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 the June 2023 Honeywell Agreement with 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.
In July 2024, the Company entered into the July 2024 Honeywell Asset Acquisition, an exclusive license agreement and acquired additional key assets for certain communication and navigation product lines from Honeywell. This transaction complements the previous Honeywell license and asset acquisition completed in June 2023. Total consideration was $4.2 million in cash.
On September 27, 2024, the Company entered into the September 2024 Honeywell Agreement with Honeywell, pursuant to which Honeywell sold, assigned or licensed certain assets related to its various generations of military display generators and flight control computers, 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 various generations of military display generators and flight control computers to repair, overhaul, manufacture sell, import, export and distribute certain products to the Company for consideration of $14.2 million in cash.
The exclusive licensing of these product lines from Honeywell is a unique opportunity for the Company to enhance 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 that each of the June 2023 Honeywell Agreement, the July 2024 Honeywell Asset Acquisition and the September 2024 Honeywell Agreement will
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help to accelerate the Company’s growth and enhance its global reputation for delivering some of the industry’s best price-for-performance product and service solutions.
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 reimbursement accounted for as a sale in accordance with the percentage-of-completion method or 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,
2024
2023
2022
Net sales:
Product
51.4
%
64.9
%
80.7
%
Services
48.6
%
35.1
%
19.3
%
Total net sales
100.0
%
100.0
%
100.0
%
Cost of sales:
Product
22.4
%
27.9
%
33.9
%
Services
22.6
%
10.9
%
6.0
%
Total cost of sales
45.0
%
38.7
%
39.9
%
Gross profit
55.0
%
61.3
%
60.1
%
Operating expenses:
Research and development
8.8
%
9.0
%
9.8
%
Selling, general and administrative
25.6
%
31.1
%
24.3
%
Total operating expenses
34.4
%
40.1
%
34.1
%
Operating income
20.6
%
21.2
%
26.0
%
Interest expense
(2.0)
%
(1.1)
%
0.0
%
Interest income
0.3
%
1.5
%
0.2
%
Other income
—
%
0.4
%
0.2
%
Income before income taxes
18.9
%
22.0
%
26.4
%
Income tax expense
3.9
%
4.6
%
6.5
%
Net income
14.9
%
17.4
%
19.9
%
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Fiscal Year Ended September 30, 2024 Compared to Fiscal Year Ended September 30, 2023
Historically, the Company presented Customer service and Engineering and development contracts Net Sales and Cost of sales separately on the Consolidated Statements of Operations. For the fiscal year ended September 30, 2024, the Company has aggregated these items into one category, “Services” and reclassified Customer service and Engineering and development contracts revenues as well as Cost of sales to conform the presentation of the Consolidated Statements of Operations for fiscal years ended September 30, 2023, and 2022. See Footnote 3. Summary of Significant Accounting Policies, (“Reclassifications ”) for additional information.
Net sales . Net sales in fiscal year 2024 increased $12.4 million, or 36.0%, to $47.2 million from $34.8 million in fiscal year 2023. The increase in Net sales was driven by a 7% increase or $1.7 million in product sales. The increase in product sales was related to increases in business aviation sales of $1.5 million and an increase of $0.5 million in defense sales, offset by a decline in commercial air transport sales of $0.3 million. The increase in business aviation sales was driven by increase in demand to support aircraft production. The increase in defense sales was primarily driven by increased market demand for our products. The decrease in commercial air transport was primarily due to the decline that occurred during the first half of fiscal year 2024. We began to experience a recovery in commercial air transport demand during the second half of 2024. Services sales in fiscal year 2024 increased $10.7 million, or 87.6%, compared to fiscal year 2023. The increase in service sales primarily reflects customer service sales of $9.7 million due to sales from the product lines acquired from Honeywell, which included a $1.7 million true-up payment from Honeywell for services performed by third parties, primarily offset by a $0.3 million decrease in legacy customer service.
Cost of sales . Cost of sales was $21.3 million, or 45.0% of Net sales, in fiscal year 2024 compared to $13.5 million, or 38.7% of Net sales, in fiscal year 2023. The increase in Cost of sales was primarily the result of an increase in Services sales volume. The Company’s overall gross margin in fiscal year 2024 was 55.0% compared to 61.3% in fiscal year 2023. The decrease in overall gross margin percentage for fiscal year 2024 is primarily the result of changes in product mix, increased depreciation and cost inefficiencies due to hiring and training of additional personnel and other integration costs.
Research and development . R&D expenses were $4.1 million in fiscal year 2024 and $3.1 million in fiscal year 2023. The increase in R&D expense was due to higher salaries and benefits due to higher headcount. As a percentage of Net sales, R&D expense decreased slightly to 8.8% of Net sales for fiscal year 2024 compared to 9.0% for fiscal year 2023.
Selling, general, and administrative. SG&A expenses increased $1.3 million or 11.9%, to $12.1 million from $10.8 million in fiscal year 2023. The increase in SG&A expense in fiscal year 2024 was primarily the result of increases in consulting and legal fees of $0.9 million primarily due to acquisition related expenses and increased costs of $0.6 million as a result of the recruitment of a new CFO and other corporate initiatives. In addition, the Company incurred amortization expense of $1,191,361 related to the customer relationships intangible asset resulting from the combined acquisitions. These increases were partially offset by a $162,000 gain from the sale of the Company’s King Air aircraft. As a percentage of Net sales, selling, general and administrative expenses were 25.6% in fiscal year 2024 compared to 31.1% for fiscal year 2023.
Interest income. Interest income of $0.1 million in fiscal year 2024 decreased by $0.4 million as compared to interest income in fiscal year 2023 of $0.5 million. The decrease in interest income was primarily the result of the decrease in the average cash balance in fiscal year 2024 and a general decrease in interest rates as compared to fiscal year 2023.
Other income. Other income was $0.2 million in fiscal year 2023. The Company did not have any other income for fiscal year 2024.
Income taxes. Income tax expense was $1.9. million in fiscal year 2024 as compared to income tax expense of $1.6 million in fiscal year 2023. The effective tax rate in fiscal year 2024 was 20.9% as compared to 21.1% in fiscal year 2023. The increase in income tax expense was primarily due to an increase in earnings in fiscal year 2024.
Net income. As a result of the factors described above, the Company’s net income in fiscal year 2024 was $7.0 million compared to net income of $6.0 million in fiscal year 2023. On a fully diluted basis, net income per share was $0.40 in fiscal year 2024, compared to a net income of $0.35 per share in fiscal year 2023.
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Fiscal Year Ended September 30, 2023 Compared to Fiscal Year Ended September 30, 2022
Net sales . Net sales in fiscal year 2023 increased $7.1 million, or 25.5%, to $34.8 million from $27.7 million in fiscal year 2022. Product sales in fiscal year 2023 increased $0.2 million compared to fiscal year 2022. Services sales in fiscal year 2023 increased $6.9 million, or 128.8%, compared to fiscal year 2022.
EDC sales increased $0.7 million, or 146.8% compared to fiscal year 2022, reflecting increased EDC business. Customer service sales increased $6.2 million, or 127.2% from fiscal year 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 38.7% of Net sales, in fiscal year 2023 compared to $11.1 million, or 39.9% of Net sales, in fiscal year 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 year 2023 was 61.3% compared to 60.1% in fiscal year 2022. The fiscal year 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 year 2023 and $2.7 million in fiscal year 2022. R&D expense decreased to 9.0% of Net sales in fiscal year 2023 compared to 9.8% of net sales in fiscal year 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 year 2022. SG&A expenses in fiscal year 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 year 2023 was primarily the result of increased stock-based compensation expense and legal fees, professional fees, audit fees and amortization expense primarily related to the June 2023 Honeywell Agreement and increased board of director fees.
Interest income . Interest income of $0.5 million in fiscal year 2023 increased by $0.4 million as compared to interest income in fiscal year 2022 of $0.1 million. The increase in interest income was primarily the result of the increase in the average cash balance in fiscal year 2023 and a general increase in interest rates as compared to fiscal year 2022.
Other income. Other income was $0.2 million in fiscal year 2023, an increase of $0.1 million from fiscal year 2022.
Income taxes. Income tax expense was $1.6 million in fiscal year 2023 as compared to income tax expense of $1.8 million in fiscal year 2022. The effective tax rate in fiscal year 2023 was 21.1% as compared to 24.8% in fiscal year 2022. The higher tax and effective tax rate in fiscal year 2022 as compared to fiscal year 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 for fiscal year 2023 was $6.0 million compared to net income of $5.5 million for fiscal year 2022. On a fully diluted basis, net income per share was $0.35 for fiscal year 2023, compared to a net income of $0.32 per share for fiscal year 2022.
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Liquidity and Capital Resources
Sources of Liquidity
The following table highlights key financial measurements of the Company:
As of
As of
September 30,
September 30,
2024
2023
Cash and cash equivalents
$
538,977
$
3,097,193
Accounts receivable
$
12,612,482
$
9,743,714
Current assets
$
34,685,698
$
34,673,703
Current liabilities
$
7,265,254
$
6,398,959
Contract liability
$
340,481
$
143,359
Other non-current liabilities
$
28,478,352
$
17,921,508
Quick ratio (1)
1.81
2.01
Current ratio (2)
4.77
5.42
Twelve Months Ended September 30,
2024
2023
2022
Cash flow activities:
Net cash provided by operating activities
$
5,796,222
$
2,096,174
$
6,094,440
Net cash (used in) provided by investing activities
(16,881,440)
(36,158,373)
2,589,346
Net cash provided by financing activities
8,527,002
19,908,846
301,154
(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 has been cash flows from current year operations and cash accumulated from prior years’ operations, supplemented with our revolving credit facility. Cash is used principally to finance inventory, accounts receivable, contract assets, payroll, debt service and acquisitions, as well as the Company’s known contractual and other commitments (including those described in Note 19, “Leases”). The Company’s existing cash balances and anticipated cash flows from operations, together with borrowings under our revolving credit 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 in this Management’s Discussion and Analysis, 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 declaration and payment of any dividend in the future will be at the discretion of the Company’s Board of Directors.
Debt Facility
In connection with the June 2023 Honeywell Agreement, the Company entered into a term loan with PNC Bank, National Association for $20.0 million to fund a portion of the June 2023 Honeywell Agreement. Refer to 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 the Loan (the “Restated Loan Amendment”) and a corresponding Amended and Restated Revolving Line of Credit Note (“Restated Line of Credit Note”) and Amended and Restated Line of Credit and Investment Sweep Rider (the “Restated Rider”), to increase the aggregate principal amount available under the Company’s senior secured revolving line of credit from $10,000,000 to $30,000,000 and extend the maturity date until December 19, 2028. The proceeds of the Restated Line of Credit Note will be used for working capital and other general corporate purposes, for acquisitions as permitted under the Restated Loan Amendments and to pay off and close the loan evidenced by that certain Term Note executed in favor of PNC, dated June 28, 2023, which provided for a senior secured term loan in aggregate principal amount of $20,000,000, with a maturity date of June 28, 2028.
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On September 30, 2024, in connection with the July 2024 Honeywell Asset Acquisition and the September 2024 Honeywell Agreement, the Company and one of its subsidiaries, Innovative Solutions and Support, LLC, entered into an Amendment to Loan Documents (the “2024 Loan Amendment”) with PNC, which amends certain terms of the Loan Agreement to increase the line of credit with PNC. Concurrently with the 2024 Loan Amendment, the Company entered into (i) an Amended and Restated Revolving Line of Credit Note in favor of PNC (the “A&R Revolving Line of Credit Note”), and (ii) an Amended and Restated Line of Credit and Investment Sweep Rider with PNC (the “A&R Rider”). The A&R Revolving Line of Credit Note provides for a senior secured revolving line of credit in an aggregate principal amount of $35,000,000, with an expiration date of December 19, 2028 (the “Revolving Line of Credit”). The interest rate applicable to loans outstanding under the Revolving Line of Credit is a rate per annum equal to the sum of (A) Daily SOFR (as defined in the A&R Revolving Line of Credit Note) plus (B) an unadjusted spread of the Applicable SOFR Margin plus (C) a SOFR adjustment of ten basis points. The Applicable SOFR Margin ranges from 1.5% to 2.5% depending on the Company’s funded debt to EBITDA ratio, as defined in the A&R Revolving Line of Credit Note. The A&R Rider provides for how PNC will make advances to the Company under the Revolving Line of Credit.
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 fiscal year ended September 30, 2024, 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 years 2023 or 2024. 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.
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Operating Activities
The Company generated $5.8 million of cash from operating activities during fiscal year 2024, as compared to cash generated of $2.1 million during fiscal year 2023. The cash generated by operating activities for the year ended September 30, 2024 was primarily generated by net income of $7.0 million, an increase in non-cash compensation expenses for stock options and stock awards of $0.3 million and $0.7 million, respectively, and depreciation and amortization expense of $2.1 million. Changes is certain other working capital accounts drove the remainder of the increase for fiscal year 2024.
The Company generated $2.1 million of cash in operating activities during fiscal year 2023, as compared to cash generated of $6.1 million during fiscal year 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 inventories of $0.8 million.
Investing Activities
Cash used in investing activities was $16.8 million for fiscal year 2024 and was primarily due to the $14.2 million acquisition of various generations of military display generators and flight control computers in September 2024 and the $4.2 million acquisitions of certain additional assets related to the Company’s communication and navigation product lines in July of 2024. In addition, the Company spent $0.7 million for the purchases of property and equipment, partially offset by proceeds of $2.2 million from the sale of the Company’s King Air aircraft. The Company plans to continue investing in capital equipment to support engineering development efforts and operations.
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 2023 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 2023 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.
Financing Activities
Net cash provided by financing activities was $8.5 million for the fiscal year 2024 and consisted of $43.8 million in payments against the Company’s line of credit offset by $52.3 million in additional borrowings used to fund the Company’s fiscal year 2024 acquisitions.
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 June 2023 Honeywell Agreement, proceeds from the exercise of stock options for $0.4 million and the paydown of the Term Loan for $0.5 million.
Summary
Future capital requirements depend upon numerous factors, including market acceptance of the Company’s products, the timing and rate of expansion of business, acquisitions, joint ventures and other factors. IS&S has experienced increases in expenditures since its inception and anticipates that increases in expenditures will continue in the foreseeable future. The Company believes that its cash and cash equivalents will provide sufficient capital to fund operations for at least the next twelve months. However, the Company may need to develop and introduce new or enhanced products, respond to competitive pressures, invest in or acquire businesses or technologies, or respond to unanticipated requirements or developments. If sufficient funds are not available, the Company may not be able to introduce new products or compete effectively.
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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 the future effects of inflation, if any.
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
We prepare our consolidated financial statements in conformity with generally accepted accounting principles (“GAAP”). See Part II, Item 8, “Financial Statements and Supplementary Data — Notes to Consolidated Financial Statements,” Note 1, “Significant Accounting and Reporting Policies,” for additional information about our significant accounting and reporting policies that require us to make certain judgments and estimates in reporting our operating results and our assets and liabilities. The following paragraphs describe the accounting policies that require significant judgment and estimates due to inherent uncertainty or complexity.
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.
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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. In addition, the Company enters fixed-price contracts, in which the Company agrees to perform the specified work for a pre-determined price. The contractual terms of the fixed-price contracts are usually long-term, however they often contain a termination for convenience clause that results in the Company treating these contracts as short-term under ASC 606. To the extent our actual costs vary from the estimates upon which the price was negotiated, the Company will generate more or less profit or could incur a loss. 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.
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.
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Acquisitions and Investments, and Goodwill and Other Indefinite-Lived Intangible Assets
We allocate the purchase price of acquired entities to the underlying tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values, with any excess recorded as goodwill. The valuations of the acquired assets and liabilities will impact the determination of future operating results. Determining the fair value of assets we acquire and liabilities we assume requires management’s judgment and often involves the use of significant estimates and assumptions, including assumptions with respect to future cash inflows and outflows, discount rates, asset lives and market multiples, among other items. We determine the fair values of intangible assets acquired generally in consultation with third-party valuation advisors. Fair value adjustments to the assets and liabilities are recognized and the results of operations of the acquired business are included in our consolidated financial statements from the effective date of the acquisition.
Intangible assets other than goodwill are recognized if the benefit of the intangible asset is obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed or exchanged, regardless of the Company’s intent to do so. Goodwill and identifiable intangible assets are recorded at their estimated fair value on the date of acquisition and are reviewed at least annually for impairment based on cash flow projections and fair value estimates.
Inventories
Inventories are stated at the lower of cost or net realizable value. Write-downs for slow-moving and obsolete inventories are provided based on current assessments about future product demand, production requirements for expected usage and usage for the last 12 months. Where we estimate that the net realizable value is below cost or have determined that future demand is lower than current inventory levels based on historical experience, current and projected market demand, current and projected volume trends and other relevant current and projected factors associated with the current economic conditions, a reduction in inventory cost to estimated net realizable value is recorded as a charge included in Cost of sales. Management believes that our estimates of excess and obsolete inventory are reasonable and material changes in future estimates or assumptions used to calculate our estimates are unlikely. However, actual results may differ materially from the estimates and additional provisions may be required in the future.
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 2024, 2023 and 2022 Net sales outside the United States amounted to $22.8 million, $15.5 million and $11.1 million, respectively.