This report contains forward looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934. We have based these forward looking statements largely on our current expectations and projections about future events and trends affecting our business. In this report, the words "believe," "may," "will," "estimate," "continue," "anticipate," "intend," "forecast," "expect," "plan," "should," "is likely" and similar expressions, as they relate to our business or our management, are intended to identify forward looking statements, but they are not exclusive means of identifying them.

The forward looking statements in this report are only predictions and actual events or results may differ materially. In evaluating such statements, a number of risks, uncertainties and other factors could cause our actual results, performance, financial condition, cash flows, prospects, and opportunities to differ materially from those expressed in, or implied by, the forward looking statements. These risks, uncertainties and other factors include the following:

† market acceptance of our flat panel display systems, or COCKPIT/IP™ system or other planned products or product enhancements;

† difficulties in developing and producing our COCKPIT/IP™ system or other planned products or product enhancements;

† continued market acceptance of our air data systems and products;

†          the availability of government funding;



†          our ability to gain regulatory approval of our products in a timely
manner;

† delays in receiving components from third party suppliers;

† the competitive environment;

† the impact of general economic trends on our business;

† the bankruptcy or insolvency of one or more key customers;

† the deferral or termination of programs or contracts for convenience by customers;

† failure to retain key personnel;

† new product offerings from competitors;

† potential future acquisitions;

† protection of intellectual property rights;

† our ability to service the international market; and

† other factors disclosed from time to time in our filings with the Securities and Exchange Commission.

Except as expressly required by the federal securities laws, we undertake no obligation to publicly update or revise any forward looking statements, whether as a result of new information, future events or otherwise after the date of this report. Our results of operations in any past period should not be considered indicative of the results to be expected for future periods. Fluctuations in operating results may also result in fluctuations in the price of our common stock.

Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Form 10-Q. The Company does not undertake any obligation to publicly release any revisions to these forward-looking statements to reflect events, circumstances or changes in expectations after the date of this Form 10-Q, or to reflect the occurrence of unanticipated events. The forward-looking statements in this document are intended to be subject to the safe harbor protection provided by Sections 27A of the Securities Act and 21E of the Exchange Act. For a discussion identifying some important factors that could cause actual results to vary materially from those anticipated in the forward-looking statements, see the Company's Securities and Exchange Commission filings including, but not limited to, the discussions of "Risk Factors" contained in the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2008.

Investors should also be aware that while we do, from time to time, communicate with securities analysts, it is against our policy to disclose any material non-public information or other confidential commercial information. Accordingly, shareholders should not assume that we agree with any statement or report issued by any analyst irrespective of the content of the statement or report. Furthermore, we have a policy against issuing or confirming financial forecasts or projections issued by others. Thus, to the extent that reports issued by securities analysts contain any projections, forecasts or opinions, such reports are not the responsibility of Innovative Solutions and Support, Inc.

Company Overview

Innovative Solutions and Support was founded in 1988. The Company designs, develops, manufactures and sells flight information computers, large flat-panel displays, and advanced monitoring systems that measure and display critical flight information, including data relative to aircraft separation, airspeed, altitude as well as engine and fuel data measurements.

Our sales are derived from the sale of our products to the retrofit market and, to a lesser extent, original equipment manufacturers ("OEMs"). Our customers include the United States Department of Defense ("DoD") and their commercial contractors, aircraft operators, aircraft modification centers and various OEMs. Although we occasionally sell our products directly to the DoD, we primarily have sold our products to commercial customers for end use in DoD programs. Sales to defense contractors are on commercial terms, although some of the termination and other provisions of government contracts are applicable to these contracts.

Our cost of sales related to product sales is comprised of material and components purchased through our supplier base and direct in-house assembly labor and overhead costs. Many of the components we use in assembling our products are standard, although certain parts are manufactured to meet our specifications. The overhead portion of cost of sales is primarily comprised of salaries and benefits, building occupancy, supplies, and outside service costs related to our production, purchasing, material control and quality departments, and warranty costs.

Our cost of sales related to Engineering-modification and development ("EMD") is comprised of engineering labor, consulting services, and other cost associated with specific design and development projects that are billable under specific customer agreements.

We intend to continue investing in the development of new products that complement our current product offerings and will expense associated research and development costs as they are incurred.

Our selling, general and administrative expenses consist of sales, marketing, business development, professional services, and salaries and benefits for executive and administrative personnel as well as facility costs, recruiting, legal, accounting, and other general corporate expenses.

We sell our products to agencies of the United States and foreign governments, aircraft operators, aircraft modification centers and original equipment manufacturers. Our customers have been and may continue to be affected by the ongoing adverse economic conditions that currently exist both in the United States and abroad. Such conditions may cause our 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 our 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 and other macroeconomic factors affecting spending behavior. In addition, spending by government agencies may in the future be further reduced due to declining tax revenues associated with this economic downturn. If our customers curtail or delay their spending or are forced to declare bankruptcy or liquidate their operations due to continuing adverse economic conditions, our revenues and results of operations will be adversely affected. However, we believe that in a declining economic environment a customer that may have otherwise elected to purchase newly manufactured aircraft will instead be interested in retrofitting existing aircraft as a cost effective alternative, which will create a market opportunity for our products.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and consolidated results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of our condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates based upon historical experience and various other assumptions that we believe to be reasonable under 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. Our actual results may differ from these estimates.

We believe that our critical accounting policies affect our more significant estimates and judgments used in the preparation of our consolidated financial statements. Our Annual Report on Form 10-K for the year ended September 30, 2008 contains a discussion of these critical accounting policies. There have been no significant changes in our critical accounting policies since September 30, 2008. See also Note 1 to our unaudited condensed consolidated financial statements for the three and nine month periods ended June 30, 2009 as set forth herein.

The following table sets forth statement of operations data expressed as a percentage of total net sales for the periods indicated (some items may not add due to rounding):

                                  Three Months Ending June 30,        Nine Months Ending June 30,
                                     2009               2008            2009               2008
Net sales:
Product                                  85.6 %             82.0 %          86.5 %             85.1 %
Engineering - modification and
development                              14.4 %             18.0 %          13.5 %             14.9 %
Total net sales                         100.0 %            100.0 %         100.0 %            100.0 %

Cost of sales
Product                                  42.6 %             44.0 %          45.9 %             50.9 %
Engineering - modification and
development                               4.1 %              8.2 %           3.1 %              8.3 %
Total cost of sales                      46.7 %             52.2 %          48.9 %             59.2 %

Gross profit                             53.3 %             47.8 %          51.1 %             40.8 %

Operating expenses:
Research and development                 16.6 %             36.8 %          14.5 %             38.1 %
Selling, general and
administrative                           23.7 %             37.5 %          22.5 %             68.7 %
Asset impairment                          0.0 %             28.3 %           0.0 %             12.2 %
Total operating expenses                 40.3 %            102.6 %          37.0 %            119.0 %

Operating income (loss)                  13.0 %            (54.8 )%         14.1 %            (78.1 )%

Interest income                           0.8 %              3.2 %           1.3 %              6.5 %
Interest expense                         (0.3 )%            (0.4 )%         (0.3 )%            (0.6 )%
Other income                              0.0 %              0.0 %           0.2 %              1.5 %
Income (loss) before income
taxes                                    13.6 %            (51.9 )%         15.3 %            (70.8 )%

Income tax expense (benefit)             (2.6 )%            (2.9 )%         (0.1 )%             5.4 %

Net income (loss)                        16.1 %            (49.0 )%         15.4 %            (76.2 )%

Three Months Ended June 30, 2009 Compared to the Three Months Ended June 30, 2008

Net sales. Net sales decreased $1.0 million, or 11.3%, to $7.8 million for the three months ended June 30, 2009 from $8.8 million in the three months ended June 30, 2008. For the three months ended June 30, 2009, product sales decreased approximately $0.6 million and EMD sales decreased approximately $0.4 million from the same period in the prior year. The decrease in product sales was primarily the result of the impact of a demand of a large customer that we defer a portion of a delivery of flat panel displays that had originally scheduled for the third quarter. We have been informed that the customer plans to accelerate modification rates by 2010, consuming the balance of fifty ship-sets already delivered and restoring our delivery schedule. We are currently in discussions with the customer to determine all future delivery dates. The decrease in EMD sales was primarily a result of the timing of completion of several projects.

Cost of sales. Cost of sales decreased $0.9 million or 20.7%, to $3.6 million, or 46.7% of net sales in the three months ended June 30, 2009 from $4.6 million, or 52.2% of net sales in the three months ended June 30, 2008. The decrease was primarily the result of the decrease in product sales during the quarter which accounted for $0.5 million of the decrease, as well as by a $0.4 million decrease in EMD related costs.

Research and development. Research and development expense decreased $1.9 million or 60.0% to $1.3 million or 16.6% of net sales in the three months ended June 30, 2009 from $3.2 million or 36.8% of net sales in the three months ended June 30, 2008. The decrease in research and development expense in the quarter was primarily due to a reduction in headcount related costs and a decrease in cost from third-party subcontractors of $1.0 million and $1.1 million, respectively. This was offset by an increase in deferred EMD related direct costs of $0.4 million. The significant research and development costs in the prior period primarily related to the Eclipse program that ended during the fourth quarter of fiscal year 2008. Since the termination of the Eclipse program the Company has reduced the total number of employees in the research and development department and has streamlined its research and development functions. However, the Company continues to invest in on-going research and development of our core products.

Selling, general, and administrative.Selling, general and administrative expenses decreased $1.4 million, or 43.9%, to $1.8 million, or 23.7% of net sales in the three months ended June 30, 2009 from $3.2 million or 37.5% of net sales in the three months ended June 30, 2008. The decrease was primarily due to a reduction in professional fees, specifically legal costs, as well as a decrease in headcount related costs of $0.5 million and $0.5 million respectively. During the three months ended June 30, 2008 the Company incurred $0.5 million of legal fees in connection with litigation related to protecting its Intellectual Property.

Interest income. Interest income was $63,000 in the three months ended June 30, 2009 as compared to $284,000 in the three months ended June 30, 2008. The decrease in interest income was primarily the result of our reduced average cash balance in the current quarter as compared to the same period in the prior year as well as lower interest rates in the quarter as compared to the same period in the prior year.

Interest expense. Interest expense was $20,000 in the three months ended June 30, 2009 as compared to $33,000 in the three months ended June 30, 2008. The reduction was primarily due to lower interest rates in effect during the period compared to the same period in the prior year.

Income tax expense (benefit). The income tax benefit for the three months ended June 30, 2009 was $199,000 as compared to $256,000 for the three months ended June 30, 2008. The decrease in the income tax benefit for the three months ended June 30, 2009 is due to a decrease in the FIN 48 liability upon the expiration of certain state statutes of limitations in the three months ended June 30, 2008. The Company continues to maintain a full valuation allowance as of the period ended June 30, 2009 on its net deferred tax assets. In accordance with FAS 109 the Company will continue to evaluate the need for a full or partial valuation allowance on a quarterly basis.

The effective tax rates for the three months ended June 30, 2009 and 2008 were (19%) and 6%, respectively. The effective tax rate differs from the statutory rate for the three months ended June 30, 2009 due to: 1) the reversal of certain deductible temporary differences which at September 30, 2008 were offset by a valuation allowance; such items will be deductible for income tax purposes in the current fiscal year based on forecasted earnings, and 2) the utilization of research and experimentation tax credits. The effective tax rate differs from the statutory rate for the three months ended June 30, 2008 due to the establishment of a full valuation allowance on net deferred tax assets during the preceding quarter.

Nine months ended June 30, 2009 Compared to the Nine months ended June 30, 2008

Net sales. Net sales increased $8.5 million, or 41.8%, to $28.8 million for the nine months ended June 30, 2009 from $20.3 million in the nine months ended June 30, 2008. For the nine months ended June 30, 2009, product sales increased $7.6 million and EMD sales increased $0.9 million from the same period in the prior year. The increase in product sales was primarily related to growth in flat panel display sales to various customers. The increase in EMD sales was primarily a result of several projects for major customers that were completed during the nine months ended June 30, 2009. During the nine months ended June 30, 2008 $10.6 million or 52% of net sales pertained to one OEM customer, which declared bankruptcy. Excluding these OEM sales the Company's net sales would have increased $19.1 million or 197%.

Cost of sales. Cost of sales increased $2.1 million or 17.3%, to $14.1 million, or 48.9% of net sales in the nine months ended June 30, 2009 from $12.0 million, or 59.2% of net sales in the nine months ended June 30, 2008. The increase was primarily the result of the additional product sales during the nine months ended June 30, 2009, which accounted for $2.9 million of the increase and was offset by a $0.8 million decrease in EMD related costs.

Research and development. Research and development expense decreased $3.6 million or 46.0% to $4.2 million or 14.5% of net sales in the nine months ended June 30, 2009 from $7.7 million or 38.1% of net sales in the nine months ended June 30, 2008. The decrease in research and development expense in the nine months ended June 30, 2009 was primarily due to a reduction in headcount related costs and a decrease in costs from third-party subcontractors of $2.3 million and $2.0 million, respectively, offset by an increase in deferred EMD costs of $1.1 million.

Selling, general, and administrative.Selling, general and administrative expenses decreased $7.5 million, or 53.6%, to $6.5 million, or 22.5% of net sales in the nine months ended June 30, 2009 from $14.0 million or 68.7% of net sales in the nine months ended June 30, 2008. The decrease was primarily due to a reduction in professional fees, specifically legal costs, as well as a decrease in headcount related costs of $5.3 million and $1.0 million respectively. During the nine months ended June 30, 2008 the Company incurred $5.4 million of legal fees in connection with litigation related to protecting its intellectual property.

Interest income. Interest income was $361,000 in the nine months ended June 30, 2009 as compared to $1.3 million in the nine months ended June 30, 2008. The decrease in interest income was primarily the result of our reduced average cash balance during the nine months ended June 30, 2009 as compared to the same period in the prior year as well as lower interest rates during the nine months ended June 30, 2009 as compared to the same period in the prior year.

Interest expense. Interest expense was $75,000 in the nine months ended June 30, 2009 as compared to $122,000 in the nine months ended June 30, 2008. The reduction was primarily due to lower interest rates in effect during the period compared to the same period in the prior year.

Other income. In March 2008, the Company received a payment of $300,000 in settlement of a claim against a shareholder for short swing profit liability to the Company pursuant to Section 16(b) of the Securities Exchange Act of 1934, as amended.

Income tax expense (benefit). The income tax expense (benefit) for the nine months ended June 30, 2009 was ($31,000) as compared to $1.1 million for the nine months ended June 30, 2008. The decrease in the income tax expense is primarily due to the establishment of a full valuation allowance on deferred tax assets as of the period ended March 31, 2008. The establishment of the valuation allowance as of March 31, 2008 caused the Company to recognize income tax expense for the nine months ended June 30, 2008 relating to net deferred tax assets that are not likely to be realized. The Company continues to maintain a full valuation allowance as of the period ended June 30, 2009 on its net deferred tax assets. In accordance with FAS 109 the Company will continue to evaluate the need for a full or partial valuation allowance on a quarterly basis.

The effective tax rates for the nine months ended June 30, 2009 and 2008 were (1%) and (8%), respectively. The effective tax rate differs from the statutory rate for the nine months ended June 30, 2009 due to: 1) the reversal of certain deductible temporary differences which at September 30, 2008 were offset by a valuation allowance; such items will be deductible for income tax purposes in the current fiscal year based on forecasted earnings, and 2) the utilization of research and experimentation tax credits. The effective tax rate differs from the statutory rate for the nine months ended June 30, 2008 due to the establishment of a full valuation allowance on net deferred tax assets during the quarter ended March 31, 2008.

Liquidity and Capital Resources



The following table highlights key financial measurements of the Company:



                                                 June 30,      September 30,
                                                   2009            2008
Cash and cash equivalents                      $ 39,307,938   $    35,031,932
Accounts receivable, net                       $  4,747,604   $     4,218,443
Working capital                                $ 47,575,403   $    42,491,253
Deferred revenue                               $    254,127   $       564,998
Total debt and other non-current liabilities   $  4,927,668   $     5,047,146
Quick ratio                                           12.20              4.94
Current ratio                                         14.18              6.35




                                                       Nine Months Ended June 30,
                                                          2009             2008
Cash flow activites:
Net cash provided by (used in) operating activites   $    4,636,299    $ (7,514,973 )
Net cash used in investing activites                       (244,127 )      (533,532 )
Net cash used in financing activites                       (116,166 )       (31,677 )

Our main source of liquidity has been cash flow from operating activities. We require cash principally to finance inventory, accounts receivable and payroll.

Operating activities

Cash provided by operating activities was $4.6 million for the nine months ended June 30, 2009 as compared to cash used in operating activities of $7.5 million for the nine months ended June 30, 2008. The improvement was primarily due to net income of $4.4 million for the nine months ended June 30, 2009 versus a net loss of $15.5 million in the prior year period. Additionally, the cash provided by operating activities during the nine months ended June 30, 2009 was impacted by decreases in inventories and prepaid expenses of $3.2 million and $0.1 million, respectively. This was offset by increases in accounts receivable and decreases in accounts payable, accrued expenses, income taxes payable and deferred revenues of $0.5 million, $1.4 million, $2.0 million, $0.7 million, and $0.3 million, respectively.

Investing activities

Cash used in investing activities was $244,000 for the nine months ended June 30, 2009 and $534,000 for the nine months ended June 30, 2008, which primarily consisted of the purchase of production and laboratory test equipment.

Financing activities

Net cash used in financing activities was $116,000 for the nine months ended June 30, 2009 which consisted of $108,000 for the repurchase of common stock and $8,000 for the repayment of capitalized lease obligations. Net cash used in financing activities of $32,000 for the nine months ended June 30, 2008 primarily consisted of $57,000 for the repurchase of common stock and a $7,000 repayment for capitalized lease obligations, offset by proceeds from the exercise of stock options of $33,000.

The Company entered into a $4,335,000 loan agreement dated August 1, 2000 with the Chester County, Pennsylvania Industrial Development Authority. The purpose of the loan was to fund the construction of the Company's new office and manufacturing facility. The loan matures in 2015 and carries an interest rate set by the remarketing agent that is consistent with 30-day tax-exempt commercial paper. The loan agreement includes an optional redemption schedule allowing the Company the option of forgoing any principal pay-down until such time the bonds expire in 2015. The Company has exercised its option not to pay-down the outstanding balance and accordingly, the balance of the notes payable will be due in 2015.

Effective November 30, 2007 the loan covenants require the Company to maintain at all times unencumbered cash and marketable securities having a market value of at least $20.0 million and a minimum tangible net worth of $65.0 million. On January 10, 2008 the lender agreed to discontinue the tangible net worth covenant. As of June 30, 2009 the Company was in compliance with the remaining loan covenant.

The Company repaid this loan in full on August 3, 2009 for an aggregate payment of $4,335,000.

Our future capital requirements depend on numerous factors, including market acceptance of our products, the timing and rate of expansion of our business, acquisitions, joint ventures and other factors. We have experienced increases in our expenditures since our inception consistent with growth in our operations, personnel and product line, and we anticipate that our expenditures will continue to increase in the foreseeable future. We believe that our cash and cash equivalents will provide sufficient capital to fund our operations for at . . .