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Item 7. Management’s Discussion and Analysis

2024-01-12 compared with 2022-12-16 · 134 added, 145 removed, 146 unchanged (66% of the section changed)

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

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 report.

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.

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, autothrottles 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.

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, United States Department of Defense (“DoD”)/governmental, and foreign military markets.

This approach, combined with the Company’s industry experience, is designed to enable IS&S to develop high-quality products and systems, to reduce product time to market and to achieve cost advantages over products offered by its competitors.

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, DoD and its commercial contractors, aircraft operators, aircraft modification centers, government agencies, and foreign militaries.

Occasionally, IS&S sells its products directly to DoD;

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.

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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).

Cost of sales related to product sales comprises material, 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 IS&S specifications.

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 includes warranty costs.

Cost of sales related to Engineering Development Contracts (“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 completed contract method of accounting.

Company funded research and development (“R&D”) expenditures relate to internally-funded efforts for the development of new products and the improvement of existing products.

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.

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 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.

IS&S sells its products to agencies of the United States and foreign governments, aircraft operators, aircraft modification centers, and OEMs.

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, the impact of the ongoing COVID-19 pandemic, general levels of consumer spending, increases in fuel and energy costs, conditions in the real estate and mortgage markets, labor and healthcare costs, access to credit, consumer confidence, and other macroeconomic factors that affect spending behavior.

Furthermore, spending by government agencies may be reduced in the future if tax revenues decline.

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, earlier 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 pandemic will result in other suspensions, delays or order cancellations by the Company’s customers or suppliers.

In particular, the ongoing COVID-19 pandemic is a significant event, driver of market trends, and source of uncertainty that may ultimately have a direct or indirect material impact on the Company’s business, financial position, liquidity, or ability to service customers or maintain critical operations.

In direct response to the COVID-19 pandemic, the Company has taken specific actions to seek to ensure the safety of its employees, including temperature monitoring, frequent sanitization of workspaces, observance of social distancing protocols, and other increased safety measures.

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.

Results of Operations

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Twelve Months Ending September 30,

Customer service

Engineering development contracts

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Cost of sales:

Customer service

Engineering development contracts

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Operating income

Interest expense

Interest income

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Fiscal Year Ended September 30, 2023 Compared to Fiscal Year Ended September 30, 2022

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.

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 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 and customer service sales increased $0.8, or 20.8% from 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 13.5%.

The increase in customer service revenue was mainly due to increases in repair work from the Department of Defense.

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 .

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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 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”) .

This decrease in R&D expense as a percent of net

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 the sale of a PC-12 aircraft.

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.

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Income taxes.

Income tax expense of $1.8 million for fiscal 2022 as compared to income tax benefit of $1.1 million in fiscal 2021.

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.

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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.

Fiscal Year Ended September 30, 2021 Compared to Fiscal Year Ended September 30, 2020

Net sales for fiscal 2021 increased $1.4 million, or 6.7%, to $23.0 million from $21.6 million for fiscal 2020.

For fiscal 2021, product sales increased $1.9 million and EDC sales decreased $0.5 million, in each case, compared to fiscal 2020.

This increase in product sales primarily reflects increased shipments for OEM programs to general aviation customers and displays for retrofit programs to commercial transport customers.

These increases were partially offset by reduced shipments under the U.S.

Navy F-5 production contract and displays for retrofit programs to other military customers compared to fiscal 2020.

The decrease in EDC sales was primarily the result of the completion of a modification contract with the U.S.

Navy in 2020.

Cost of sales .

Cost of sales was $10.3 million or 44.5% of net sales, for fiscal 2021 compared to $9.8 million, or 45.3% of net sales, in fiscal 2020.

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 55.5% compared to 54.7% in fiscal 2020.

The fiscal 2021 gross margin percentage increase was attributable to product mix as well as the favorable leverage achieved by the growth in revenues.

Research and development .

R&D expense was $2.6 million for fiscal 2021 and $3.0 million for fiscal 2020.

R&D expense decreased to 11.4% of net sales in fiscal 2021 compared to 13.7% of net sales in fiscal 2020.

This decrease in R&D expense was primarily the result of a decrease in third party costs related to STC certifications offset by an increase in payroll and payroll related benefits.

Selling, general, and administrative (“SG&A”) .

SG&A expense increased $0.2 million or 2.6% to $6.3 million or 27.2% of net sales, for fiscal 2021 from $6.1 million, or 28.2%, for fiscal 2020.

The increase in SG&A expense was primarily the result of an increase in employee stock compensation, payroll and payroll related benefits.

Interest income, net.

Net interest income of $1,234 in fiscal 2021 decreased by $153,716 as compared to fiscal 2020 interest income of $154,950.

The decrease in interest income was primarily the result of decreased cash balance and lower interest rates in fiscal 2021 as compared to fiscal 2020.

Other income.

Other income is primarily composed of royalties earned and increased by $14,409, to $74,906 in fiscal 2021 from $60,497 in fiscal 2020.

Income taxes.

Income tax benefit for fiscal 2021 was $1,087,783 as compared to income tax benefit of $308,882 for fiscal 2020.

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 with the exception of certain state net operating losses for jurisdictions in which the Company does not believe these net operating losses are more likely than not to be realized.

This release both increased the deferred tax asset and removed the valuation allowance.

As a result of the factors described above, the Company’s net income for fiscal 2021 was $5.1 million compared to net income of $3.3 million for fiscal 2020.

On a fully diluted basis, net income per share was $0.29 for fiscal 2021, compared to a net income of $0.19 per share for fiscal 2020.

Liquidity and Capital Resources

Sources of Liquidity

The following table highlights key financial measurements of the Company:

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Net cash provided by operating activities

Net cash provided by (used in) investing activities

Net cash (used in) provided by investing activities

Net cash provided by (used in) financing activities

(1) Excludes contract liability

(1) Calculated as:

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current assets divided by current liabilities

The Company’s principal source of liquidity has been cash flows from current year operations and cash accumulated from prior years’ operations.

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.”

The Company’s existing cash balances and anticipated cash flows from operations are expected to be adequate to satisfy the Company’s liquidity needs for at least the next 12 months.

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

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 Company did not pay cash dividends in fiscal 2022.

The declaration and payment of any dividend in the future will be at the discretion of the Company’s Board of Directors.

On September 4, 2020, the Company’s Board of Directors declared a special cash dividend in the amount of $0.65 per share, payable on October 1, 2020 to shareholders of record as of the close of business on September 15, 2020.

The total dividend payment was approximately $11.2 million.

On December 10, 2020, the Company’s Board of Directors declared a special cash dividend in the amount of $0.50 per share, payable on December 30, 2020 to shareholders of record as of the close of business on December 21, 2020.

The total dividend payment was approximately $8.6 million.

The ongoing COVID-19 pandemic is a significant event, driver of market trends, and source of uncertainty that may have a material impact on the Company’s liquidity, financial condition, capital resources, cash flows or operating results.

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, 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.

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, 2021 was primarily generated by net income of $5.1 million, depreciation and amortization of $0.4 million and a decrease in accounts receivable of $0.3 million, partially offset by an increase in deferred income tax assets of $1.2 million.

Investing Activities

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.

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 used in investing activities was $0.3 million for fiscal year 2021 and consisted of spending for manufacturing facility and laboratory test equipment.

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.

The Company plans to continue investing in capital equipment to support engineering development efforts and operations.

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.

Cash used by financing activities was $19.8 million for fiscal year 2021 and consisted primarily of dividends paid.

Future capital requirements depend upon numerous factors, including market acceptance of the Company’s products, the timing and rate of expansion of business, acquisitions, joint ventures and other factors.

IS&S has experienced increases in expenditures since its inception and anticipates that expenditures will remain relatively constant with the levels experienced in fiscal 2022 and fiscal 2021.

The Company believes that its cash and cash equivalents will provide sufficient capital to fund operations for at least the next twelve months.

Further, IS&S 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.

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.

IS&S does not believe inflation had a material effect on its financial position or results of operations during the past three years;

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.

Impact of the COVID-19 Pandemic

The Company has not yet seen a material impact from the COVID-19 pandemic on its business, financial position, liquidity, or ability to service customers or maintain critical operations.

However, some parts of the world are continuing to see a rise in COVID-19 cases and hospitalizations and it is possible that new, more virulent strains and variants of COVID-19 may emerge and lead governments and private sectors to re-institute quarantine and trade restrictions, which could adversely impact market conditions.

IS&S will continue to monitor the impact of the COVID-19 pandemic on its business, including how it has impacted and will impact the Company’s employees, customers, suppliers and distribution channels.

The Company could face liquidity shortages, weaker product demand from its customers, disruptions in its supply chain, and/or staffing shortages in its workforce in the future due to the direct and indirect effects of the COVID-19 pandemic.

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 Company’s Board of Directors 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 of improvement.

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.

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Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period.

The Company’s most critical accounting policies are revenue recognition, income taxes and inventory valuation.

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.

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.

Revenue recognition

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Revenue from Contracts with Customers

The Company accounts for revenue in accordance with ASC 606, Revenue from Contracts with Customers (“ASC 606”).

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.

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1) Identify the contract with a customer

The Company’s contract with its customers typically is 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.

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.

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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 sales and product cost of sales, respectively, on the accompanying consolidated statements of operations.

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 NOLs and tax credit carry-forwards.

The impact on deferred taxes of changes in tax rates and laws, if any, are applied to the years during which temporary differences are expected to be settled, and are reflected in the consolidated financial statements in the period of enactment.

At the end of each interim 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 Act, 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 frees up previously utilized R&D credits, resulting in an estimated increase in 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 (the “CAA”) was enacted as a supplement to the CARES Act legislation providing additional financial relief to taxpayers adversely impacted by restrictions put into place in response to the COVID-19 pandemic.

In addition, the CCA 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, the 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.

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, 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.

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.

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;

● historical and expected customer attrition rates and anticipated growth in revenue from acquired customers;

● discount rates.

Inventory valuation

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New Accounting Pronouncements

In June 2016, FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326):

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”).

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The adoption of this standard is not expected to have a material impact on our condensed consolidated financial statements or related disclosures.

In December 2019, the FASB issued ASU 2019-12, “ Income Taxes (Topic 740):

Simplifying the Accounting for Income Taxes ” (“ASU 2019-12”), which simplifies the accounting for income taxes, eliminates certain exceptions within Accounting Standards Codification Topic 740, “Income Taxes” (“ASC 740”), and clarifies certain aspects of ASC 740 to promote consistency among reporting entities.

We adopted this update effective October 1, 2021.

The adoption of this standard did not 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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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.

The Company currently derives the majority of its revenues from the sale of this equipment and related EDC services.

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.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis