CPI AEROSTRUCTURES INC - Quarter Report: 2019 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

 For the quarterly period ended September 30, 2019

OR

For the transition period from ___________ to __________

Commission File Number: 1-11398

CPI AEROSTRUCTURES, INC.

(Exact name of registrant as specified in its charter)

(631) 586-5200
(Registrant’s telephone number including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒   No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act:

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No  ☒

As of November 4, 2019, the number of shares of common stock, par value $.001 per share, outstanding was 11,857,737.

INDEX

Part I - Financial Information

Part I - Financial Information

Item 1 – Consolidated Financial Statements

CONSOLIDATED BALANCE SHEETS

See Notes to Consolidated Financial Statements

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

See Notes to Consolidated Financial Statements

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (UNAUDITED)

See Notes to Consolidated Financial Statements

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

See Notes to Consolidated Financial Statements

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1.       INTERIM FINANCIAL STATEMENTS

The Company consists of CPI Aerostructures, Inc. (“CPI”) and Welding Metallurgy, Inc. (“WMI”), a wholly owned subsidiary acquired on December 20, 2018 and Compac Development Corporation (“Compac”), a wholly owned subsidiary of WMI, collectively the “Company.”

An operating segment, in part, is a component of an enterprise whose operating results are regularly reviewed by the chief operating decision maker (the “CODM”) to make decisions about resources to be allocated to the segment and assess its performance. Operating segments may be aggregated only to a limited extent. The Company’s CODM, the Chief Executive Officer, reviews financial information presented on a consolidated basis, accompanied by disaggregated information about revenues for purposes of making operating decisions and assessing financial performance. Accordingly, the Company has determined that it has a single operating and reportable segment.

The consolidated financial statements of the Company as of September 30, 2019 and for the three and nine months ended September 30, 2019 and 2018 have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and note disclosures normally included in annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to those rules and regulations, although the Company believes that the disclosures made are adequate to make the information not misleading.

The consolidated balance sheet at December 31, 2018 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and notes required by accounting principles generally accepted in the United States of America for complete consolidated financial statements. All adjustments that, in the opinion of management, are necessary for a fair presentation for the periods presented have been reflected. Such adjustments are of a normal, recurring nature. It is suggested that these consolidated financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018. The results of operations for interim periods are not necessarily indicative of the operating results to be expected for the full year or any other interim period.

The Company maintains its cash in five financial institutions. The balances are insured by the Federal Deposit Insurance Corporation. From time to time, the Company’s balances may exceed insurance limits. As of September 30, 2019, the Company had $595,906 of uninsured balances. The Company limits its credit risk by selecting financial institutions considered to be highly creditworthy.

The Company applied business combination accounting for the WMI acquisition in accordance with Accounting Standards Codification (“ASC”) 805, “Business Combinations” (“ASC 805”). Business combination accounting requires that the assets acquired and liabilities assumed be recorded at their respective estimated fair values at the date of acquisition. The excess purchase price over fair value of the net assets acquired is recorded as goodwill. In determining estimated fair values, we are required to make estimates and assumptions that affect the recorded amounts, including, but not limited to, expected future cash flows, discount rates, remaining useful lives of long-lived assets, useful lives of identified intangible assets, replacement or reproduction costs of property and equipment and the amounts to be recovered in future periods from acquired net operating losses and other deferred tax assets. Our estimates in this area impact, among other items, the amount of depreciation and amortization, impairment charges in certain instances if the asset becomes impaired, and income tax expense or benefit that we report. Our provisional estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain. See Note 2 for a summary and status of the application of business combination accounting.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Effective January 1, 2018, the Company adopted ASC Topic 606 Revenue from Contracts with Customers (“ASC 606”) using the modified retrospective method for all of its contracts. ASC 606 requires sales and gross profit to be recognized over the contract period as work is performed based on the relationship between actual costs incurred and total estimated costs at the completion of the contract. Recognized revenues that will not be billed under the terms of the contract until a later date are recorded as an asset captioned “Contract assets.” Contracts where billings to date have exceeded recognized revenues are recorded as a liability captioned “Contract liabilities.” Changes to the original estimates may be required during the life of the contract. Estimates are reviewed monthly and the effect of any change in the estimated gross margin percentage for a contract is reflected in revenue in the period the change becomes known. ASC 606 involves considerable use of estimates in determining revenues, costs and profits and in assigning the amounts to accounting periods. As a result, there can be a significant disparity between earnings (both for accounting and tax purposes) as reported and actual cash received during any reporting period. The Company continually evaluates all of the issues related to the assumptions, risks and uncertainties inherent with the process; however, it cannot be assured that estimates will be accurate. If estimates are not accurate or a contract is terminated, the Company is required to adjust revenue in later periods. Furthermore, even if estimates are accurate, there may be a shortfall in cash flow and the Company may need to borrow money, or seek access to other forms of liquidity, to fund its work in process or to pay taxes until the reported earnings materialize as actual cash receipts.

When changes are required for the estimated total revenue on a contract, these changes are recognized with an inception-to-date effect in the current period. Also, when estimates of total costs to be incurred exceed estimates of total revenue to be earned, a provision for the entire loss on the contract is recorded in the period in which the loss is determined.

Following the adoption of ASC 606, the Company’s revenue recognition for all of its contracts remained materially consistent with historical practice and there was no material impact on the consolidated financial statements upon adoption.

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, “Leases” (“ASC 842”), which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both lessees and lessors. On January 1, 2019, the Company adopted the new lease standard using the optional transition method under which comparative financial information will not be restated and continue to apply the provisions of the previous lease standard in its annual disclosures for the comparative periods. In addition, the new lease standard provides a number of optional practical expedients in transition. The Company elected the package of practical expedients. As such, the Company did not have to reassess whether expired or existing contracts are or contain a lease and did not have to reassess the lease classifications or reassess the initial direct costs associated with expired or existing leases.

ASC 842 also provides practical expedients for an entity's ongoing accounting. The Company elected the short-term lease recognition exemption under which the Company will not recognize right-of-use (“ROU”) assets or lease liabilities, and this includes not recognizing ROU assets or lease liabilities for existing short-term leases. The Company elected the practical expedient to not separate lease and non-lease components for certain classes of assets (office buildings).

On January 1, 2019, the Company recognized ROU assets and lease liabilities of approximately $5.3 million and $5.8 million, respectively, on its consolidated balance sheet using an estimated incremental borrowing rate of 6%.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

2.       Business Combinations

As discussed in Note 1, the Company completed the WMI acquisition on December 20, 2018. The acquisition was accounted for as a business combination in accordance with ASC 805. Accordingly, the Company is required to determine and record the fair value of the assets acquired, including any potential intangible assets, and liabilities assumed at the date of acquisition. The acquisition was considered a stock purchase for tax purposes.

The purchase price for the acquisition was $7.9 million, which is subject to a post-closing working capital adjustment. Two million dollars of the purchase price was placed in escrow at closing and may be released after the completion of the working capital adjustment and for the indemnification contingencies. The escrowed amount is shown as restricted cash on the consolidated balance sheet as of September 30, 2019. The working capital adjustment is based on the historical values of components of working capital as defined in the Stock Purchase Agreement. We have calculated a post-closing working capital adjustment. Air Industries Group (“Air”) formally objected to our calculation. The Stock Purchase Agreement provided the parties 30 days to come to an agreement on the working capital adjustment. The Company and Air could not come to an agreement within the time specified and the issues were submitted to BDO USA, LLP (“BDO”) for a binding resolution. During the course of BDO’s work, Air conceded on three of the four items of contention, leaving only the inventory valuation in dispute. In its report dated September 3, 2019, BDO found in favor of the Company and that there should be no changes to the Closing Working Capital Statement as prepared by the Company. The result of the conceded items and BDO determination would decrease the purchase price of the acquisition by approximately $4.2 million. On September 16, 2019, the Company received a letter from Air acknowledging the conceded items and, among other things, rejecting the determination by BDO. On September 27, 2019, the Company filed a notice of motion in the Supreme Court of the State of New York, County of New York, against Air seeking, among other things, an order of specific performance requiring Air to comply with its obligations under the SPA and Escrow Agreement and a judgment against Air in the amount of approximately $4.2 million.

In October 2019, Air and the Company jointly authorized the release of approximately $619,000 from escrow, which represents the value of the conceded items. The remaining amount of approximately $3.6 million is still in dispute. Because of the uncertain outcome of the September 27 court filing, the Company has not recorded any adjustments to the provisional estimates of the fair value of the assets acquired and liabilities assumed from WMI related to the BDO determination.

The Company is in the process of determining the fair values of the assets and liabilities acquired and has recorded provisional estimates as of the acquisition date. As the Company completes this process and additional information becomes known concerning the acquired assets and assumed liabilities, management will make adjustments to the fair value of the amounts provisionally recorded in the opening balance sheet of WMI during the measurement period, which is no longer than a one-year period following the acquisition date. The determination of the fair values of the acquired assets and liabilities assumed (and the related determination of estimated lives of depreciable tangible and identifiable intangible assets) requires significant judgment. If the final aggregate fair value of the net assets acquired is less than the final purchase price paid, then the Company may be required to record goodwill. Conversely, if the final aggregate fair value of the net assets acquired is in excess of the final purchase price paid, then the Company may potentially conclude that the purchase of WMI was a “bargain purchase.”

As stated above, the Company has determined the following provisional estimates of the fair value of the assets acquired and liabilities assumed from WMI:

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

The following table presents the unaudited pro forma revenue and net income for the period presented as if the WMI Acquisition had occurred on January 1, 2018, based on the provisional estimates of the fair value of the net assets acquired:

3.       REVENUE RECOGNITION

The majority of the Company’s revenues are from long-term contracts with the U.S. government and commercial contractors. The contracts with the U.S. government typically are subject to the Federal Acquisition Regulation (“FAR”) which provides guidance on the types of costs that are allowable in establishing prices for goods and services provided under U.S. government contracts. The pricing for commercial contractors is based on the specific negotiations with each customer.

The Company accounts for a contract when it has approval and commitment from both parties, the rights of the parties are identified and payment terms are identified.

To determine the proper revenue recognition method, the Company evaluates whether two or more contracts should be combined and accounted for as one single contract and whether the combined or single contract should be accounted for as more than one performance obligation. This evaluation requires significant judgment and the decision to combine a group of contracts or separate the combined or single contract into multiple performance obligations could change the amount of revenue and profit recorded in a given period.

All of the Company’s current long-term contracts have a single performance obligation as the promise to transfer the goods or services are not separately identifiable from other promises in the contracts and, therefore, not distinct. The Company’s contracts are often modified to account for changes in contract specifications and requirements. The Company considers contract modifications to exist when the modification either creates new or changes the existing enforceable rights and obligations. All of the Company’s contract modifications are for goods or services that are not distinct from the existing contract due to the significant integration service provided in the context of the contract and are accounted for as if they were part of that existing contract. The effect of a contract modification on the transaction price, and the measure of progress for the performance obligation to which it relates, is recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) on a cumulative catch-up basis.

Revenues for the Company’s long-term contracts are recognized over time as the Company performs its obligations because of continuous transfer of control to the customer. The continuous transfer of control to the customer is supported by clauses in contracts that either allow the customer to unilaterally terminate the contract for convenience, pay the Company for costs incurred plus a reasonable profit and the products and services have no alternative use or the customer controls the work in progress.

Because of control transferring over time, revenue is recognized based on the extent of progress towards completion of the performance obligation. The selection of the method to measure progress towards completion requires judgment and is based on the nature of the products or services to be provided. The Company uses the cost-to-cost input method to measure progress for its contracts because it best depicts the transfer of assets to the customer which occurs as the Company incurs costs on its contracts.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

In applying the cost-to-cost input method, the Company compares the actual costs incurred relative to the total estimated costs to determine its progress towards contract completion and to calculate the corresponding amount of estimated revenue and estimated gross profit recognized. For any costs incurred that do not contribute to a performance obligation, the Company excludes such costs from its input methods of revenue recognition as the amounts are not reflective in transferring control of the asset to the customer. Costs to fulfill a performance obligation include labor, materials and subcontractors’ costs, other direct costs and an allocation of indirect costs.

Changes to the original estimates may be required during the life of the contract. Estimates are reviewed monthly and the effect of any change in the estimated gross margin for a contract is reflected in revenue in the period the change becomes known. Contract estimates involve considerable use of judgement in determining revenues, profits and in assigning the amounts to accounting periods. As a result, there can be a significant disparity between earnings (both for accounting and tax purposes) as reported and actual cash received during any reporting period. The Company continually evaluates all of the issues related to the assumptions, risks and uncertainties inherent with the application of the cost-to-cost input method; however, it cannot be assured that estimates will be accurate. If estimates are not accurate or a contract is terminated, the Company is required to adjust revenue in later periods. Furthermore, even if estimates are accurate, there may be a shortfall in cash flow and the Company may need to borrow money, or seek access to other forms of liquidity, to fund its work in process or to pay taxes until the reported earnings materialize as actual cash receipts.

For the Company’s uncompleted contracts, contract assets include unbilled amounts when the estimated revenues recognized exceed the amount billed to the customer and right to payment is not just subject to the passage of time. Amounts may not exceed their net realizable value. Contract assets are classified as current. The Company’s contract liabilities consist of billings in excess of estimated revenues recognized and contract losses. Contract liabilities are classified as current. The Company’s contract assets and liabilities are reported on a contract-by-contract basis at the end of each reporting period.

Revenue recognized for the three and nine months ended September 30, 2019, that was included in the contract liabilities at January 1, 2019 was $2.6 million.

The Company’s remaining performance obligations represent the transaction price of its long-term contracts for which work has not been performed. As of September 30, 2019, the aggregate amount of transaction price allocated to the remaining performance obligations was $255.2 million. The Company estimates that it expects to recognize approximately 18% of its remaining performance obligations in 2019 and 82% revenue in 2020.

In addition, the Company recognizes revenue for products manufactured by WMI and parts supplied for certain Maintenance Repair and Overhaul (“MRO”) contracts at a point in time following the transfer of control to the customer, which typically occurs upon shipment or delivery, depending on the terms of the underlying contract.

Revenue from long-term contracts recognized over time and revenue from contracts recognized at a point in time accounted for approximately 83% and 17%, respectively, for the nine months ended September 30, 2019.

Revenue from long-term contracts recognized over time and revenue from contracts recognized at a point in time accounted for approximately 76% and 24%, respectively, for the three months ended September 30, 2019.

Revenue by long-term contracts type for the three and nine months ended September 30, 2019 and 2018 is as follows:

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

4.       lEases

The Company leases a building and equipment. Under ASC 842, at contract inception we determine whether the contract is or contains a lease and whether the lease should be classified as an operating or a financing lease. Operating leases are included in ROU assets and operating lease liabilities in our consolidated balance sheets.

The Company leases manufacturing and office space under an agreement classified as an operating lease.

The lease agreement expires on April 30, 2022 and does not include any renewal options. The agreement provides for an initial monthly base amount plus annual escalations through the term of the lease.

In addition to the monthly base amounts in the lease agreement, the Company is required to pay real estate taxes and operating expenses during the lease terms.

The Company also leases office equipment in agreements classified as operating leases.

For the three and nine months ended September 30, 2019, the Company’s operating lease expense was $439,825 and $1,319,764, respectively.

Future minimum lease payments under non-cancellable operating leases as of September 30, 2019 were as follows:

The following table sets forth the ROU assets and operating lease liabilities as of September 30, 2019:

The Company’s weighted average remaining lease term for its operating leases is 2.3 years.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

5.       reconciliation of cash and restricted cash

6.       inventory

The components of inventory consisted of the following:

7.       stock-based compensation

The Company accounts for stock-based compensation based on the fair value of the stock or stock-based instrument on the date of grant.

In January 2019, the Company granted 75,353 restricted stock units (“RSUs”) to its board of directors as partial compensation for the 2019 year. In January 2018, the Company granted 58,578 RSUs to its board of directors as partial compensation for the 2018 year. RSUs vest quarterly on a straight-line basis over a one-year period. The Company’s net income for the nine months ended September 30, 2019 and 2018 includes approximately $409,000 and $491,500, respectively, of non-cash compensation expense related to the RSU grants to the board of directors. This expense is recorded as a component of selling, general and administrative expenses.

In June 2019 a board member retired and 7,326 of his unvested RSUs were forfeited which were valued at approximately $47,000. In addition, in April 2019, the Company granted 6,677 RSUs to one of its board members as partial compensation for the 2019 year. RSUs vest quarterly on a straight-line basis over a one-year period. The Company’s net income for the nine months ended September 30, 2019 includes approximately $29,000 of non-cash compensation expense related to the RSU grants to the board member. In June 2019, two board members were granted an additional 2,725 RSUs as partial compensation for the 2019 year. The Company’s net income for the nine months ended September 30, 2019 includes approximately $15,000 of non-cash compensation expense related to the RSU grants to the board of directors.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

In April 2019, the Company granted 4,950 shares of common stock to various employees. For the nine months ended September 30, 2019, approximately $6,000 of compensation expense is included in selling, general and administrative expenses and approximately $26,000 of compensation expense is included in cost of revenue for this grant. In January 2018, the Company granted 5,130 shares of common stock to various employees. For the nine months ended September 30, 2018, approximately $10,000 of compensation expense is included in selling, general and administrative expenses and approximately $36,000 of compensation expense is included in cost of revenue for this grant. 

In March 2018, the Company granted 68,764 shares of common stock to various employees. In the event that any of these employees voluntarily terminates their employment prior to certain dates, portions of the shares may be forfeited. In addition, if certain Company performance criteria are not achieved, portions of these shares may be forfeited. These shares will be expensed during various periods through March 2022 based upon the service and performance thresholds. For the nine months ended September 30, 2019, approximately $197,000 of compensation expense is included in selling, general and administrative expenses and approximately $38,000 of compensation expense is included in cost of revenue for this grant.

In April 2019, the Company granted 94,972 shares of common stock to various employees. In the event that any of these employees voluntarily terminates their employment prior to certain dates, portions of the shares may be forfeited. In addition, if certain Company performance criteria are not achieved, portions of these shares may be forfeited. These shares will be expensed during various periods through March 2023 based upon the service and performance thresholds. For the nine months ended September 30, 2019, approximately $137,000 of compensation expense is included in selling, general and administrative expenses and approximately $42,000 of compensation expense is included in cost of revenue for this grant.

On February 12, 2019, these employees returned 1,221 common shares, valued at approximately $7,893, to pay the employees’ withholding taxes.

In April 2019, 11,193, 8,299 and 8,593 of the shares granted in 2016, 2017 and 2018, respectively, were forfeited because the Company failed to achieve certain performance criteria for the year ended December 31, 2018. In addition, on April 2, 2019, these employees returned 9,806 common shares, valued at approximately $64,000, to pay the employees’ withholding taxes.

In March 2018, 12,330 and 9,130 of the shares granted in 2016 and 2017, respectively, were forfeited because the Company failed to achieve certain performance criteria for the year ended December 31, 2017. In addition, on March 22, 2018, these employees returned 7,552 common shares, valued at approximately $62,000, to pay the employees’ withholding taxes.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

A summary of the status of the Company’s stock option plans as of September 30, 2019 and changes during the nine months ended September 30, 2019 is as follows:

During the nine months ended September 30, 2019, 35,000 stock options were exercised, pursuant to the provisions of the stock option plan, where the Company received no cash and 34,478 shares of its common stock in exchange for the 35,000 shares issued in the exercise. The 34,478 shares that the Company received were valued at $231,003, the fair market value of the shares on the date of exercise. During the nine months ended September 30, 2018, no stock options were granted or exercised.

8.       Fair Value

Fair Value

At September 30, 2019 and December 31, 2018, the fair values of cash, accounts receivable and accounts payable approximated their carrying values because of the short-term nature of these instruments.

We estimated the fair value of debt using market quotes and calculations based on market rates.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

9.        Contract assets and contract liabilities

Net contract assets consist of the following:

The increase in the Company’s net contract assets from January 1, 2019 to September 30, 2019 was primarily due to costs incurred on the G-650 program ($2.2 million increase), the new design of the HondaJet engine inlet ($1.8 million increase), for which the Company has not begun billing on a steady rate and the Raytheon Next Generation Jammer pod 2.0 ($3.3 million increase). Additionally, contract assets on the Company’s F-35 Lock Assembly program increased $0.6 million.

U.S. government contracts includes contracts directly with the U.S. government and government subcontractors.

Revisions in the estimated gross profits on contracts and contract amounts are made in the period in which the circumstances requiring the revisions occur. During the nine months ended September 30, 2019, the effect of such revisions in total estimated contract profits resulted in a decrease to the total gross profit to be earned on the contracts of approximately $327,000 from that which would have been reported had the revised estimates been used as the basis of recognition of contract profits in prior years. During the nine months ended September 30, 2018, the effect of such revisions was a decrease to total gross profit of approximately $683,000.

Although management believes it has established adequate procedures for estimating costs to uncompleted open contracts, it is possible that additional significant costs could occur on contracts prior to completion.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Basic income per common share is computed using the weighted average number of common shares outstanding. Diluted income per common share for the three and nine months ended September 30, 2019 and 2018 is computed using the weighted-average number of common shares outstanding adjusted for the incremental shares attributed to outstanding options to purchase common stock, as well as unvested RSUs. Incremental shares of 18,672 were used in the calculation of diluted income per common share in the three and nine months ended September 30, 2019. Incremental shares of 49,641 were used in the calculation of diluted income per common share in the three and nine months ended September 30, 2018. Incremental shares of 43,064 were not used in the calculation of diluted income per common share in the three and nine months ended September 30, 2018, as their exercise price was in excess of the Company’s average stock price for the respective period and, accordingly, these shares are not assumed to be exercised for the diluted earnings per share calculation, as they would be anti-dilutive.

On March 24, 2016, the Company entered into a Credit Agreement (as amended, the “Credit Agreement”) with BankUnited, N.A. as the sole arranger, administrative agent and collateral agent and a lender and Citizens Bank N.A. as a lender (the “BankUnited Facility”). The BankUnited Facility provides for a revolving credit loan commitment of $30 million (the “Revolving Loan”) and a $10 million term loan (“Term Loan”). The Revolving Loan bears interest at a rate based upon a pricing grid, as defined in the agreement. On June 25, 2019, the Credit Agreement was amended and the Company and the banks entered into an assignment and acceptance agreement whereby Citizens Bank N.A.’s interest in the BankUnited Facility was transferred to BNB Bank. Additionally, the Revolving Loan and Term Loan maturity date was extended to June 30, 2021.

Under the Credit Agreement, upon the consummation of a public offering of common stock that results in gross proceeds of $7 million or more, (A) the Company will prepay the loans in an amount equal to 25% of net proceeds of the offering (with $1.2 million applied to the Term Loan and the remainder applied to the revolving line of credit) and (B) the Company will maintain a minimum of $3 million of combined unrestricted cash in accounts with BankUnited, N.A., and in availability under the Revolving Loan. As of September 30, 2019, the Company had approximately $1.1 million of availability under the revolving line of credit for this combined criteria.

As of September 30, 2019, the Company had $26.7 million outstanding under the Revolving Loan bearing interest at 5.87%.

The Company paid to BankUnited, N.A. commitment and agent fees in the amount of $25,000, together with out-of-pocket costs, expenses, and reasonable attorney’s fees incurred by BankUnited, N.A. in connection with the amendment.

The Company paid approximately $488,000 of total debt issuance costs in connection with the BankUnited Facility, of which approximately $99,000 is included in other assets and $22,000 is a reduction of long-term debt at September 30, 2019.

The Term Loan had an initial amount of $10 million, payable in monthly installments, as defined in the agreement, which originally matured on June 30, 2020.

The maturities of long-term debt (excluding unamortized debt issuance costs) are as follows:

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

As of September 30, 2019, the Company was in compliance with all of the financial covenants contained in the BankUnited Facility, as amended.

The BankUnited Facility is secured by all of the Company’s assets.

In addition to the Term Loan, included in long-term debt are capital leases and notes payable of $1,034,706, including a current portion of $399,012.

12.       Income taxes

In February 2019, the Company received information that the net operating loss carryback that was generated in 2014 and carried back to 2012 and 13 was under examination and could possibly be disallowed by the IRS. The Company had not received a written notice or tax assessment related to the possible disallowance of the net operating loss carryback. Although the Company had not received any formal documentation or notice of such disallowance, in accordance with ASC 740-10 “Accounting for Uncertainty in Tax Positions”, the Company recorded a liability of approximately $3.1 million in the year ended December 31, 2018 for this uncertainty. The liability represents the maximum net tax adjustment for the disallowance of the net operating loss carryback, computed at the pre-2018 tax rates, and tax savings of recording a net operating loss carryforward, calculated at the current tax rates.

In May 2019, the Company received further information from the IRS related to the possible disallowance of our net operating loss carryback. Based on the new IRS communication, the liability related to this uncertain tax position was reduced by approximately $1.4 million in the three months ended September 30, 2019, which results in a provision for income taxes of $323,000 and a benefit from income taxes $276,000 for the three and nine months ended September 30, 2019, respectively, compared to provision for income taxes of $126,000 and $775,000 for the three and nine months ended September 30, 2018, respectively.

The Company has not yet received an assessment of additional tax related to this matter. If the Company receives an official tax assessment we have the ability to appeal the disallowance, as well as go to tax court to challenge the notice. 

13.       MAJOR CUSTOMERS

During the nine months ended September 30, 2019, the Company’s four largest commercial customers accounted for 26%, 16%, 13% and 13% of revenue. During the nine months ended September 30, 2018, the Company’s four largest commercial customers accounted for 25%, 12%, 12% and 12% of revenue. In addition, during the nine months ended September 30, 2019 and 2018, 8% and 13% of revenue, respectively, was directly from the U.S. government.

At September 30, 2019, 38%, 13%, 13% and 12% of contract assets were from the Company’s four largest commercial customers. At December 31, 2018, 39%, 14%, 13% and 13% of contract assets were from the Company’s four largest commercial customers.

At September 30, 2019 and December 31, 2018, 1% and 2%, respectively, of contract assets were directly from the U.S. government.

At September 30, 2019, 39% and 12% of our accounts receivable were from our two largest commercial customers. At December 31, 2018, 20%, 18%, and 17% of accounts receivable were from our three largest commercial customers.

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the Company’s consolidated financial statements and notes thereto contained in this report.

Forward Looking Statements

When used in this Form 10-Q and in future filings by us with the Securities and Exchange Commission, the words or phrases “will likely result,” “management expects” or “we expect,” “will continue,” “is anticipated,” “estimated” or similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Readers are cautioned not to place undue reliance on any such forward-looking statements, each of which speaks only as of the date made. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. The risks are included in Item 1A - Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2018 and Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this Form 10-Q. We have no obligation to publicly release the result of any revisions which may be made to any forward-looking statements to reflect anticipated or unanticipated events or circumstances occurring after the date of such statements.

Business Operations

We are a manufacturer of structural aircraft parts for fixed wing aircraft and helicopters in both the commercial and defense markets. Within the global aerostructure supply chain, we are either a Tier 1 supplier to aircraft Original Equipment Manufacturers (“OEMs”) or a Tier 2 subcontractor to major Tier 1 manufacturers. We also are a prime contractor to the U.S. Department of Defense, primarily the Air Force. In conjunction with our assembly operations, we provide engineering, program management, supply chain management, and Maintenance Repair & Overhaul (“MRO”) services.

Recent defense industry consolidation may result in leaner supply chains across the industry, a decrease in the number of preferred suppliers, and new priorities for consolidated OEMs, increasing competition for the programs and contracts that we supply. In addition, vertical consolidation may mean that our major customers may choose not to outsource production of products that we currently supply.

We have positioned our Company to take advantage of opportunities in the military aerospace market to a broad customer base, which we believe will reduce the potential impact of industry consolidation. Our success as a subcontractor to defense prime contractors has provided us with opportunities to act as a subcontractor to prime contractors in the production of commercial aircraft structures, which we believe will also reduce our exposure to defense industry consolidation, government spending decisions, and other defense industry risks.

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

Backlog

We produce custom assemblies pursuant to long-term contracts and customer purchase orders. Backlog consists of aggregate values under such contracts and purchase orders, excluding the portion previously included in operating revenues pursuant to ASC 606, and including estimates of future contract price escalation. Substantially all of our backlog is subject to termination at will and rescheduling, without significant penalty. Funds are often appropriated for programs or contracts on a yearly or quarterly basis, even though the contract may call for performance that is expected to take a number of years. Therefore, our funded backlog does not include the full value of our contracts. Our total backlog as of September 30, 2019 and December 31, 2018 was as follows:

Approximately 91% of the total amount of our total backlog at September 30, 2019 was attributable to government contracts. Our backlog attributable to government contracts at September 30, 2019 and December 31, 2018 was as follows:

Our backlog attributable to commercial contracts at September 30, 2019 and December 31, 2018 was as follows:

Our unfunded backlog is primarily comprised of the long-term contracts for the Northrop Grumman E-2D, F-16 Falcon, T-38C trainer aircraft for the U.S. government, Lockheed F-35, HondaJet Light Business Jet, Bell AH-1Z, Sikorsky S-92, Boeing A-10, Embraer Phenom 300 and Raytheon Next Generation Jammer pod. These long-term contracts are expected to have yearly orders, which will be funded in the future.

The low level of funded backlog on commercial programs is the result of customers placing funded orders based upon expected lead time. These programs are under long-term agreements with our customers, and as such, we are protected by termination liability provisions.

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

Critical Accounting Policies

Revenue Recognition

Effective January 1, 2018, the Company adopted Accounting Standards Codification Topic 606 “Revenue from Contracts with Customers” (“ASC 606”) using the modified retrospective method for all of its contracts. ASC 606 requires sales and gross profit to be recognized over the contract period as work is performed based on the relationship between actual costs incurred and total estimated costs at the completion of the contract. Recognized revenues that will not be billed under the terms of the contract until a later date are recorded as an asset captioned “Contract assets.” Contracts where billings to date have exceeded recognized revenues are recorded as a liability captioned “Contract liabilities.” Changes to the original estimates may be required during the life of the contract. Estimates are reviewed monthly and the effect of any change in the estimated gross margin percentage for a contract is reflected in cost of sales in the period the change becomes known. ASC 606 involves considerable use of estimates in determining revenues, costs and profits and in assigning the amounts to accounting periods. As a result, there can be a significant disparity between earnings (both for accounting and tax purposes) as reported and actual cash received during any reporting period. The Company continually evaluates all of the issues related to the assumptions, risks and uncertainties inherent with the process; however, it cannot be assured that estimates will be accurate. If estimates are not accurate or a contract is terminated, the Company is required to adjust revenue in later periods. Furthermore, even if estimates are accurate, there may be a shortfall in cash flow and the Company may need to borrow money, or seek access to other forms of liquidity, to fund its work in process or to pay taxes until the reported earnings materialize as actual cash receipts.

When changes are required for the estimated total revenue on a contract, these changes are recognized with an inception-to-date effect in the current period. Also, when estimates of total costs to be incurred exceed estimates of total revenue to be earned, a provision for the entire loss on the contract is recorded in the period in which the loss is determined.

Following the adoption of ASC 606, the Company’s revenue recognition for all of its contracts remained materially consistent with historical practice and there was no impact in the three months ended March 31, 2018 consolidated financial statements upon adoption.

Leases

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, Leases (“ASC 842”), which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both lessees and lessors. On January 1, 2019, the Company adopted the new lease standard using the optional transition method under which comparative financial information will not be restated and continue to apply the provisions of the previous lease standard in its annual disclosures for the comparative periods. In addition, the new lease standard provides a number of optional practical expedients in transition. The Company elected the package of practical expedients. As such, the Company did not have to reassess whether expired or existing contracts are or contain a lease; did not have to reassess the lease classifications or reassess the initial direct costs associated with expired or existing leases.

ASC 842 also provides practical expedients for an entity's ongoing accounting. The Company elected the short-term lease recognition exemption under which the Company will not recognize right-of-use (“ROU”) assets or lease liabilities, and this includes not recognizing ROU assets or lease liabilities for existing short-term leases. The Company elected the practical expedient to not separate lease and non-lease components for certain classes of assets (office building).

On January 1, 2019, the Company recognized ROU assets and lease liabilities of approximately $5.3 million and $5.8 million, respectively, on its consolidated balance sheets using an estimated incremental borrowing rate of 6%.

Item 2 – Management’s Discussion and Analysis of Financial Condition and

Results of Operations

Results of Operations

Revenue

Revenue for the three months ended September 30, 2019 was $25,711,153 compared to $19,017,301 for the same period last year, an increase of $6,693,852 or 35.2%. Approximately $5.2 million of this increase is the result of the inclusion of WMI revenue, which we acquired in December of 2018. Additionally, there was an increase of $1.3 million related to the E-2D program.

Revenue for the nine months ended September 30, 2019 was $74,452,935 compared to $57,470,163 for the same period last year, an increase of $16,982,772 or 29.6%. Approximately $9.1 million of this increase is the result of the inclusion of WMI revenue, which we acquired in December of 2018. Additionally, there was an increase of $8.1 million because of the increasing production rates of the Next Generation Jammer pod program.

Revenue from government subcontracts was $17,082,754 for the three months ended September 30, 2019 compared to $9,516,799 for the three months ended September 30, 2018, an increase of $7,565,955 or 79.5%. Approximately $5 million of this increase is the result of the inclusion of WMI revenue, which we acquired in December of 2018. Additionally, there was an increase in revenue related to the E-2D program described above.

Revenue from government subcontracts was $48,344,906 for the nine months ended September 30, 2019 compared to $28,228,457 for the nine months ended September 30, 2018, an increase of $20,116,449 or 71.3%. Approximately $8.4 million of this increase is the result of the inclusion of WMI revenue, which we acquired in December of 2018. Additionally, the increase in revenue is a result of the increasing production rates of the Next Generation Jammer pod program as described above.

Revenue from direct military was $1,818,783 for the three months ended September 30, 2019 compared to $1,963,805 for the three months ended September 30, 2018, a decrease of $145,022 or 7.4%. The decrease in revenue is primarily driven by a decrease in revenue from T-38 kits, offset by an increase in revenue because of F-16 sales and the addition of WMI.

Revenue from direct military was $5,902,340 for the nine months ended September 30, 2019 compared to $6,877,727 for the nine months ended September 30, 2018, a decrease of $975,387 or 14.2%. The decrease in revenue is primarily driven by a decrease in revenue from T-38 kits, offset by an increase in revenue of F-16 sales and the addition of WMI.

Revenue from commercial subcontracts was $6,809,616 for the three months ended September 30, 2019 compared to $7,536,697 for the three months ended September 30, 2018, a decrease of $727,081 or 9.6%. The decrease is the result of lower revenue from the HondaJet program of $0.6 million and on the G650 program of approximately $0.2 million.

Revenue from commercial subcontracts was $20,205,689 for the nine months ended September 30, 2019 compared to $22,363,979 for the nine months ended September 30, 2018, a decrease of $2,158,290 or 9.7%. The decrease is predominately the result of lower revenue on the G650 program of approximately $2.7 million, offset by the increase in revenue from HondaJet program of approximately $0.2 million.

Inflation historically has not had a material effect on our operations.

Cost of sales

Cost of sales for the three months ended September 30, 2019 and 2018 was $20,748,065 and $15,146,080, respectively, an increase of $5,601,985 or 37%. This increase is the result of the comparable increase in revenue.

Cost of sales for the nine months ended September 30, 2019 and 2018 was $59,117,855 and $44,964,256, respectively, an increase of $14,153,599 or 31.5%. This increase is the result of the comparable increase in revenue.

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

The components of the cost of sales were as follows:

Other contract costs (credit), net for the three months ended September 30, 2019 were $195,321 compared to $(50,452), an increase of $245,773. Other contract costs (credit), net for the nine months ended September 30, 2019 were $105,865 compared to $(53,440), an increase of $159,305. Other contract costs relate to expenses recognized for changes in estimates and expenses predominately associated with loss contracts. In the three months ended September 30, 2018 and nine months ended September 30, 2018, other contract costs are a credit, as we have incurred actual expenses on our A-10 program that had been previously recognized as part of the change in estimate charge.

Procurement for the three months ended September 30, 2019 was $11,868,864 compared to $9,606,143, an increase of $2,262,721 or 23.6%. Increase is predominantly the result of WMI which accounted for approximately $1.4 million of procurement. Procurement for the nine months ended September 30, 2019 was $38,738,996 compared to $28,551,130, an increase of $10,187,866 or 35.7%. This increase is predominately the result of a $4.9 million increase in procurement related to the Raytheon Next Generation Jammer pod program.

Labor costs for the three months ended September 30, 2019 were $1,967,144 compared to $1,490,227, an increase of $476,916 or 32%. The increase is predominantly the result of $337,000 of WMI labor and $163,000 associated with the Next Generation Jammer pod program, which is very labor intensive.

Labor costs for the nine months ended September 30, 2019 were $5,876,664 compared to $4,737,522, an increase of $1,139,142 or 24%. The increase is predominantly the result of $933,000 of WMI labor and $231,000 associated with the Next Generation Jammer pod program, as described above.

Factory overhead for the three months ended September 30, 2019 was $5,164,788 compared to $4,100,162, an increase of $1,064,626 or 26%. The increase in factory overhead is predominately the result of an increase of additional costs in the current year related to WMI.

Factory overhead for the nine months ended September 30, 2019 was $15,088,391 compared to $11,729,044, an increase of $3,359,347 or 28.6%. The increase in factory overhead is predominately the result of an increase of additional costs in the current year related to WMI.

Gross Profit

Gross profit for the three months ended September 30, 2019 was $4,963,088 compared to $3,871,221 for the three months ended September 30, 2018, an increase of $1,091,867 or 28.2%, predominately the result of higher volume. Gross profit percentage three months ended September 30, 2019 was 19.3% compared to 20.4% for the three months ended September 30, 2018, a decrease of 1.1%, predominately the result of a lower margin from WMI.

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

Gross profit for the nine months ended September 30, 2019 was $15,335,080 compared to $12,505,907 for the nine months ended September 30, 2018, an increase of $2,829,173 or 22.6%, predominately the result of higher volume. Gross profit percentage nine months ended September 30, 2019 was 20.6% compared to 21.8% for the nine months ended September 30, 2018, a decrease of 1.2%, predominately the result of a lower margin from WMI.

Favorable/Unfavorable Adjustments to Gross Profit (Loss)

During the nine months ended September 30, 2019 and 2018, circumstances required that we make changes in estimates to various contracts. Such changes in estimates resulted in changes in total gross profit as follows:

During the nine months ended September 30, 2019, we had one contract that had a $368,000 favorable adjustment, caused by the completion of the program at a favorable rate. In addition, we had two contracts that had unfavorable adjustments totaling $440,000 caused by excess overhead and material costs incurred. There were no other material changes favorable or unfavorable during the nine months ended September 30, 2019.

During the nine months ended September 30, 2018, we had one contract which had approximately $240,000 unfavorable adjustment caused by changing estimates on a long-term program, for which we are working with the customer to agree to contract extensions and are adjusting our long-term margin estimates. In addition, we had two contracts that had unfavorable adjustments totaling $381,000 caused by excess overhead and material costs incurred. There were no other material changes favorable or unfavorable during the nine months ended September 30, 2018.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the three months ended September 30, 2019 were $2,594,980 compared to $2,584,560 for the three months ended September 30, 2018, an increase of $10,420, or 0.4%. This change was predominately the result of an increase of additional costs in the current year related to WMI and approximately $285,000 in salaries offset by lower accounting and legal fees.

Selling, general and administrative expenses for the nine months ended September 30, 2019 were $8,110,736 compared to $7,192,159 for the nine months ended September 30, 2018, an increase of $918,577, or 12.8%. This change was predominately the result of an increase of additional costs in the current year related to WMI and approximately $767,000 in salaries.

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

Income Before Provision for (Benefit from) Income Taxes

Income before provision for (benefit from) income taxes for the three months ended September 30, 2019 was $1,989,913 compared to $711,896 for the same period last year, an increase of $1,278,017 or 179.5%, predominately the result of higher government subcontractor revenue. Income before provision for (benefit from) income taxes for the nine months ended September 30, 2019 was $5,759,968 compared to $3,874,886 for the same period last year, an increase of $1,885,082 or 48.6%, predominately the result of higher government subcontractor revenue.

Provision for (Benefit from) Income Taxes

In February 2019, the Company received information that the net operating loss carryback that was generated in 2014 and carried back to 2012 and 13 was under examination and could possibly be disallowed by the IRS. The Company had not received a written notice or tax assessment related to the possible disallowance of our net operating loss carryback. Although the Company had not received any formal documentation or notice of such disallowance, in accordance with ASC 740-10 “Accounting for Uncertainty in Tax Positions”, the Company recorded a liability of approximately $3.1 million in the year ended December 31, 2018 for this uncertainty. The liability represents the maximum net tax adjustment for the disallowance of the net operating loss carryback, computed at the pre-2018 tax rates, and tax savings of recording a net operating loss carryforward, calculated at the current tax rates.

In May 2019, we received further information from the IRS related to the possible disallowance of our net operating loss carryback. Based on the new IRS communication, the liability related to this uncertain tax position was reduced by approximately $1.4 million in the three months ended September 30, 2019, which results in a provision for income taxes of $323,000 and a benefit from income taxes $276,000 for the three and nine months ended September 30, 2019, respectively, compared to provision for income taxes of $126,000 and $775,000 for the three and nine months ended September 30, 2018, respectively.

We have not yet received an assessment of additional tax related to this matter. If we receive an official tax assessment we have the ability to appeal the disallowance, as well as go to tax court to challenge the notice. 

Net Income

Net income for the three months ended September 30, 2019 was $1,666,913 or $0.14 per basic share, compared to $585,896 or $0.07 per basic share, for the same period last year. Diluted income per share was $0.14 for the three months ended September 30, 2019 calculated utilizing 11,724,993 weighted average shares outstanding. Diluted income per share was $0.07 for the three months ended September 30, 2018 calculated utilizing 8,977,075 weighted average shares outstanding.

Net income for the nine months ended September 30, 2019 was $6,035,968 or $0.51 per basic share, compared to $3,099,886 or $0.35 per basic share, for the same period last year. Diluted income per share was $0.51 for the nine months ended September 30, 2019 calculated utilizing 11,815,252 weighted average shares outstanding. Diluted income per share was $0.35 for the nine months ended September 30, 2018 calculated utilizing 8,951,640 weighted average shares outstanding.

Net income for the three and nine months ended September 30, 2019 includes an approximate $0.09 adjustment for the reversal of tax liability described above.

Liquidity and Capital Resources

General

At September 30, 2019, we had working capital of $100,931,458 compared to $98,350,176 at December 31, 2018, an increase of $2,581,282 or 2.6%.

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

Cash Flow

A large portion of our cash flow is used to pay for materials and processing costs associated with contracts that are in process and which do not provide for progress payments. Costs for which we are not able to bill on a progress basis are components of “Contract Assets” on our consolidated balance sheets and represent the aggregate costs and related earnings for uncompleted contracts for which the customer has not yet been billed. These costs and earnings are recovered upon shipment of products and presentation of billings in accordance with contract terms.

Because ASC 606 requires us to use estimates in determining revenue, costs and profits and in assigning the amounts to accounting periods, there can be a significant disparity between earnings (both for accounting and tax purposes) as reported and actual cash that we receive during any reporting period. Accordingly, it is possible that we may have a shortfall in our cash flow and may need to borrow money, or to raise additional capital, until the reported earnings materialize into actual cash receipts.

At September 30, 2019, we had a cash balance of $468,536 compared to $4,128,142 at December 31, 2018. Additionally, at September 30, 2019 and December 31, 2018, we have $2,000,000 of restricted cash, which is cash held in escrow pursuant to the WMI acquisition and the determination of a final working capital adjustment.

Our contract assets increased by approximately $8.1 million during the nine months ended September 30, 2019.

Several of our programs require us to expend up-front costs that may have to be amortized over a portion of production units. In the case of significant program delays and/or program cancellations, we could be required to bear impairment charges which may be material, for costs that are not recoverable. Such charges and the loss of up-front costs could have a material impact on our liquidity.

We continue to work to obtain better payment terms with our customers, including accelerated progress payment arrangements, as well as exploring alternative funding sources.

We believe that our existing resources, together with the availability under our credit facility and the commitment that we have from BankUnited to extend our credit facility, will be sufficient to meet our current working capital needs for at least 12 months from the date of this filing.

Credit Facilities

Credit Agreement and Term Loan

On March 24, 2016, the Company entered into a Credit Agreement (as amended, the “Credit Agreement”) with BankUnited, N.A. as the sole arranger, administrative agent and collateral agent and a lender and Citizens Bank, N.A. as a lender (the “BankUnited Facility”). The BankUnited Facility provides for a revolving credit loan commitment of $30 million (the “Revolving Loan”) and a $10 million term loan (“Term Loan”). The Revolving Loan bears interest at a rate based upon a pricing grid, as defined in the agreement. On June 25, 2019, the Credit Agreement was amended and the Company and the banks entered into an assignment and acceptance agreement whereby Citizens Bank N.A.’s interest in the BankUnited Facility was transferred to BNB Bank. Additionally, the Revolving Loan and Term Loan maturity date was extended to June 30, 2021.

Under the Credit Agreement, upon the consummation of a public offering of common stock that results in gross proceeds of $7 million or more, (A) the Company will prepay the loans in an amount equal to 25% of net proceeds of the offering (with $1.2 million applied to the Term Loan and the remainder applied to the revolving line of credit) and (B) the Company will maintain a minimum of $3 million of combined unrestricted cash in accounts with BankUnited, N.A., and in availability under the Revolving Loan. As of September 30, 2019, the Company had approximately $1.1 million of availability under the revolving line of credit for this combined criteria.

As of September 30, 2019, the Company had $26.7 million outstanding under the Revolving Loan bearing interest at 5.87%.

The Term Loan had an initial amount of $10 million, payable in monthly installments, as defined in the agreement, which matures on June 30, 2021. The maturities of the Term Loan are included in the maturities of long-term debt.

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

As of September 30, 2019, the Company was in compliance with all of the financial covenants contained in the BankUnited Facility, as amended.

The BankUnited Revolving Facility is secured by all of our assets.

Contractual Obligations

For information concerning our contractual obligations, see Contractual Obligations under Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the year ended December 31, 2018.

Item 3 – Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

Item 4 – Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain a system of disclosure controls and procedures that is designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, as appropriate, to allow timely decisions regarding required disclosures. Disclosure controls and procedures also include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, or persons performing similar functions, and Board of Directors, as appropriate, to allow timely decisions regarding required disclosure.

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of September 30, 2019. Based on this evaluation and considering the material weakness in internal control over financial reporting described below, we concluded as of September 30, 2019, that our disclosure controls and procedures were effective at the reasonable assurance level.

A material weakness is a control deficiency or combination of control deficiencies that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. The following material weakness was identified subsequent to September 30, 2018. The review control procedures were inadequately designed to ensure that sales invoices were coded to the correct contract type. The result was a failure to identify, in a timely manner, the miscoding of an invoice in the Company’s records and the resulting overstatement of revenue. Because the foregoing material weakness in the Company’s internal control over financial reporting had not been remediated by or before the filing of the Form 10-Q for the three and nine months ended September 30, 2018 as originally filed with the SEC on November 13, 2018, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were not effective at the reasonable assurance level as of September 30, 2018. The Company has reviewed its financial closing process and has identified the corrective action to remediate the control failure that was the cause of this error and has implemented this control as well as certain other procedures in the first quarter of 2019. The Company has evaluated the effectiveness of the corrective action and has determined that the implementation of the new control procedures provides reasonable assurance that this type of error will not occur in the future.

Our evaluation excluded WMI which was acquired on December 20, 2018. As of and for the nine months ended September 30, 2019, WMI represented approximately 8% of total assets and 12% of revenue. In accordance with guidance issued by the SEC, companies are allowed to exclude acquisitions from their assessment of internal control over financial reporting during the first year subsequent to the acquisition while integrating the acquired operations.

Changes in Internal Control Over Financial Reporting

There has been no change in our internal control over financial reporting during the quarter ended September 30, 2019 that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.

Part II: Other Information

Item 1 – Legal Proceedings

CPI Aerostructures, Inc. v. Air Industries Group, et al. On September 27, 2019, the Company filed a notice of motion in the Supreme Court of the State of New York, County of New York against Air Industries Group (“Air Industries”) in connection with a working capital dispute. The Company is seeking, among other things, (i) an order of specific performance requiring Air Industries to comply with its obligations under the Stock Purchase Agreement entered into between the Company and Air Industries on March 21, 2018 and the Escrow Agreement entered into between the Company and Air Industries on December 20, 2018, and (ii) a judgment against Air Industries in the amount of approximately $3.6 million.

Item 1A – Risk Factors

Material risks related to our business, financial condition and results of operations are disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2018, as filed with the SEC on April 1, 2019. There have been no material changes to such risk factors. The risk factors disclosed in our Annual Report should be carefully considered in evaluating our business because such factors may have a significant impact on our business, operating results, liquidity and financial condition.

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

There have been no sales of unregistered equity securities for the nine months ended September 30, 2019.

Item 3 – Defaults Upon Senior Securities

None.

Item 4 – Mine Safety Disclosures

Not applicable.

Item 5 – Other Information

None.

Item 6 – Exhibits

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.