309,412. A receivable was setup for this amount as of March 31, 2020, and the cash has since been received.

In December 2020, the Consolidations Appropriations Act of 2020 (“CAA”) was enacted as a supplement to the CARES Act legislation and provided additional financial relief to taxpayers adversely impacted by restrictions put into place in response to the COVID-19 pandemic. In addition, the CAA provides funding for public health initiatives in response to the pandemic. This legislation did not have a material impact on the Company’s tax position.

In March, 2021, American Rescue Plan Act of 2021 (the “ARPA”), which includes certain business tax provisions, was signed into law. This legislation did not have a material impact on the Company’s tax position.

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In August 2022, the U.S. government enacted the Inflation Reduction Act (the “IRA”). The IRA makes the following changes to the U.S tax code: imposes a corporate alternative minimum tax of 15% on corporations with an average annual Adjusted Financial Statement Income over a three year period in excess of $1 billion, increases the amount of R&D credit that qualified businesses can apply against payroll taxes to $500,000 and imposes an excise tax equal to one percent of the fair market value of stock of a publicly traded U.S. corporation that is repurchased by the company. These changes predominately apply to tax years beginning after December 31, 2022. It does not appear that this legislation will have a material impact on the Company’s tax position.

Engineering Development

Total engineering development expense comprises both internally funded R&D, which is expensed in research and development, and product development and design charges related to specific customer contracts. Engineering development expense consists primarily of payroll-related expenses of employees engaged in EDC projects, engineering related product materials and equipment, and subcontracting costs. R&D charges incurred for product design, product enhancements and future product development are expensed as incurred. Product development and design charges related to specific customer contracts are charged to cost of sales-EDC based on the method of contract accounting (either percentage-of-completion or completed contract) applicable to such contracts.

Fair Value of Financial Instruments

The net carrying amounts of cash and cash equivalents, accounts receivable and accounts payable approximate their fair value because of the short-term nature of these instruments. The carrying value of our debt approximates fair value as the interest rate is variable and approximates current market levels. For financial assets and liabilities measured at fair value on a recurring basis, fair value is the price the Company would receive to sell an asset or pay to transfer a liability in an orderly transaction with a market participant at the measurement date. A three-level fair value hierarchy prioritizes the inputs used to measure fair value as follows:

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

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

● Quoted prices for similar assets or liabilities in active markets;

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

Level 3 — Unobservable inputs that cannot be corroborated by observable market data and reflect the use of significant management judgment. These values are generally determined using pricing models for which the assumptions utilize management’s estimates of market participant assumptions.

The following table sets forth by level within the fair value hierarchy the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis as of September 30, 2023 and 2022, according to the valuation techniques the Company used to determine their fair values.

Fair Value Measurement on September 30, 2023

Quoted Price in Significant Other Significant

Active Markets for Observable Unobservable

Identical Assets Inputs Inputs

(Level 1) (Level 2) (Level 3)

Assets

Cash and cash equivalents:

Money market funds $ 3,665,128 $ — $ —

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Fair Value Measurement on September 30, 2022

Quoted Price in Significant Other Significant

Active Markets for Observable Unobservable

Identical Assets Inputs Inputs

(Level 1) (Level 2) (Level 3)

Assets

Cash and cash equivalents:

Money market funds $ 16,083,571 $ — $ —

The fiscal 2023 money market funds balance differs from the cash and cash equivalents balance on the consolidated balance sheet due to the timing of sweep transactions within the PNC cash investment accounts.

Share-Based Compensation

The Company accounts for share-based compensation under ASC Topic 718, which requires the Company to measure the cost of employee or non-employee director services received in exchange for an award of equity instruments based on the grant-date fair value of the award using an option pricing model. The Company recognizes such cost over the period during which an employee or non-employee director is required to provide service in exchange for the award.

Accordingly, adoption of ASC Topic 718’s fair value method results in recording compensation costs under the Company’s stock based compensation plans. The Company determined the fair value of its stock option awards at the date of grant using the Black-Scholes option pricing model. Option pricing models and generally accepted valuation techniques require management to make assumptions and to apply judgment to determine the fair value of its awards. These assumptions and judgments include estimating future volatility of the Company’s stock price, expected dividend yield, future employee turnover rates, and future employee stock option exercise behaviors. Changes in these assumptions can materially affect fair value estimates. The Company does not believe that a reasonable likelihood exists that there will be a material change in future estimates or assumptions used to determine share-based compensation expense. However, if actual results are not consistent with the Company’s estimates or assumptions, the Company would adjust its estimates. Such adjustments could have a material impact on the Company’s financial position.

Warranty Reserves

The Company offers warranties on some products of various lengths, however the standard warranty period is twenty-four months. At the time of shipment, the Company establishes a reserve for estimated costs of warranties based on its best estimate of the amounts necessary to settle future and existing claims using historical data on products sold as of the balance sheet date. The length of the warranty period, the product’s failure rates and the customer’s usage affect warranty cost. If actual warranty costs differ from the Company’s estimated amounts, future results of operations could be affected adversely. Warranty cost is recorded as cost of sales, and the reserve balance recorded as an accrued expense. While the Company maintains product quality programs and processes, its warranty obligation is affected by product failure rates and the related corrective costs. If actual product failure rates and/or corrective costs differ from the estimates, the Company revises the estimated warranty liability accordingly.

Self-Insurance Reserves

Since January 1, 2014, the Company has self-insured a significant portion of its employee medical insurance. The Company maintains a stop-loss insurance policy that limits its losses both on a per employee basis and an aggregate basis. Liabilities associated with the risks that are retained by the Company are estimated based upon actuarial assumptions such as historical claims experience and demographic factors. The Company estimated the total medical claims incurred but not reported, and the Company believes that it has adequate reserves for these claims at September 30, 2023 and 2022. However, the actual value of such claims could be significantly affected if future occurrences and claims differ from these assumptions. At September 30, 2023 and 2022, the estimated liability for medical claims incurred but not reported was $62,300 and $51,600, respectively. The Company has recorded the excess of funded premiums over estimated claims incurred but not reported of $382,000 as a current asset in the accompanying consolidated balance sheet. During the year ended September 30, 2023, the Company has used the excess of funded premiums to reduce amounts payable for claims incurred.

Treasury Stock

We account for treasury stock purchased under the cost method and include treasury stock as a component of shareholders’ equity. Treasury stock purchased with intent to retire (whether or not the retirement is actually accomplished) is charged to common stock.

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New Accounting Pronouncements

In June 2016, 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.

4. Acquisition

On June 30, 2023, the Company entered into the Honeywell Agreement with 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 to the Company (the “Transaction”). The Transaction involves 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 allows the Company to diversify its product offerings in the aerospace industry. The Company determined that the Transaction met the definition of a business under ASC 805; therefore, the Company accounted for the Transaction as a business combination and applied the acquisition method of accounting.

In connection with the Transaction, the Company entered into a term loan with PNC Bank, National Association for $20.0 million to fund a portion of the Transaction (the “Term Loan”) – refer to Note 20, “Loan Agreement” for further details. The purchase consideration transferred at the Acquisition Date was $35.9 million, which was entirely cash.

The allocation of the purchase price is based upon certain preliminary valuations and other analyses. The allocation of the purchase price has not been finalized as of the date of this filing due to fact that while legal control has occurred, the Company has not received physical possession of the prepaid inventory, equipment and construction in progress, and thus these assets will be subject to settlement adjustments upon transfer as outlined in the Honeywell Agreement. The transfer of the prepaid inventory, equipment and construction in progress is expected to occur within the measurement period. As a result, the purchase price amount for the Transaction and the allocation of the preliminary purchase consideration for prepaid inventory, equipment, construction in progress and goodwill are preliminary estimates, which may be subject to change within the measurement period.

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The allocation of the preliminary purchase consideration as of the Acquisition Date is as follows:

Amounts Recognized as of

Acquisition Date Measurement Purchase Price

(as previously reported) Period Adjustments Allocation

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Innovative Solutions & Support Inc ISSC US Equity

ISSC · 10-K · period ended 2023-09-30

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

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Item 8. Financial Statements and Supplementary Data.

Innovative Solutions & Support Inc ISSC US Equity☆

ISSC · 10-K · period ended 2023-09-30

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

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Item 8. Financial Statements and Supplementary Data.

Innovative Solutions & Support Inc ISSC US Equity