CPI AEROSTRUCTURES, INC. The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis includes forward-looking statements involving risks and uncertainties and should be read together with the "Risk Factors" section of this Annual Report on Form 10-K. Such risks and uncertainties could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. Recent Developments
Restatement of Non-Reliance Period Consolidated Financial Statements
OnFebruary 14, 2020 , the Company filed a Form 8-K disclosing that theAudit & Finance Committee of the Company's Board of Directors determined, based on the recommendation of management, that the Company's consolidated financial statements for the Non-Reliance Periods should no longer be relied upon due to errors in such consolidated financial statements relating to the Company's recognition of revenue from contracts with customers. 24
The Company applied the cost-to-cost percentage of completion method at the program level, that is, for the entire duration of production activity on a particular program. The Company used program-level accounting to both measure progress and estimate profit margin. The Company believed that the program was the correct unit of accounting under ASC Topic 606. The Company now recognizes that accounting guidance under ASC Topic 606 does not support its use of a manufacturing program as the unit of accounting. Instead, under ASC Topic 606, the performance obligation is the appropriate use of accounting. Determining each performance obligation under a particular program requires significant judgment but, in general, under ASC Topic 606, the Company has a performance obligation upon which it can recognize revenue when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are identified and enforceable, the contract has commercial substance and collectability of consideration is probable. For the Company, the contract under ASC 606 is typically established upon execution of a purchase order either in accordance with a long-term customer contract or on a standalone basis. The Company's cost-to-cost input method to measure progress must consider only the costs incurred relative to the total expected costs of satisfying a performance obligation. Similarly, under ASC Topic 606, the Company must estimate profit margins based on expected performance under a performance obligation. Revenue and profit margin must be constrained to revenue related to the satisfaction of a performance obligation to which the Company has an enforceable right to payment for performance completed. The errors were uncovered as part of the preparation of the Company's consolidated financial statements for the fiscal year endedDecember 31, 2019 . After reconsideration of the terms of the Company's contracts with customers, management concluded that certain revenues and net income were recognized inaccurately due to an incorrect application of generally accepted accounting principles inU.S. GAAP. Therefore, previously reported revenue and net income were overstated. In connection with its restatement, the Company andCohnReznick LLP identified and reported to theAudit and Finance Committee of the Company's Board of Directors material weaknesses. Please see "Item 9A, Controls and Procedures" for a description of these matters.
Amendment and Waiver to our BankUnited Credit Facility
OnAugust 24, 2020 , we entered into a Sixth Amendment and Waiver ("Sixth Amendment") to that certain Amended and Restated Credit Agreement with the Lenders named therein andBankUnited, N.A. ("BankUnited") as Sole Arranger, Agent and Collateral Agent, dated as ofMarch 24, 2016 (as amended from time to time, the "Credit Agreement"). In connection with the Sixth Amendment, we also amended the Amended and Restated Revolving Credit Note, dated as ofMarch 24, 2016 , which represents an aggregate principal revolving loan commitment amount of$30 million ("Revolving Note") and the Amended and Restated Term Note, dated as ofMarch 24, 2016 , with an original principal amount of$10 million ("Term Note").
Under the Sixth Amendment, and the related amendments to the Revolving Note and Term Note, an aggregate of$6 million of the outstanding balance under the Revolving Note was converted into and added to the outstanding balance on the Term Note. The availability under the Revolving Note was permanently reduced by$6 million , to$24 million , and the outstanding principal amount on the Term Note was increased to approximately$7,933,000 . Additionally, under the Sixth Amendment, the parties amended the Credit Agreement by (i) extending the maturity date of the Revolving Note and Term Note toMay 2, 2022 , and making conforming changes to the payment schedule on the Term Note, (ii) amending the fixed charge coverage ratio covenant by requiring the ratio to be quarterly forSeptember 30, 2020 andDecember 31, 2020 and then determined on a trailing twelve-month basis beginning onMarch 31, 2021 , (iii) waiving the leverage covenant noncompliance for each quarter ended during the period fromMarch 31, 2018 throughDecember 31, 2019 . The leverage covenant will not be tested for the four quarters fromMarch 31, 2020 throughDecember 31, 2020 . Then beginning with the quarter endingMarch 31, 2021 , the funded debt to EBITDA ratio shall be 4.0:1.0, tested on a trailing four quarter basis, (iv) reducing the minimum quarterly EBITDA covenant from$2 million to$1 million beginning onSeptember 30, 2020 , (v) maintaining a minimum net income, after taxes, of no less than$1.00 and (vi) replacing the interest pricing grid for the Revolving Note with an interest rate for Eurodollar loans of LIBOR plus 3.25% with a floor of 50 basis points or an interest rate for base rate loans equal to BankUnited's prime rate plus 0.25%. The errors in the financial statements for the Non-Reliance Periods and our internal control weaknesses caused us to be in violation of certain financial and non-financial covenants under the BankUnited Facility as of and afterMarch 31, 2018 . BankUnited has agreed to waive each covenant violation under the Credit Agreement in connection with the previously disclosed errors in our financial statements for the Non-Reliance Periods and to prospectively waive the covenant violation for late delivery of our financial statements for the first three quarters of 2020. BankUnited agreed not to test our compliance with the financial covenants under the Credit Agreement for the first half of 2020. Financial covenant testing will resume for the quarter endingSeptember 30, 2020 . BankUnited also consented to the incurrence of additional indebtedness by the Company pursuant to the previously-announced loan made byBNB Bank onApril 10, 2020 , of an aggregate principal amount of$4,795,000 pursuant to the Paycheck Protection Program under the Coronavirus Aid, Relief, and Economic Security ("CARES") Act and agreed that the income and debt effects of such loan will be excluded for covenant calculation purposes.
Paycheck Protection Program Loan
OnApril 10, 2020 , we entered into the PPP Loan, withBNB Bank as the Lender, in an aggregate principal amount of$4,795,000 , pursuant to the Paycheck Protection Program under the CARES Act. The PPP Loan is evidenced by the Note. Subject to the terms of the Note, the PPP Loan bears interest at a fixed rate of one percent (1%) per annum, with the first six months of interest deferred, has an initial term of two years, and is unsecured and guaranteed by theSmall Business Administration . The Company may apply to the Lender for forgiveness of the PPP Loan, with the amount which may be forgiven equal to the sum of payroll costs, covered rent and mortgage obligations, and covered utility payments incurred by the Company during the 24-week period beginning onApril 10, 2020 , calculated in accordance with the terms of the CARES Act, as modified by the Paycheck Protection Flexibility Act.
The Note provides for customary events of default including, among other things, cross-defaults on any other loan with the Lender. The PPP Loan may be accelerated upon the occurrence of an event of default.
Impact of COVID-19 The impact that the recent COVID-19 pandemic will have on our business is uncertain. Although we have been classified as an "essential business" byNew York State and is exempt from the state's mandate that all non-essentialNew York businesses close until further notice due to circumstances related to the coronavirus pandemic, certain of our staff have been working modified hours and remotely due to social distancing protocols and concern over their safety and the safety of others since on or aboutMarch 19, 2019 . 25 We anticipate potential supply chain disruptions, employee absenteeism, reductions in commercial aircraft orders and short-term suspensions of manufacturing at ours or our customers' facilities related to the COVID-19 pandemic that could unfavorably impact our business. We expect these disruptions to be limited to programs within our commercial business that accounts for approximately 20% of our total business and also to be temporary, but there can be no assurance that our military business will be unaffected and there is still uncertainty around the duration and overall impact to our business operation. We believe it is possible that the impact of the COVID-19 pandemic could have an adverse effect on the results of our operations, financial position and cash flow for the year endingDecember 31, 2020 . We have taken mitigating steps in an attempt to reduce the adverse effects. For example, we have curtailed discretionary spending, deferred all business travel, implemented a hiring freeze and other steps to preserve cash. We have also taken action to more closely manage the flow of materials into the operations in response to potentially weakened demand in our commercial programs. Certain Transactions
The following transactions occurred during the periods covered by this Management's Discussion and Analysis of Financial Condition and Results of Operations:
Acquisition of WMI OnMarch 21, 2018 , the Company entered into a SPA with Air Industries, pursuant to which the Company purchased from Air Industries all of the shares of WMI. OnDecember 20, 2018 , the Company completed the WMI Acquisition for a total purchase price of approximately$7.9 million . The Company's operating results include the operating results of WMI from the date of acquisition.
Underwritten Public Offering
OnOctober 19, 2018 , the Company completed an underwritten public offering of 2,760,000 shares of its common stock, including 360,000 shares pursuant to the underwriters' full exercise of their over-allotment option, at a public offering price of$6.25 per share. The Company's net proceeds from the offering, after deducting underwriting discounts, commissions, and other offering expenses, were approximately$16.1 million . The Company used a portion of the proceeds of the offering for the WMI Acquisition and used the balance of the net proceeds for general corporate purposes, including working capital, capital expenditures
and debt repayment. Business Operations
We are engaged in the contract production of structural aircraft parts for fixed wing aircraft and helicopters in both the commercial and defense markets. We also have a strong and growing presence in the aerosystems segment of the market, with our production of various reconnaissance pod structures and fuel panel systems. Within the global aerostructure and aerosystem supply chain, we are either a Tier 1 supplier to aircraft OEMs or a Tier 2 subcontractor to major Tier 1 manufacturers. We also are a prime contractor to theU.S. DOD , primarily the USAF. In conjunction with our assembly operations, we provide engineering, program management, supply chain management and kitting, and MRO services.
Restatement of Previously Issued Consolidated Financial Statements
The accompanying Management's Discussion and Analysis of Financial Condition and Results of Operations gives effect to the restatement adjustments made to the previously reported Consolidated Financial Statements as of and for the year endedDecember 31, 2018 . For additional information and a detailed discussion of the restatement, see Note 18, "Restatement of Previously Issued Consolidated Financial Statements" included in "Item 15, Exhibits and Financial Statement Schedules," of this Annual Report on Form 10-K. Critical Accounting Policies Revenue Recognition EffectiveJanuary 1, 2018 , the Company adopted Accounting Standards Codification Topic 606, "Revenue from Contracts with Customers" ("ASC 606"), using the modified retrospective method. In accordance with ASC 606, the Company recognizes revenue when it transfers control of a promised good or service to a customer in an amount that reflects the consideration it expects to be entitled to in exchange for the good or service. The majority of the Company's performance obligations are satisfied over time as the Company (i) sells products with no alternative use to the Company and (ii) has an enforceable right to recover costs incurred plus a reasonable profit margin for work completed to date. Under the over time revenue recognition model, revenue and gross profit are recognized over the contract period as work is performed based on actual costs incurred and an estimate of costs to complete and resulting total estimated costs at completion.
The corrected adoption of ASC 606 resulted in a restatement of previously issued consolidated financial statements. See Note 18.
See Note 3 "Revenue", for additional information regarding the Company's revenue recognition policy.
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Leases
InFebruary 2016 , theFinancial 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. OnJanuary 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). OnJanuary 1, 2019 , the Company recognized ROU assets and lease liabilities of approximately$5.3 million and$5.9 million , respectively, on its consolidated balance sheet using an estimated incremental borrowing rate of 6%. Results of Operations
The following discussion provides an analysis of our results of operations and should be read in conjunction with the accompanying consolidated financial statements and notes thereto.
Year Ended
Revenue.Revenue for the year endedDecember 31, 2019 was$87,518,688 compared to$70,366,016 (restated) for the same period last year, representing an increase of$17,152,672 . The majority of our revenue growth was contributed by our WMI subsidiary that was acquired inDecember 2018 and had immaterial revenue in 2018. Organic revenue growth during 2019 was approximately 7% driven primarily by increases in our E-2D kitting programs withNorthrop Grumman , the NGJ-MB pod program with Raytheon and our advanced missile wing contract with Raytheon that was a new start in 2019. Growth in these and other programs was partially offset by a decrease in revenue from our Gulfstream G650 fixed leading edge program with Triumph Group, our Pacer Classic III Phase 2 program with USAF as this effort transitions to Phase 3, and our AH-1Z engine inlet contract with Bell Helicopter. Overall, revenue generated from prime government contracts for the year endedDecember 31, 2019 was$6,429,860 compared to$8,774,967 (restated) for the year endedDecember 31, 2018 , a decrease of$2,345,107 . This decrease is primarily a result of a decrease in revenue recognized on the T-38C Pacer Classic III. Phase 2 aircraft structural modification program, as this program is transitioning from the Phase 2 to Phase 3. CPI Aero was awarded the Phase 3 contract in 2019. Revenue generated from government subcontracts for the year endedDecember 31, 2019 was$62,319,526 compared to$39,250,656 (restated) for the year endedDecember 31, 2018 , an increase of$23,068,870 . Year-end 2019 results include revenue from WMI which was acquired inDecember 2018 . The increase was a result of contributions from our WMI business which was acquired inDecember 2018 , increased production of E-2D wing panel kits and NGJ-MB pod structures, partially offset by a decrease in the production rate of the AH-1Z helicopter engine inlets. Revenue generated from commercial contracts was$18,769,302 for the year endedDecember 31, 2019 compared to$22,340,393 (restated) for the year endedDecember 31, 2018 , a decrease of$3,571,091 . Most of this decrease resulted from decreased production of the Gulfstream G650 fixed leading edge assembly. We also had year-over-year revenue declines in our programs with Honda and Embraer largely due to decreased business jet demand.
Cost of sales. Cost of sales for the years ended
The components of cost of sales were as follows:
Years ended
December 31,
December 31, 2018
2019 (restated)
Procurement $ 49,920,962 $ 43,810,298
Labor 7,778,571 6,251,997
Factory overhead 20,726,990 15,569,568
Other (39,526 ) 524,123
Cost of sales $ 78,386,997 $ 66,155,986
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Procurement for the year ended December 31, 2019 was $49,920,962 compared to
$43,810,298 (restated) for the year ended December 31, 2018 , an increase of
$6,110,664 or 14%. The majority of our procurement growth was for material
required by our WMI subsidiary that was acquired in December 2018 and had
immaterial procurement receipts in 2018. We also required more material compared
to 2018 for the programs that drove revenue growth in 2019, particularly our
E-2D kitting programs and the NGJ-MB pod.
Labor costs for the year ended December 31, 2019 were $7,778,571 compared to
$6,251,997 (restated for the year ended December 31, 2018 , an increase of
$1,526,574 or 24%. This increase is primarily from labor costs within our WMI
subsidiary as well as from increased labor required by higher production rates
of the NGJ-MB pod.)
Factory Overhead for the year ended December 31, 2019 were $20,726,990 compared
to $15,569,568 (restated for the year ended December 31, 2018 , an increase of
$5,157,422 or 33%. This increase is primarily from costs within our WMI
subsidiary.)
Other costs for the year ended December 31, 2019 was $(39,526) compared to
$524,123 (restated for the year ended December 31, 2018 , a decrease of $563,649 .
Other costs relate to expenses recognized for changes in estimates and expenses
primarily associated with inventory and loss contracts.)
Gross profit. Gross profit for the year ended December 31, 2019 was $9,131,691
compared to $4,210,030 for the year ended December 31, 2018 , an increase of
$4,921,661 . Gross profit percentage ("gross margin") for the year ended December
31, 2019 was 10.4% compared to 6% for the same period last year. The majority of
the increase was from our WMI subsidiary that was acquired in December 2018 and
had immaterial gross profit in 2018. Organic growth was primarily from our E2-D
programs kitting programs, partially offset by a decrease in gross profit on our
Pacer Classic III Phase 2 program with USAF as this effort transitions to Phase
3.
Favorable/Unfavorable Adjustments to Gross Profit
During the years endedDecember 31, 2019 and 2018, we made changes in estimates to various contracts. Such changes in estimates resulted in changes in total gross profit as follows: Years Ended December 31, December 31, 2018 2019 (restated) Favorable adjustments$ 416,130 $ 491,141 Unfavorable adjustments (321,715 ) (292,593 ) Net adjustments$ 94,415 $ 198,548 28
For the year endedDecember 31, 2019 , we evaluated all contractual data and revised estimated gross profit percentages accordingly. We had 17 contracts with favorable adjustments and 18 contracts with unfavorable adjustments, all due to changes in estimate.
For the year endedDecember 31, 2018 , we evaluated all contractual data and revised estimated gross profit percentages accordingly. We had 17 contracts with favorable adjustments and 13 contracts with unfavorable adjustments, all due to changes in estimate.
Selling, general and administrative expenses
Selling, general and administrative expenses ("SG&A") for the year ended
December 31, 2019 were $11,562,781 compared to $9,780,027 (restated) for the
year ended December 31, 2018 , an increase of $1,782,754 or 18.2%. This increase
was primarily due to the addition of SG&A required by our WMI subsidiary, as
well as, increased legal and accounting expenses compared to the prior period.
The increase in legal expenses is the result of increased legal fees associated
with the working capital dispute related to the WMI Acquisition.
Interest expense
Interest expense for the year ended December 31, 2019 was $2,104,851 , compared
to $1,989,417 (restated) for the year ended December 31, 2018 , an increase of
$115,434 or 5.8%. The increase in interest expense is the result of an increase
in the average amount of outstanding debt during 2019 as compared to 2018.Loss from operations We had a loss from operations for the year endedDecember 31, 2019 of ($2,433,090 ) compared to a loss from operations of ($5,569,997 ) (restated) for the year endedDecember 31, 2018 . This was primarily the result of the income generated by our WMI subsidiary which was acquired inDecember 2018 , as well as, favorable sales mix more weighted to higher margin military products. Provision for income taxes. The provision for income taxes for the year endedDecember 31, 2019 was$3,877 , an effective tax rate of 0.08%. InFebruary 2019 , the Company received information that the net operating loss carryback that was utilized in 2014 was under examination and could possibly be partially disallowed by the Internal Revenue Service ("IRS"). This adjustment was an issue of timing of the loss and had no income tax provision effect. InJune 2020 , the Company received a letter from theIRS stating that the returns will be accepted as filed. There is no uncertain tax position recorded for this item. Business Outlook
The statements in the "Business Outlook" section and other forward-looking statements of this Annual Report on Form 10-K are subject to revision during the course of the year in our quarterly earnings releases andSEC filings and at other times.
Liquidity and Capital Resources
General. AtDecember 31, 2019 , we had working capital of$13,851,717 compared to working capital of$21,282,972 (restated) atDecember 31, 2018 , a decrease of$7,431,255 , or 35%. This decrease is primarily the result of a decrease in current assets primarily driven by a decrease in WMI inventory as a result of shipments and final acquisition accounting valuation adjustments. Cash Flow A large portion of our cash 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 sheet 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 revenues, 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 until the reported earnings materialize into actual cash receipts. 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 and results of operations.
We continue to work to obtain better payment terms with our customers, including accelerated progress payment arrangements, as well as exploring alternative funding sources.
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At December 31, 2019 , our cash balance was $4,052,109 compared to $4,128,142 at
December 31, 2018 , a decrease of $76,033 . Our accounts receivable balance at
December 31, 2019 decreased to $7,029,602 from $8,722,571 at December 31, 2018 .
Additionally, at December 31, 2019 , we have $1,380,684 of restricted cash, which
is cash retained in escrow pursuant to the WMI Acquisition.
Bank Credit Facilities
OnMarch 24, 2016 , the Company entered into the BankUnited Facility. The Credit Agreement entered into in connection with the BankUnited Facility provided 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 Credit Agreement. OnJune 25, 2019 , the Company entered into a Fifth Amendment (the "Fifth Amendment") to the Credit Agreement. Under the Fifth Amendment, the parties amended the Credit Agreement by extending the maturity date of the Company's Revolving Loan and Term Loan toJune 30, 2021 and making conforming changes to the repayment schedule of the Term Loan. Additionally, in connection with the Fifth Amendment,Citizens Bank, N.A. assigned all of its obligations under the BankUnited Facility toBNB Bank . The BankUnited Facility, as amended by the Fifth Amendment, required us to maintain the following financial covenants: (1) maintain a debt service coverage ratio at the end of each quarter for the trailing four quarter period of no less than 1.5 to 1.0, (2) maintain a minimum net income, after taxes, of no less than$1.00 , (3) maintain a maximum leverage ratio at the end of each quarter for the trailing four quarter period of no more than 3.0 to 1.0, and (4) maintain a minimum adjusted EBITDA at the end of each quarter of no less than$2 million . The errors in our consolidated financial statements for the Non-Reliance Periods and our internal control material weaknesses caused us to be in violation of each of the foregoing covenants and other non-financial covenants as of and afterMarch 31, 2018 . As ofDecember 31, 2019 , the Company was not in compliance with the covenants contained in the BankUnited Facility, as amended. BankUnited has subsequently waived these covenant violations in conjunction with execution of the Sixth Amendment, which further amends the Credit Agreement, Revolving Note and Term Note. In addition to the covenant waivers, onAugust 24, 2020 , we entered into the Sixth Amendment, which further amends the Credit Agreement, Revolving Note and Term Note. See Note 17, "Subsequent Events", for a discussion of the amendments and waivers.
As of
We believe that our existing resources, together with the availability under the BankUnited Facility, will be sufficient to meet our current working capital needs for at least the next 12 months from the date of issuance of our consolidated financial statements.
The Term Loan had an initial amount of$10 million , payable in monthly installments, as defined in the Credit Agreement. After giving effect to the Sixth Amendment (described in more detail elsewhere in this Annual Report on Form 10-K) the Term Loan matures onMay 2, 2022 . The maturities of the Term Loan are included in the maturities of long-term debt. Contractual Obligations. The table below summarizes information about our contractual obligations as ofDecember 31, 2019 and the effects these obligations are expected to have on our liquidity and cash flow in the future years: Payments Due By Period Less than Contractual Obligations Total 1 year 1-3 years 4-5 years After 5 years Debt$ 3,318,514 $ 2,100,000 $ 1,218,514 $ - $ - Capital Lease Obligations 930,719 384,619 421,488 124,612 - Operating Leases 4,305,937 1,709,153 2,588,615 8,169 - Total Contractual Cash Obligations$ 8,555,170 $ 4,193,772 $ 4,228,617 $ 132,781 $ -
Inflation. Inflation historically has not had a material effect on our operations.
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