Item 7. Management’s Discussion and Analysis
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,
2023
2022
2021
Net sales:
Product
64.9
%
80.7
%
81.3
%
Customer service
31.8
%
17.6
%
17.5
%
Engineering development contracts
3.3
%
1.7
%
1.2
%
Total net sales
100.0
%
100.0
%
100.0
%
Cost of sales:
Product
28.0
%
33.9
%
37.7
%
Customer service
9.7
%
5.4
%
6.5
%
Engineering development contracts
1.1
%
0.6
%
0.3
%
Total cost of sales
38.8
%
39.9
%
44.5
%
Gross profit
61.2
%
60.1
%
55.5
%
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
%
Operating income
21.1
%
26.0
%
17.0
%
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)
%
Net income
17.3
%
19.9
%
22.0
%
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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,
2023
2022
Cash and cash equivalents
$
3,097,193
$
17,250,546
Accounts receivable
$
9,743,714
$
4,297,457
Current assets
$
34,673,703
$
28,202,319
Current liabilities
$
6,398,959
$
3,940,303
Contract liability
$
143,359
$
259,183
Other non-current liabilities
$
17,921,508
$
15,065
Quick ratio (1)
2.01
5.47
Current ratio (2)
5.42
7.16
Twelve Months Ended September 30,
2023
2022
2021
Cash flow activities:
Net cash provided by operating activities
$
2,096,174
$
6,094,440
$
4,592,499
Net cash (used in) provided by investing activities
(36,158,373)
2,589,346
(340,678)
Net cash provided by (used in) financing activities
19,908,846
301,154
(19,771,082)
(1) Calculated as: the sum of cash and cash equivalents plus accounts receivable, net, divided by current liabilities
(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.
In connection with the Transaction, the Company entered into the Term Loan with PNC for $20.0 million to fund a portion of the Transaction (see Note 20, “Loan Agreement” for further details). The preliminary purchase consideration was $35.9 million in cash.
Cash provided by investing activities was $2.6 million for fiscal year 2022 and consisted primarily of proceeds from the sale of the Company’s Pilatus PC-12 airplane offset by spending of $0.2 million primarily for quality test equipment and computer hardware. The Company plans to continue investing in capital equipment to support engineering development efforts and operations.
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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;
● historical and expected customer attrition rates and anticipated growth in revenue from acquired customers; and
● 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.