CPI Aerostructures Inc: Form 10-Q for the period ended Jun 30, 2024

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 “SEC”), 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 Part I, Item 1A – Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2023 (the “Form 10-K”). 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 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 sector 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 original equipment manufacturers (“OEMs”) or a Tier 2 subcontractor to major Tier 1 manufacturers. We also are a prime contractor to the United States Department of Defense (“DOD”), primarily the United States Air Force (“USAF”). In conjunction with our assembly operations, we provide engineering, program management, supply chain management and kitting, and maintenance, repair and overhaul (“MRO”) services.

Recent Developments

None.

Backlog

We produce custom assemblies pursuant to long-term contracts and customer purchase orders. Funded backlog consists of aggregate funded values under such contracts and purchase orders, excluding the portion previously included in operating revenues pursuant to Accounting Standards Codification Topic 606 (“ASC 606”). Unfunded backlog is the estimated amount of future orders under the expected duration of the programs. 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 June 30, 2024 and December 31, 2023 is shown below. We are currently in customer negotiations which, when concluded, will result in an estimated amount of approximately $32 million of the June 30, 2024 Unfunded Backlog converting to Funded Backlog.

Approximately 96% of the total amount of our backlog at June 30, 2024 was attributable to government and military contractor contracts. Our backlog attributable to government contracts at June 30, 2024 and December 31, 2023 was as follows:

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Our backlog attributable to commercial contracts at June 30, 2024 and December 31, 2023 was as follows:

The total backlog at June 30, 2024 is primarily comprised of long-term programs with Raytheon (Next Generation Jammer (“NGJ”) – Mid Band Pods and Advanced Tactical Pods), Lockheed Martin (F-16 RI/DCC’s), Raytheon (B-52 Radar Racks), USAF (T-38 Classic Structural Modification Kits), Raytheon (Airborne Reconnaissance Pods) and Embraer (Phenom 300 Engine Inlets).

The funded backlog at June 30, 2024 is primarily from purchase orders under long-term contracts with Raytheon (NGJ – Mid Band Pods and Advanced Tactical Pods), USAF (T-38 Classic Structural Modification Kits), Sikorsky (CH-53K Welded Tubes), Sikorsky (UH-60 BLACKHAWK Gunner Windows), Raytheon (Airborne Reconnaissance Pods), Boeing (A-10 Main Landing Gear Pods), Lockheed Martin (F-16 RI/DCC’s), and Embraer (Phenom 300 Engine Inlets).

Critical Accounting Estimates

We make a number of significant estimates, assumptions and judgments in the preparation of our financial statements. See Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Form 10-K, for a discussion of our critical accounting estimates. There have been no significant changes to the application of our critical accounting estimates during the quarter ended June 30, 2024.

Results of Operations

Revenue

Total Revenue for the three months ended June 30, 2024 was $20,810,334 compared to $20,547,555 for the same period last year, an increase of $262,779 or 1.3%, driven primarily by increases in our Raytheon NGJ – Mid Band Pods, Raytheon Airborne Reconnaissance Pods and Sikorsky Welded Tubes programs, partly offset by decreases in our Northrop Grumman E-2D Advanced Hawkeye Outer Wing Panels (“OWP”) and our Sikorsky UH-60 BLACKHAWK Hover Infrared Suppression System (“HIRSS”) Module Assemblies programs.

Total Revenue for the six months ended June 30, 2024 was $39,891,477 compared to $42,564,223 for the same period last year, a decrease of $2,672,746 or 6.3%, driven primarily by decreases in our Sikorsky UH-60 BLACKHAWK Hover Infrared Suppression System (“HIRSS”) Module Assemblies, Northrop Grumman E-2D Advanced Hawkeye Outer Wing Panels (“OWP”) and Sikorsky UH-60 BLACKHAWK Stabilator MRO programs, partly offset by increases in our Raytheon Airborne Reconnaissance Pods, Sikorsky Welded Tubes and USAF T-38 Pacer Classic Structural Modification Kits programs.

Revenue from military subcontracts was $16,963,874 for the three months ended June 30, 2024 compared to $16,502,026 for the three months ended June 30, 2023, an increase of $461,848 or 2.8%, driven primarily by increases in our Raytheon NGJ – Mid Band Pods, Raytheon Airborne Reconnaissance Pods and Sikorsky Welded Tubes programs, partly offset by decreases in our Northrop Grumman E-2D Advanced Hawkeye Outer Wing Panels (“OWP”) and our Sikorsky UH-60 BLACKHAWK Hover Infrared Suppression System (“HIRSS”) Module Assemblies programs.

Revenue from military subcontracts was $31,965,642 for the six months ended June 30, 2024 compared to $35,174,919 for the six months ended June 30, 2023, a decrease of $3,209,277 or 9.12%, driven primarily by decreases in our Sikorsky UH-60 BLACKHAWK Hover Infrared Suppression System (“HIRSS”) Module Assemblies, Northrop Grumman E-2D Advanced Hawkeye Outer Wing Panels (“OWP”) and Sikorsky UH-60 BLACKHAWK Stabilator MRO programs, partly offset by increases in our Raytheon Airborne Reconnaissance Pods, Sikorsky Welded Tubes and USAF T-38 Pacer Classic Structural Modification Kits programs.

Revenue from government military contracts was $2,601,347 for the three months ended June 30, 2024 compared to $2,710,925 for the three months ended June 30, 2023, a decrease of $109,578 or 4.0%, driven primarily by a decrease in our DLA F-16 Wing Skins program, partly offset by an increase in our USAF T-38 Pacer Classic Structural Modification Kits program.

Revenue from government military contracts was $5,383,228 for the six months ended June 30, 2024 compared to $4,118,959 for the six months ended June 30, 2023, an increase of $1,264,269 or 30.7%, driven primarily by an increase in our USAF T-38 Pacer Classic Structural Modification Kits program, partly offset by a decrease in our DLA F-16 Wing Skins program.

Revenue from commercial subcontracts was $1,245,113 for the three months ended June 30, 2024 compared to $1,334,604 for the three months ended June 30, 2023, a decrease of $89,491 or 6.7%, primarily on a decrease in our Embraer Phenom Engine Inlet Assemblies program.

Revenue from commercial subcontracts was $2,542,607 for the six months ended June 30, 2024 compared to $3,270,345 for the six months ended June 30, 2023, a decrease of $727,738 or 22.3%, primarily on a decrease in our Embraer Phenom Engine Inlet Assemblies program.

Cost of Sales

Total Cost of Sales for the three months ended June 30, 2024 and 2023 was $15,694,910 and $15,943,555, respectively, a decrease of $248,645 or 1.6%.

Total Cost of Sales for the six months ended June 30, 2024 and 2023 was $31,222,304 and $33,297,707, respectively, a decrease of $2,075,403 or 6.2%.

The components of the cost of sales were as follows:

Procurement for the three months ended June 30, 2024 was $10,118,041 compared to $9,470,763 for the three months ended June 30, 2023, an increase of $647,278 or 6.8%, driven primarily by higher procurement for our Raytheon NGJ – Mid Band Pods program.

Procurement for the six months ended June 30, 2024 was $19,483,061 compared to $20,958,854 for the six months ended June 30, 2023, a decrease of $1,475,793 or 7.0%, driven primarily by lower procurement for our Sikorsky UH-60 BLACKHAWK Hover Infrared Suppression System (“HIRSS”) Module Assemblies program.

Labor costs for the three months ended June 30, 2024 were $1,800,940 compared to $1,867,283 for the three months ended June 30, 2023, a decrease of $66,343 or 3.6%.

Labor costs for the six months ended June 30, 2024 were $3,598,730 compared to $3,722,146 for the six months ended June 30, 2023, a decrease of $123,416 or 3.3%.

Factory overhead for the three months ended June 30, 2024 was $3,770,396 compared to $4,266,566 for the three months ended June 30, 2023, a decrease of $496,170 or 11.6%. The decrease was primarily the result of lower employee insurance costs.

Factory overhead for the six months ended June 30, 2024 was $8,037,491 compared to $8,046,445 for the six months ended June 30, 2023, a decrease of $8,594 or 0.1%.

Other cost of sales relates to items that can increase or decrease cost of sales such as changes in inventory reserves, changes in loss contract provisions, absorption variances and direct charges to cost of sales. Other cost of sales for the three months ended June 30, 2024 was $5,533 compared to a $338,943 for the three months ended June 30, 2023, a decrease of $333,410 or 98.4%. The decrease is primarily the result of a lower level of direct charges to cost of sales during the three months ended June 30, 2024 as compared to the three months ended June 30, 2023.

Other cost of sales for the six months ended June 30, 2024 was $103,022 compared to $570,262 for the six months ended June 30, 2023, a decrease in cost of $467,240 or 81.9%. The decrease is primarily the result of a lower level of direct charges to cost of sales during the six months ended June 30, 2024 as compared to the six months ended June 30, 2023.

Gross Profit

Gross profit and gross profit percentage (“gross margin”) for the three months ended June 30, 2024 was $5,115,424 and 24.6%, respectively, compared to $4,604,000 and 22.4%, respectively, for the three months ended June 30, 2023, an increase of $511,424, or 11.1%, and 220 basis points, respectively, for the reasons noted above and a favorable year-over-year mix.

Gross profit and gross profit percentage (“gross margin”) for the six months ended June 30, 2024 was $8,669,173 and 21.7%, respectively, compared to $9,266,516 and 21.8%, respectively, for the six months ended June 30, 2023, a decrease of $597,343, or 6.4%, and 10 basis points, respectively, for the reasons noted above.

Favorable/Unfavorable Adjustments to Gross Profit

During the six months ended June 30, 2024 and 2023, circumstances required that we make changes in estimates to various contracts. Such changes in estimates resulted in changes in total gross profit as follows:

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the three months ended June 30, 2024 were $2,775,935 compared to $2,806,480 for the three months ended June 30, 2023, a decrease of $30,545 or 1.1%. The decrease was primarily the result of lower personnel related expenses.

Selling, general and administrative expenses for the six months ended June 30, 2024 were $5,489,839 compared to $5,675,538 for the six months ended June 30, 2023, a decrease of $185,699 or 3.3%. The decrease was primarily the result of lower personnel related expenses.

Interest expense

Interest expense for the three months ended June 30, 2024 was $587,971, compared to $541,655 for the three months ended June 30, 2023, an increase of $46,316 or 8.6%. The increase was the result of higher year-over-year interest rates charged on our outstanding debt under the Credit Agreement, partially offset by a year-over-year decrease in the amount of our outstanding debt under the Credit Agreement.

Interest expense for the six months ended June 30, 2024 was $1,220,106, compared to $1,152,551 for the six months ended June 30, 2023, an increase of $67,555 or 5.9%. The increase was the result of higher year-over-year interest rates charged on our outstanding debt under the Credit Agreement, partially offset by a year-over-year decrease in the amount of our outstanding debt under the Credit Agreement.

Income Before Provision for Income Taxes

Income before provision for income taxes for the three months ended June 30, 2024 was $1,751,518 compared to $1,255,865 for the three months ended June 30, 2023, an increase of $495,653 or 39.5% for the reasons noted above.

Income before provision for income taxes for the six months ended June 30, 2024 was $1,959,228 compared to $2,438,427 for the six months ended June 30, 2023, a decrease of $479,199 or 19.7% for the reasons noted above.

Provision for Income Taxes

Provision for income taxes for the three months ended June 30, 2024 was $341,572 compared to $98,789 for the three months ended June 30, 2023, an increase of $242,783, or 245.8%. The increase in the provision for income tax is primarily the result of the partial release of approximately $121,000 of the Company’s valuation allowance on its deferred tax asset recorded during the three months ending June 30, 2023.

The effective income tax rate for the three months ended June 30, 2024 is 19.5%. The difference between the effective income tax rate for the three months ended June 30, 2024 and the statutory income tax rate of 21% for the three months ended June 30, 2024 is primarily due estimated R&D credit, state income taxes and permanent tax differences.

Provision for income taxes for the six months ended June 30, 2024 was $381,044 compared to $298,046 for the six months ended June 30, 2023, an increase of $82,998, or 27.8%. The increase in the provision for income tax is primarily the result of the partial release of approximately $121,000 of the Company’s valuation allowance on its deferred tax asset recorded during the three months ending June 30, 2023.

The effective income tax rate for the six months ended June 30, 2024 is 19.4%. The difference between the effective income tax rate for the six months ended June 30, 2024 and the statutory income tax rate of 21% for the six months ended June 30, 2024 is primarily due estimated R&D credit, state income taxes and permanent tax differences.

Net Income and Earnings per Share

Net income for the three months ended June 30, 2024 was $1,409,946 compared to $1,157,076 for the three months ended June 30, 2023, an increase of $252,870 or 21.9% for the reasons noted above.

Basic and diluted income per share for the three months ended June 30, 2024 of $0.11 compared to $0.09 for the three months ended June 30, 2023, an increase of $0.02, or 22.2%.

Basic and diluted income per share for the three months ended June 30, 2024 was calculated using 12,440,426 and 12,554,153 weighted average basic and diluted shares outstanding, respectively, as compared to 12,558,793 and 12,625,241 weighted average basic and diluted shares outstanding, respectively, for the three months ended June 30, 2023.

Net income for the six months ended June 30, 2024 was $1,578,184 compared to $2,140,381 for the six months ended June 30, 2023, a decrease of $562,197 or 26.3% for the reasons noted above.

Basic income per share for the six months ended June 30, 2024 of $0.13 compared to $0.17 for the six months ended June 30, 2023, a decrease of $0.04, or 23.5%. Diluted income per share for the six months ended June 30, 2024 of $0.12 compared to $0.17 for the six months ended June 30, 2023, a decrease of $0.05, or 29.4%.

Basic and diluted income per share for the six months ended June 30, 2024 was calculated using 12,515,824 and 12,656,753 weighted average basic and diluted shares outstanding, respectively, as compared to 12,539,652 and 12,606,100 weighted average basic and diluted shares outstanding, respectively, for the six months ended June 30, 2023.

Liquidity and Capital Resources

General

At June 30, 2024, we had working capital of $16,239,499 compared to $15,402,381 at December 31, 2023, an increase of $837,118 or 5.4%. The increase was driven primarily by lower contract liabilities and higher accounts receivable, partly offset by lower cash and contract assets.

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 and related earnings for which we do not bill on a progress basis, and which, as a result, we bill upon shipment of products, 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 take steps to defer cash outflows until the reported earnings materialize into actual cash receipts.

Some 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 experience margin degradation, 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 continuously work to improve our payment terms from our customers, including accelerated progress payment arrangements, as well as exploring alternate funding sources.

At June 30, 2024, we had cash of $1,936,697 compared to $5,094,794 at December 31, 2023, a decrease of $3,158,097 or 62%. This decrease was primarily the result of cash flow used in operating activities and repayment of debt.

Bank Credit Facilities

On March 24, 2016, the Company entered into an Amended and Restated Credit Agreement with the lenders named therein and BankUnited N.A. as Sole Arranger, Agent and Collateral Agent (as amended from time to time, the “Credit Agreement” or the “BankUnited Facility”). The Credit Agreement originally 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 as defined in the Credit Agreement.

On February 20, 2024, the Company entered into a Thirteenth Amendment to the Credit Agreement (the “Thirteenth Amendment”). Under the Thirteenth Amendment, the parties amended the Credit Agreement by (a) extending the maturity date of the Company’s existing revolving line of credit to August 31, 2025; and (b) setting the aggregate maximum principal amount of all revolving line of credit loans to $19,800,000 from January 1, 2024 through March 31, 2024, $19,080,000 from April 1, 2024 through June 30, 2024, $18,360,000 from July 1, 2024 through September 30, 2024, $17,640,000 from October 1, 2024 through December 31, 2024, $16,920,000 from January 1, 2025 through March 31, 2025, $16,200,000 from April 1, 2025 through June 30, 2025 and $15,480,000 thereafter, and for payments to be made by the Company to comply therewith (if any such payments are necessary), on the first day of each such period.

The Credit Agreement, as amended, requires us to maintain the following financial covenants: (a) minimum debt service coverage ratio of no less than 1.5 to 1.0 for trailing four fiscal quarter periods; (b) maximum leverage ratio of no less than 4.0 to 1.0 for trailing four fiscal quarter periods; (c) minimum net income after taxes as of the end of each fiscal quarter being no less than $1.00; and (d) a minimum adjusted EBITDA at the end of each fiscal quarter of no less than $1.0 million. The additional principal payments, increase in interest and the Amendment Fee provided for in the Eighth Amendment (entered into on October 28, 2021) and Ninth Amendment to the Credit Agreement (entered into on April 12, 2022) are excluded for purposes of calculating compliance with each of the financial covenants.

The BankUnited Facility is secured by all of the Company’s assets and the Revolving Loan bears interest at the Prime Rate + 3.50%. The Prime Rate was 8.50% as of June 30, 2024 and as such, the Company’s interest rate on the Revolving Loan was 12.00% as of June 30, 2024.

As of June 30, 2024 and December 31, 2023, the Company had $18,840,000 and $20,040,000 outstanding under the Revolving Loan, respectively.

There is currently no availability for borrowings under the Revolving Loan and the Company finances its operations from internally generated cash flow.

Liquidity

We believe that our existing resources as of June 30, 2024 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. However, our working capital requirements can vary significantly, depending in part on the timing of new program awards and the payment terms with our customers and suppliers. If our working capital needs exceed our cash flows from operations, we would look to our cash balances and availability for borrowings under our borrowing arrangement to satisfy those needs, as well as potential sources of additional capital, which may not be available on satisfactory terms and in adequate amounts, if at all.

Contractual Obligations

For information concerning our contractual obligations, see Contractual Obligations under Item 7 of 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, 2023.

Inflation

Inflation historically has not had a material effect on our operations, although the current inflationary environment in the U.S., and its impact on interest rates, the supply chain, the labor market and general economic conditions, are factors that the Company actively monitors in an attempt to mitigate and manage potential negative impacts on and risks faced by the Company. The majority of the Company’s long term contracts with its customers reflect fixed pricing and its long term contracts with its suppliers reflect fixed pricing. When bidding for work, the Company takes inflation risk and supply side pricing risk into account in its proposals.

Management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting, as defined in Exchange Act Rules 13a-15(f) and 15d-15(f), is a process designed by, or under the supervision of, our principal executive and principal financial officers and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP and includes those policies and procedures that:

• pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;
• provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and
• provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our consolidated financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management conducted an evaluation of the effectiveness of internal control over financial reporting for the twelve months ended December 31, 2023 based on criteria established in Internal Control- Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). In connection with this evaluation, management identified a deficiency that constituted a material weakness in our internal control over financial reporting as of December 31, 2023, pertaining to income tax accounting. For more information on this deficiency, see Item 9A. Controls and Procedures, included in our Annual Report on Form 10-K. Based on management’s evaluation of internal control over financial reporting for the twelve months ended December 31, 2023, and as of June 30, 2024, our disclosure controls and procedures were not effective as of June 30, 2024 due to the aforementioned material weakness pertaining to income tax accounting.

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim consolidated financial statements will not be prevented or detected on a timely basis.

The Company has begun to develop new controls designed to remediate the aforementioned 2023 material weakness pertaining to income tax accounting, which the Company intends to implement during 2024.

Changes in Internal Control Over Financial Reporting

During the quarter ended June 30, 2024, we implemented the following changes in our internal control over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting as follows: (a) we replaced the Company’s outside tax accounting and tax return preparer with a new firm (the “Tax Accounting Firm”); (b) we retained the Tax Accounting Firm (i) to prepare the Company’s income tax accounting and disclosures for the quarter ended June 30, 2024 and (ii) to review the income tax accounting and disclosures prepared by the predecessor firm for the quarter ended March 31, 2024 prior to the filing of the Form 10-Q for the quarter ended March 31, 2024; (c) we updated our financial risk assessment to reflect tax accounting as a high risk area, and (d) we adopted a tax accounting review checklist provided by our Sarbanes-Oxley consulting firm for use by CPI’s finance management in reviewing the quarterly and annual work of the Tax Accounting Firm, beginning with the tax accounting for the quarter ended June 30, 2024.

“Item 1A. Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2023, includes a discussion of significant factors known to us that could materially adversely affect our business, financial condition, or results of operations. There have been no material changes from the risk factors disclosed in the Annual Report.