UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM
| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For
the quarterly period ended
OR
| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from ___________ to __________
Commission
File Number:
(Exact name of registrant as specified in its charter)
| (State or other jurisdiction | (IRS Employer Identification Number) |
| of incorporation or organization) | |
| (Address of principal executive offices) | (Zip code) |
(Registrant’s telephone number including area code)
| Securities registered pursuant to Section 12(b) of the Act: | ||
| Title of each class | Trading symbol(s) | Name of each exchange on which registered |
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 ☐
Indicate
by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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
such files).
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:
| Large accelerated filer ☐ | |
| Non-accelerated filer ☐ | Smaller
reporting company |
| Emerging
growth company |
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 ☐
As of December 31, 2020, the registrant had shares of common stock, $.001 par value, outstanding.
INDEX
Part I - Financial Information
2
Part I - Financial Information
Item 1 – Consolidated Financial Statements
CONSOLIDATED BALANCE SHEETS
| September 30, 2020 (Unaudited) | December
31, 2019 (Note 1) | |||||||
| ASSETS | ||||||||
| Current Assets: | ||||||||
| Cash | $ | $ | ||||||
| Restricted cash | ||||||||
| Accounts
receivable, net of allowance for doubtful accounts of $ | ||||||||
| Contract assets | ||||||||
| Inventory | ||||||||
| Refundable income taxes | ||||||||
| Prepaid expenses and other current assets | ||||||||
| Total current assets | ||||||||
| Operating lease right-of-use assets | ||||||||
| Property and equipment, net | ||||||||
| Intangibles, net | ||||||||
| Goodwill | ||||||||
| Other assets | ||||||||
| Total assets | $ | $ | ||||||
| LIABILITIES AND SHAREHOLDERS’ DEFICIT | ||||||||
| Current Liabilities: | ||||||||
| Accounts payable | $ | $ | ||||||
| Accrued expenses | ||||||||
| Contract liabilities | ||||||||
| Loss contract reserve | ||||||||
| Current portion of long-term debt | ||||||||
| Operating lease liabilities | ||||||||
| Income tax payable | ||||||||
| Total current liabilities | ||||||||
| Line of credit | ||||||||
| Long-term operating lease liabilities | ||||||||
| Long-term debt, net of current portion | ||||||||
| Total liabilities | ||||||||
| Shareholders’ Deficit: | ||||||||
| Common stock - $ par value; authorized shares, and shares, respectively, issued and outstanding | ||||||||
| Additional paid-in capital | ||||||||
| Accumulated deficit | ( | ) | ( | ) | ||||
| Total Shareholders’ Deficit | ( | ) | ( | ) | ||||
| Total Liabilities and Shareholders’ Deficit | $ | $ | ||||||
See Notes to Consolidated Financial Statements
3
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
| For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||||||
| 2020 | 2019 | 2020 | 2019 | |||||||||||||
| Revenue | $ | $ | $ | $ | ||||||||||||
| Cost of sales | ||||||||||||||||
| Gross profit | ||||||||||||||||
| Selling, general and administrative expenses | ||||||||||||||||
| Income (loss) from operations | ( | ) | ( | ) | ( | ) | ||||||||||
| Interest expense | ||||||||||||||||
| Income (loss) before provision for income taxes | ( | ) | ( | ) | ( | |||||||||||
| Provision for income taxes | ||||||||||||||||
| Net income (loss) | $ | $ | ( | ) | $ | ( | ) | $ | ( | ) | ||||||
| Income (loss) per common share – basic | $ | $ | ( | ) | $ | ( | ) | $ | ( | ) | ||||||
| Income (loss) per common share – diluted | $ | $ | ( | ) | $ | ( | ) | $ | ( | ) | ||||||
| Shares used in computing income (loss) per common share: | ||||||||||||||||
| Basic | ||||||||||||||||
| Diluted | ||||||||||||||||
See Notes to Consolidated Financial Statements
4
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ DEFICIT (UNAUDITED)
| Common Stock Shares | Common Stock Amount | Additional Paid-in Capital | Accumulated Deficit | Total Shareholders’ Deficit | ||||||||||||||||
| Balance at January 1, 2019 | $ | $ | $ | ( | ) | $ | ( | ) | ||||||||||||
| Net loss | — | ( | ) | ( | ) | |||||||||||||||
| Costs related to stock offering | — | ( | ) | ( | ) | |||||||||||||||
| Common stock issued upon exercise of options | ||||||||||||||||||||
| Stock-based compensation expense | ||||||||||||||||||||
| Balance at March 31, 2019 | ( | ) | ( | ) | ||||||||||||||||
| Net loss | — | ( | ) | ( | ) | |||||||||||||||
| Costs related to stock offering | — | ( | ) | ( | ) | |||||||||||||||
| Common stock issued as employee compensation | ||||||||||||||||||||
| Stock-based compensation expense | ||||||||||||||||||||
| Balance at June 30, 2019 | ( | ) | ( | ) | ||||||||||||||||
| Net loss | — | ( | ) | ( | ) | |||||||||||||||
| Stock-based compensation expense | ||||||||||||||||||||
| Balance at September 30, 2019 | $ | $ | $ | ( | ) | $ | ( | ) | ||||||||||||
| Balance at January 1, 2020 | $ | $ | $ | ( | ) | $ | ( | ) | ||||||||||||
| Net loss | — | ( | ) | ( | ) | |||||||||||||||
| Stock-based compensation expense | ||||||||||||||||||||
| Balance at March 31, 2020 | ( | ) | ( | ) | ||||||||||||||||
| Net loss | — | ( | ) | ( | ) | |||||||||||||||
| Stock-based compensation expense | ||||||||||||||||||||
| Balance at June 30, 2020 | ( | ) | ( | ) | ||||||||||||||||
| Net income | — | |||||||||||||||||||
| Stock-based compensation expense | ||||||||||||||||||||
| Balance at September 30, 2020 | $ | $ | $ | ( | ) | $ | ( | ) |
See Notes to Consolidated Financial Statements
5
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
| For the Nine Months Ended September 30, | ||||||||
| 2020 | 2019 | |||||||
| Cash flows from operating activities: | ||||||||
| Net loss | $ | ( | ) | $ | ( | ) | ||
| Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||
| Depreciation and amortization | ||||||||
| Amortization of debt issuance cost | ||||||||
| Cash expended in excess of rent expense | ( | ) | ( | ) | ||||
| Stock-based compensation | ||||||||
| Common stock issued as employee compensation | ||||||||
| Bad debt expense (recovery) | ( | ) | ||||||
| Changes in operating assets and liabilities: | ||||||||
| Increase in accounts receivable | ( | ) | ( | ) | ||||
| (Increase) decrease in contract assets | ( | ) | ||||||
| Increase in inventory | ( | ) | ( | ) | ||||
| Decrease in prepaid expenses and other assets | ||||||||
| (Increase) decrease in refundable income taxes | ( | ) | ||||||
| Increase in accounts payable and accrued expenses | ||||||||
| Decrease in contract liabilities | ( | ) | ( | ) | ||||
| Decrease in loss contract reserve | ( | ) | ( | ) | ||||
| Decrease in income taxes payable | ||||||||
| Net cash used in operating activities | ( | ) | ( | ) | ||||
| Cash flows from investing activities: | ||||||||
| Purchase of property and equipment | ( | ) | ( | ) | ||||
| Net cash used in investing activities | ( | ) | ( | ) | ||||
| Cash flows from financing activities: | ||||||||
| Payments on long-term debt | ( | ) | ( | ) | ||||
| Proceeds from line of credit | ||||||||
| Payments on line of credit | ( | ) | ||||||
| Proceeds from PPP loan | ||||||||
| Stock offering costs paid | ( | ) | ||||||
| Debt issue costs paid | ( | ) | ( | ) | ||||
| Net cash provided by financing activities | ||||||||
| Net decrease in cash and restricted cash | ( | ) | ( | ) | ||||
| Cash and restricted cash at beginning of period | ||||||||
| Cash and restricted cash at end of period | $ | $ | ||||||
| Supplemental disclosures of cash flow information: | ||||||||
| Cash (received) paid during the period for: | ||||||||
| Interest | $ | $ | ||||||
| Income taxes | $ | ( | ) | $ | ||||
| Non-cash investing and financing activities: | ||||||||
| Refinance revolving loan | $ | $ | ||||||
| Equipment acquired under financing lease | $ | $ | ||||||
See Notes to Consolidated Financial Statements
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. INTERIM FINANCIAL STATEMENTS
The Company consists of CPI Aerostructures, Inc. (“CPI”), 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.” The acquisition of WMI and Compac is referred to throughout this document as the “WMI Acquisition”.
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. The Company has determined that it has a single operating and reportable segment.
The consolidated financial statements of the Company as of September 30, 2020 and for the three and nine months ended September 30, 2020 and 2019 have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and notes normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) have been condensed or omitted pursuant to those rules and regulations. The consolidated balance sheet at December 31, 2019 has been derived from audited consolidated financial statements at that date, but does not include all of the information and notes required by U.S. GAAP. The Company believes that the disclosures are adequate to make the information presented not misleading.
All adjustments that, in the opinion of the 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, 2019. 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,
2020, the Company had $
The
Company currently has a shareholders’ deficit and has experienced continuing losses from operations and negative cash
flows from operations year to date that collectively represent significant risks to the Company to continue to operate as a
going concern. To address these matters, the Company has a) negotiated a revised credit facility with BankUnited effective
August 24, 2020, b) have concluded negotiations with a customer that will result in the Company exiting an unprofitable
program in the near future to avoid continuing cash losses (see note 14, Honda Aircraft Company, Inc. Settlement and
Release Agreement), c) obtained and is seeking additional progress payment and advance payment customer contract funding
provisions, d) initiated new procedures to reduce investments in inventory and contract assets, e) remained focused on its
military segment which has proven to be less susceptible to COVID-19 related impacts and f) maintained a strong
(approximately $
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
WMI Acquisition:
The Company completed the WMI Acquisition on December 20, 2018. The acquisition was accounted for as a business combination in accordance with ASC Topic 805. Accordingly, the Company recorded the fair value of the assets acquired and liabilities assumed at the date of acquisition.
The
purchase price for the acquisition was $
In the fourth quarter of 2019, the Company recorded 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 has determined the fair values of the assets acquired and liabilities assumed and has recorded the fair value of the assets acquired as of December 31, 2019, assuming only the collection of the remaining amount escrowed which was released to the Company on December 28, 2020.
COVID-19:
In March 2020, the novel coronavirus (“COVID-19”) was declared a pandemic by the World Health Organization. The pandemic has negatively affected the U.S. and global economy, disrupted global supply chains and financial markets, and has resulted in shelter in place orders. The Company has followed the recommendations of government and health authorities to minimize exposure risk for its employees, including having employees work modified hours or remotely since on or about March 19, 2020, practicing social distancing, and performing deep cleaning of its facilities. We have also taken actions to support our community in addressing challenges posed by the pandemic, including the donation of personal protective equipment.
There are many uncertainties regarding the COVID-19 pandemic, and the Company is closely monitoring the impact of the pandemic on all aspects of its business, including how it will impact its employees, customers, suppliers, and liquidity. On March 20, 2020, the Company was notified that it was considered part of the Defense Industrial Base Essential Critical Infrastructure Workforce and, as such, has remained open during the COVID-19 pandemic. However, the extent to which COVID-19 may affect our operations will depend on future developments which are highly uncertain, including the duration of the outbreak, new information which may emerge concerning the severity of the coronavirus and the actions to contain the coronavirus or address its impact, among others. The Company is unable to predict the impact that COVID-19 will have on its financial position and operating results.
2. REVENUE RECOGNITION
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.
8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The Company also has contracts that are considered point in time. Under the point in time revenue recognition model, revenue is recognized when control of the components has transferred to the customer; in most cases this will be based on shipping terms.
Contracts with Customers and Performance Obligations
The majority of the Company’s revenues are from long-term contracts with the U.S. government and commercial contractors. The Company accounts for a contract when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, 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.
To determine the proper revenue recognition for our contracts, we must evaluate whether two or more contracts should be combined and accounted for as a single contract, and whether the combined or single contract should be accounted for as one performance obligation or more than one performance obligation. This evaluation requires significant judgment, and the decision to combine a group of contracts or to separate a contract into multiple performance obligations could change the amount of revenue and profit recorded in a period. A performance obligation is a promise within a contract to transfer a distinct good or service to the customer in exchange for payment and is the unit of account for recognizing revenue. The Company’s performance obligations in its contracts with customers are typically the sale of each individual product contemplated in the contract or a single performance obligation representing a series of products when the contract contains multiple products that are substantially the same. The Company has elected to account for shipping performed after control over a product has transferred to a customer as fulfillment activities. When revenue is recognized in advance of incurring shipping costs, the costs related to the shipping are accrued. Shipping costs are included in costs of sales. The Company provides warranties on many of its products; however, since customers cannot purchase such warranties separately and they do not provide services beyond standard assurances, warranties are not separate performance obligations.
A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when or as the performance obligation is satisfied. For contracts with more than one performance obligation, the Company allocates the transaction price to each performance obligation based on its estimated standalone selling price. When standalone selling prices are not available, the transaction price is allocated using an expected cost plus margin approach as pricing for such contracts is typically negotiated on the basis of cost.
The contracts with the U.S. government typically are subject to the FAR (“Federal Acquisition Regulation”) 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 contracts are based on the specific negotiations with each customer and any taxes imposed by governmental authorities are excluded from revenue. The transaction price is primarily comprised of fixed consideration as the customer typically pays a fixed fee for each product sold. The Company does not adjust the amount of revenue to be recognized under a customer contract for the effects of the time value of money when the timing difference between receipt of payment and transferring the good or service is less than one year.
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. The Company uses the cost-to-cost input method to measure progress for its performance obligations because it best depicts the transfer of control to the customer which occurs as the Company incurs costs on its contracts.
The Company generally utilizes the portfolio approach to estimate the amount of revenue to recognize for its contracts and groups contracts together that have similar characteristics. Significant judgment is used to determine which contracts are grouped together to form a portfolio. The portfolio approach is utilized only when the result of the accounting is not expected to be materially different than if applied to individual contracts.
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. The effect of a contract modification on the transaction price, and the measure of progress for the performance obligation to which it relates, are recognized prospectively when the remaining goods or services are distinct and on a cumulative catch-up basis when the remaining goods or services are not distinct.
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Contract Estimates
Certain contracts contain forms of variable consideration, such as price discounts and performance penalties. The Company generally estimates variable consideration using the most likely amount based on an assessment of all available information (i.e., historical experience, current and forecasted performance) and only to the extent it is probable that a significant reversal of revenue recognized will not occur when the uncertainty is resolved.
In applying the cost-to-cost input method, the Company compares the actual costs incurred relative to the total estimated costs expected at completion to determine its progress towards satisfying its performance obligation and to calculate the corresponding amount of revenue to recognize. For any costs incurred that do not depict the Company’s performance in transferring control of goods or services to the customer, the Company excludes such costs from its input method measure of progress as the amounts are not reflected in the price of the contract. Costs that are inputs to the satisfaction of 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 quarterly 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 and judgment in determining revenues, costs and profits and in assigning the amounts to accounting periods. For instance, management must make assumptions and estimates regarding labor productivity and availability, the complexity of the work to be performed, the availability of materials, the length of time to complete the performance obligation, execution by our subcontractors, the availability and timing of funding from the customer, and overhead cost rates, among other variables. The Company continually evaluates all of the factors 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 which will affect estimates at completion, the Company is required to adjust revenue in the period the change is determined.
When changes are required for the estimated total revenue on a contract, these changes are recognized on a cumulative catch-up basis in the current period. A significant change in one or more estimates could affect the profitability of one or more of our performance obligations. If estimates of total costs to be incurred exceed estimates of total consideration the Company expects to receive, a provision for the remaining loss on the contract is recorded in the period in which the loss becomes evident.
Capitalized Contract Acquisition Costs and Fulfillment Costs
Contract acquisition costs are those incremental costs that the Company incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained. The Company does not typically incur contract acquisition costs or contract fulfillment costs that are subject to capitalization in accordance with the guidance in Accounting Standards Codification Subtopic 340-40, “Other Assets and Deferred Costs—Contracts with Customers.”
Disaggregation of Revenue
The following tables present the Company’s revenue disaggregated by contract type:
Three months ended
September 30, | Nine months ended
September 30, | |||||||||||||||
| 2020 | 2019 (restated) | 2020 | 2019 (restated) | |||||||||||||
| Aerostructures | $ | $ | $ | $ | ||||||||||||
| Aerosystems | ||||||||||||||||
| Kitting and Supply Chain Management | ||||||||||||||||
| $ | $ | $ | $ | |||||||||||||
10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Transaction Price Allocated to Remaining Performance Obligations
Our
backlog represents the estimated transaction prices on performance obligations to our customers for which work remains to be performed.
Backlog is converted into revenue in future periods as work is performed. As of September 30, 2020, the aggregate amount of transaction
price allocated to the remaining performance obligations was approximately $
3. 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 (right-of-use) 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, as amended, expires on
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 nine and three months ended September 30, 2020, the Company’s operating lease expense was $
Future minimum lease payments under non-cancellable operating leases as of September 30, 2020 were as follows:
Twelve months ending September 30, | |||||
| 2021 | $ | ||||
| 2022 | |||||
| 2023 | |||||
| 2024 | |||||
| 2025 | |||||
| Total undiscounted operating lease payments | |||||
| Less imputed interest | ( | ) | |||
| Present value of operating lease payments | $ | ||||
The following table sets forth the ROU assets and operating lease liabilities as of September 30, 2020:
| Assets | ||||
| ROU assets | $ | |||
| Liabilities | ||||
| Current operating lease liabilities | $ | |||
| Long-term operating lease liabilities | ||||
| Total ROU liabilities | $ | |||
11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The
Company’s weighted average remaining lease term for its operating leases is
4. RECONCILIATION OF CASH AND RESTRICTED CASH
The following table provides a reconciliation of cash and restricted cash reported within the consolidated balance sheet that sum to the total of the same such amounts shown in the statement of cash flows:
| September 30, 2020 | December 31, 2019 | |||||||
| Cash | $ | $ | ||||||
| Restricted cash | ||||||||
| Total cash and restricted cash shown in the consolidated statement of cash flow | $ | $ | ||||||
5. INVENTORY
The components of inventory consisted of the following:
September 30, 2020 | December 31,
2019 | |||||||
| Raw materials | $ | $ | ||||||
| Work in progress | ||||||||
| Finished goods | ||||||||
| Total | $ | $ | ||||||
12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 August 2020, the Company granted RSUs (Restricted Stock Units) to one of its board members as partial compensation for the 2020 year. RSUs vest quarterly on a straight-line basis over a one-year period. For the nine months ended September 30, 2020, approximately $ of non-cash compensation expense related to the RSU grants to the board member. There were no similar grants in Q3 2019.
In August 2020, the Company granted 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 2024 based upon the service and performance thresholds. For the nine months ended September 30, 2020, approximately $ of compensation expense is included in selling, general and administrative expenses and approximately $ of compensation expense is included in cost of sales for this grant. There were no similar grants in Q3 2019.
In August 2020, the Company granted shares of common stock to an employee. The shares will be fully vested August 26, 2021. In the event that this employee voluntarily terminates his employment prior to vesting the shares will be forfeited. For the nine months ended September 30, 2020, approximately $ of compensation expense is included in selling, general and administrative expenses for this grant. There were no similar grants in Q3 2019.
In August 2020, , , and of the shares granted in 2016, 2017, 2018 and 2019, respectively, were forfeited because the Company failed to achieve certain performance criteria for the year ended December 31, 2019. In addition, on August 26, 2020, these employees returned common shares, valued at approximately $, to pay the employees’ withholding taxes.
7. FAIR VALUE
Fair Value
At September 30, 2020 and December 31, 2019, the fair values of cash, accounts receivable and accounts payable approximated their carrying values because of the short-term nature of these instruments.
| September 30, 2020 | ||||||||
| Carrying Amount | Fair Value | |||||||
| Debt | ||||||||
| Short-term borrowings, PPP loan, long-term debt | $ | $ | ||||||
| December 31, 2019 | ||||||||
| Carrying Amount | Fair Value | |||||||
| Debt | ||||||||
| Short-term borrowings and long-term debt | $ | $ | ||||||
We estimated the fair value of debt using market quotes and calculations based on market rates.
13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
8. CONTRACT ASSETS AND CONTRACT LIABILITIES
Contract assets represent revenue recognized on contracts in excess of amounts invoiced to the customer and the Company’s right to consideration is conditional on something other than the passage of time. Amounts may not exceed their net realizable value. Under the typical payment terms of our government contracts, the customer retains a portion of the contract price until completion of the contract, as a measure of protection for the customer. Our government contracts therefore typically result in revenue recognized in excess of billings, which we present as contract assets. Contract assets are classified as current. The Company’s contract liabilities represent customer payments received or due from the customer in excess of revenue recognized. Contract liabilities are classified as current.
Revenue
recognized for the periods ended September 30, 2020 and 2019, respectively, that was included in the contract liabilities
balance as of January 1, 2020 and 2019 was approximately $
Basic and diluted income (loss) per common share for the three and nine months ended September 30, 2020 and 2019 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 were not used in the calculation of diluted loss per common share in the three and nine months ended September 30, 2019, as the Company is in a loss position and these shares would be considered anti-dilutive. There were no incremental shares used in the calculation of diluted income (loss) per common share in the three and nine months ended September 30, 2020.
10. DEBT
On
March 24, 2016, the Company entered into an Amended and Restated Credit Agreement (the “Credit Agreement”) with BankUnited,
N.A. (“BankUnited”) as a lender and the sole arranger, administrative agent and collateral agent and Citizens Bank
N.A. (the “BankUnited Facility”). The BankUnited Facility provided for a revolving credit loan commitment of $
On
August 24, 2020, the Company entered into a Sixth Amendment and Waiver (“Sixth Amendment”) to the Credit Agreement
with BankUnited. In connection with the Sixth Amendment, we also amended the Amended and Restated Revolving Credit Note, dated
as of March 24, 2016, which represents an aggregate principal revolving loan commitment amount of $
Under
the Sixth Amendment, and the related amendments to the Revolving Note and Term Note, an aggregate of $
Additionally,
under the Sixth Amendment, the parties amended the Credit Agreement by (i) extending the maturity date of the Revolving Note and
Term Note to
14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
As
of September 30, 2020, the Company had $
The
Term Loan, as amended, had an aggregate principal amount of $
The maturities of long-term debt (excluding unamortized debt issuance costs) are as follows:
| Twelve months ending September 30, | |||||
| 2021 | $ | ||||
| 2022 | |||||
| 2023 | |||||
| 2024 | |||||
| Total | $ | ||||
The BankUnited Facility is secured by all of the Company’s assets.
The
Company has cumulatively paid approximately $
On
April 10, 2020, the Company entered into a loan with BNB Bank as the lender (“Lender”) in an aggregate principal amount
of $
In
addition to the Term Loan and PPP Loan, included in long-term debt are financing leases of $
11. MAJOR CUSTOMERS
During
the nine months ended September 30, 2020, the Company’s
At
September 30, 2020,
At
September 30, 2020,
15
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
12. INCOME TAXES
Income taxes are accounted for under the asset and liability method whereby deferred tax assets and liabilities are recognized for future tax consequences attributable to the temporary differences between the consolidated financial statements carrying amounts of assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company’s policy is to record estimated interest and penalties related to uncertain tax positions in income tax expense.
13. SUBSEQUENT EVENTS
NYSE American Filing Delinquency:
On April 17, 2020, we received a notice from NYSE Regulation, Inc. stating that we were not in compliance with the NYSE American exchange’s continued listing standards because we failed to timely file restated financial statements for the year ended December 31, 2018, and quarters ended March 31, 2018, June 30, 2018, September 30, 2018, March 31, 2019, June 30, 2019, and September 30, 2019 (“Non-Reliance Periods”) and granting us a six-month initial cure period. We filed restated financial statements for the Non-Reliance Periods on August 25, 2020 and filed our quarterly report on Form 10-Q for the quarter ended March 31, 2020 on September 30, 2020, and June 30, 2020 on November 16, 2020. On October 15, 2020, we were granted an additional three-month period, or until January 15, 2021, in which to file this quarterly report for the quarter ended September 30, 2020, and to regain compliance with the exchange’s timely filing criteria. This Quarterly Report constitutes such filing, and accordingly, as of the date of the filing of this Quarterly Report, we expect to regain compliance with the exchange’s timely filing criteria.
On October 6, 2020, our stockholders approved an amendment to the Company’s 2016 Long-Term Incentive Plan to increase the total number of shares of common stock available for issuance thereunder by shares, from shares to shares.
14. COMMITMENTS AND CONTINGENCIES
Class Action Lawsuit
As previously disclosed, a consolidated class action lawsuit has been filed against the Company, Messrs. McCrosson and Palazzolo, and the two underwriters of the Company’s October 16, 2018 offering of common stock, Canaccord Genuity LLC and B. Riley FBR. The Amended Complaint in the action asserts claims on behalf of two plaintiff classes, (i) purchasers of the Company’s common stock issued pursuant to and/or traceable to the Company’s offering conducted on or about October 16, 2018; and (ii) purchasers of the Company’s common stock between March 22, 2018 through February 14, 2020. The Amended Complaint alleges that the defendants violated Sections 11, 12(a)(2), and 15 of the Securities Act by negligently permitting false and misleading statements to be included in the registration statement and prospectus supplements issued in connection with its October 16, 2018 securities offering. The Amended Complaint also alleges that the defendants violated Sections 10(b) and 20(a) of the Exchange Act, and Rule 10b-5 promulgated by the SEC, by making false and misleading statements in the Company’s periodic reports filed between March 22, 2018 through February 14, 2020. Plaintiffs seek unspecified compensatory damages, including interest; rescission or a rescissory measure of damages; unspecified equitable or injunctive relief; and costs and expenses, including attorney’s fees and expert fees.
16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Shareholder Derivative Actions
Two shareholder derivative actions have been filed against current members of our board of directors and certain of our current and former officers. The first action was filed in the United States District Court for the Eastern District of New York, and purports to assert derivative claims against the individual defendants for violations of Section 10(b) and 21(d) of the Exchange Act and breach of fiduciary duty, unjust enrichment, and contribution, and seeks to recover on behalf of the Company for any liability the Company might incur as a result of the individual defendants’ alleged misconduct. The second action was filed in the Supreme Court of the State of New York (Suffolk County), purports to assert derivative claims against the individual defendants for breach of fiduciary duty and unjust enrichment, and seeks to recover on behalf of the Company for any liability the Company might incur as a result of the individual defendants’ alleged misconduct, along with declaratory, equitable, injunctive and monetary relief, as well as attorneys’ fees and other costs. Both derivative actions are based substantially on the same facts alleged in the class action complaint summarized above.
On November 10, a third shareholder derivative action was filed against current and former members of our board of directors, and certain of our current and former officers, in the United States District Court for the Eastern District of New York. The complaint, which is based on the shareholder’s inspection of certain corporate books and records, purports to assert derivative claims against the individual defendants for breach of fiduciary duty and unjust enrichment, and seeks to implement reforms to the Company’s corporate governance and internal procedures and to recover on behalf of the Company an unspecified amount of monetary damages.
While the outcome of any litigation is inherently uncertain and the class action and derivative lawsuits are each still at an early stage, the Company and its officers and directors intend to vigorously defend against the claims and believe the claims are without merit.
SEC Investigation
As previously disclosed, on May 22, 2020, the Company received a subpoena from the SEC Division of Enforcement (the “Division”) seeking documents and information relating, among other things, to previously disclosed errors in and restatement of the Company’s financial statements, the Company’s October 16, 2018 equity offering and the recent separation of the Company’s former Chief Financial Officers. The Company intends to fully cooperate with the Division’s requests. We cannot predict the length, scope, or results of the investigation or the impact, if any, of the investigation on our results of operations.
Honda Aircraft Company, Inc. Settlement and Release Agreement
In January 2020, the Company requested a modification to the recurring sales
price contained in the Master Purchase Agreement dated January 14, 2019 (“Honda MPA”) with Honda Aircraft Company, Inc. (“HACI”)
for the manufacture of engine inlet assemblies for the HondaJet aircraft. Honda denied the Company’s request. HACI and the Company
subsequently commenced discussions that would result in the Company exiting the program. On December 23, 2020 HACI and the Company entered
into a Settlement and Release Agreement that, subject to the terms and conditions therein, terminated the Honda MPA and canceled all remaining
purchase orders placed with the Company thereunder, and requires HACI to purchase approximately $
17
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, 2019 and Part II Item 1A 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 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 Original Equipment Manufacturers 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 U.S. Air Force. In conjunction with our assembly operations, we provide engineering, program management, supply chain management and kitting, and maintenance repair and overhaul services.
Impact of the COVID-19 Pandemic on Third Quarter Results and Forward-Looking Impacts
The impact that the COVID-19 pandemic will have on our business is uncertain. We were classified as an “essential business” by New York State and made exempt from the state’s closure of non-essential New York businesses during the first quarter. We remain an essential business today; however, 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 about March 19, 2020.
We have experienced and anticipate further 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 account for approximately 10% 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 ending December 31, 2020. We have taken mitigating steps in an attempt to reduce such 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.
18
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
Recent Developments
Paycheck Protection Program Loan
On April 10, 2020, the Company entered into a loan with BNB Bank as the lender (“Lender”) in an aggregate principal amount of $4,795,000 (“PPP Loan”) pursuant to the Paycheck Protection Program, part of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act. The PPP Loan is evidenced by a promissory note (“Note”). Subject to the terms of the Note, the PPP Loan bears interest at a fixed rate of one percent (1%) per annum, and interest is deferred until a decision is made by the SBA (Small Business Administration) on the amount of the loan that is to be forgiven. The Note has an initial term of two years, and is unsecured and guaranteed by the SBA. On October 16, 2020, the Company applied to the Lender for full forgiveness of the PPP Loan. On November 2, the Company was notified that the Lender approved the application and submitted it to the SBA for final approval in accordance with the applicable provisions of the CARES Act. We cannot assure you that the PPP Loan will be forgiven in full, or at all.
Amendment and Waiver to our BankUnited Credit Facility
On August 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 and BankUnited, N.A. (“BankUnited”) as Sole Arranger, Agent and Collateral Agent, dated as of March 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 of March 24, 2016, which represented an aggregate principal revolving loan commitment amount of $30 million (“Revolving Note”) and the Amended and Restated Term Note, dated as of March 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. The maturity date of the Revolving Note and Term Note was extended to May 2, 2022. Additionally, BankUnited agreed to waive certain covenant violations arising from the restatement of our financial statements and to make certain amendments to the financial covenants under the Credit Agreement.
Gulfstream G650 Program
On April 29, 2020, the Company received a letter from Triumph Group stating that due to the COVID-19 pandemic, it had received a significant schedule change from its customer, Gulfstream Aerospace, and requested that we immediately stop work on the contract we have to produce certain fixed leading edge assemblies on the wing of the G650 business jet. In May 2020, Triumph Group cancelled nearly all open orders with the Company, decreasing our G650 leading edge backlog by $3.6 million. On May 27, 2020, Triumph Group announced it had reached an agreement in principle to sell the G650 wing program to Gulfstream Aerospace. On June 12, 2020, the Company received a joint communication from Gulfstream Aerospace and Triumph Group that stated Gulfstream Aerospace’s intention at the conclusion of the transaction is to continue to purchase G650 wing components from the Company. In December 2020 the Company received purchase orders from Gulfstream Aerospace for G650 wing components.
Working Capital Dispute Settlement
As previously disclosed, 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 in connection with a working capital dispute. The motion sought, 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 $3.5 million (representing the $4.1 million working capital deficiency less approximately $619,000, which Air Industries previously agreed to release from escrow to cover undisputed items of working capital deficiency). On October 1, 2020, the court denied the Company’s motion on procedural grounds, holding that the Company must commence a special proceeding to obtain the relief sought. The court’s decision was made without prejudice and did not resolve the working capital dispute. As of December 23, 2020, the Company and Air Industries entered into the Settlement Agreement, which resolves the post-closing working capital adjustment dispute in exchange for the release to the Company of the $1,381,000 cash remaining in escrow. Such amount was released from escrow to the Company on December 28, 2020. As part of the settlement agreement CPI agreed to give up the right to pursue the additional disputed amount of approximately $2.1 million.
19
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. Funded backlog consists of aggregate funded 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. Unfunded backlog is the estimated amount of future orders under long-term contracts. 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, 2020 and December 31, 2019 was as follows:
Backlog (Total) | September 30, 2020 | December
31, 2019 | ||||||
| Funded | $ | 189,600,000 | $ | 147,647,000 | ||||
| Unfunded | 347,300,000 | 414,231,000 | ||||||
| Total | $ | 536,900,000 | $ | 561,878,000 | ||||
Approximately 89% of the total amount of our backlog at September 30, 2020 was attributable to government contracts. Our backlog attributable to government contracts at September 30, 2020 and December 31, 2019 was as follows:
| Backlog (Government) | September 30, 2020 | December
31, 2019 | ||||||
| Funded | $ | 183,900,000 | $ | 136,932,000 | ||||
| Unfunded | 296,300,000 | 359,770,000 | ||||||
| Total | $ | 480,200,000 | $ | 496,702,000 | ||||
Our backlog attributable to commercial contracts at September 30, 2020 and December 31, 2019 was as follows:
Backlog (Commercial) | September 30, 2020 | December
31, 2019 | ||||||
| Funded | $ | 5,700,000 | $ | 10,715,000 | ||||
| Unfunded | 51,000,000 | 54,461,000 | ||||||
| Total | $ | 56,700,000 | $ | 65,176,000 | ||||
The total backlog at September 30, 2020 is primarily comprised of long-term programs with Raytheon (Next Generation Jammer – Mid Band), Northrop Grumman (E-2D and Wet Outer Wing Panel (“WOWP”)), U.S. Air Force (T-38), Boeing A-10, HIRRS (Hovering InfraRed Suppression System), Embraer E175, F16 Rudder Island, and Sikorsky Stabilator. Funded backlog is primarily from purchase orders under long-term contracts with Northrop Grumman (E-2D and WOWP), Raytheon (Next Generation Jammer Pods), Boeing A-10, HIRRS, and U.S. Air Force (T-38).
20
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
Critical Accounting Policies
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 our Form 10-K for the year ended December 31, 2019, for a discussion of our critical accounting policies. There have been no significant changes to the application of our critical accounting policies during the quarter ended September 30, 2020.
Results of Operations
Revenue
Revenue for the three months ended September 30, 2020 was $25,576,718 compared to $22,689,762 for the same period last year, an increase of $2,886,956 or 12.7%. The increase was primarily related to the new multi-year award for the Northrop Grumman E2D program as well as increases related to the programs T-38 Pacer, Northrop Grumman WOWP and the F16 Rudder Island. These revenue increases were offset primarily by the Raytheon Next Generation Jammer (“NGJ”) Pod program, which was essentially complete by December 31, 2019. There was also a decrease in the G650 program.
Revenue for the nine months ended September 30, 2020 was $62,175,872 compared to $64,779,858 for the same period last year, a decrease of $2,603,986 or 4%. The year to date decrease was driven by the Raytheon NGJ Pod program and the G650 program as described above. In addition, we had year to date decreases in the Sikorsky fuel panels and WPA (Weapons Pylon Assembly) programs.
Revenue from government subcontracts was $20,887,968 for the three months ended September 30, 2020 compared to $16,179,389 for the three months ended September 30, 2019, an increase of $4,708,579 or 29%. The increase in revenue related to the start of a new multi-year award for the Northrop Grumman E2D program as well as increases related to the following programs NGC WOWP, and F16 Rudder Island, and was partially offset by a decrease in the Raytheon NGJ Pod program as described above.
Revenue from government subcontracts was $47,829,529 for the nine months ended September 30, 2020 compared to $44,592,902 for the nine months ended September 30, 2019, an increase of $3,236,627 or 7.2%. The increase was primarily related to the Raytheon program as described above and the Sikorsky fuel panels and WPA programs offset by increases in the following programs NGC E2D, WOWP, F16 Rudder Island, Lockheed Martin F35 and the Boeing A10.
Revenue from direct military contracts was $3,778,686 for the three months ended September 30, 2020 compared to $1,702,951 for the three months ended September 30, 2019, an increase of $2,075,735 or 121.9%. The increase in revenue is primarily driven by an increase in revenue from the Pacer Classic III program which will vary period to period due to the nature of indefinite delivery indefinite quantity (“IDIQ”) contracts.
Revenue from direct military contracts was $7,947,977 for the nine months ended September 30, 2020 compared to $5,690,080 for the nine months ended September 30, 2019, an increase of $2,257,897 or 39.7%. The increase in revenue is primarily driven by an increase in revenue from the Pacer Classic III program mentioned above offset by a decrease in WMI programs.
Revenue from commercial subcontracts was $910,064 for the three months ended September 30, 2020 compared to $4,807,422 for the three months ended September 30, 2019, a decrease of $3,897,358 or 81%. The decrease is primarily the result of lower revenue from the G650 program and lower revenue from the Embraer program.
Revenue from commercial subcontracts was $6,398,366 for the nine months ended September 30, 2020 compared to $14,496,876 for the nine months ended September 30, 2019, a decrease of $8,098,510 or 55.9%. The decrease is driven by the same programs as the quarterly decrease mentioned above. Inflation historically has not had a material effect on our operations.
21
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
Cost of Sales
Cost of sales for the three months ended September 30, 2020 and 2019 was $21,394,243 and $20,757,649, respectively, an increase of $636,594 or 3.1%. The increase this quarter is substantially less than the increase in revenue due to more margin contribution from higher margin defense programs.
Cost of sales for the nine months ended September 30, 2020 and 2019 was $54,715,508 and $58,120,687, respectively, a decrease of $3,405,179 or 5.8%. This decrease is due to more margin contribution from higher margin defense programs.
The components of the cost of sales were as follows:
| Three months ended | Nine months ended | |||||||||||||||
|
September 30, 2020 | September 30, 2019 | September 30, 2020 | September 30, 2019 | |||||||||||||
| Procurement | $ | 17,478,009 | $ | 11,941,699 | $ | 39,215,182 | $ | 37,128,787 | ||||||||
| Labor | 1,670,761 | 1,967,144 | 4,997,514 | 5,876,663 | ||||||||||||
| Factory OH | 4,596,516 | 5,164,788 | 14,507,755 | 15,088,391 | ||||||||||||
Inventory Change | (1,083,585 | ) | 1,647,414 | (2,850,707 | ) | (764,898 | ) | |||||||||
| Other | (1,267,458 | ) | 36,604 | (1,154,236 | ) | 791,744 | ||||||||||
| Cost of sales | $ | 21,394,243 | $ | 20,757,649 | $ | 54,715,508 | $ | 58,120,687 | ||||||||
Procurement for the three months ended September 30, 2020 was $17,478,009 compared to $11,941,699 for the three months ended September 30, 2019, an increase of $5,536,310 or 46.3%. This increase is primarily the result of an increase in procurement for the E2D and WOWP programs.
Procurement for the nine months ended September 30, 2020 was $39,215,182 compared to $37,128,787 for the nine months ended September 30, 2019, an increase of $2,086,395 or 5.6%. This increase was primarily due to an increase in procurement for the E2D and WOWP programs.
Labor costs for the three months ended September 30, 2020 were $1,670,761 compared to $1,967,144 for the three months ended September 30, 2019, a decrease of $296,383 or 15%. The decrease is primarily the result of lower direct labor requirements on the Raytheon NGJ POD, Honda Jet and G650 programs.
Labor costs for the nine months ended September 30, 2020 were $4,997,514 compared to $5,876,663 for the nine months ended September 30, 2019, a decrease of $879,149 or 15%. The decrease is primarily the result of the absence in 2020 of labor associated with the NGJ pod program, which was very labor intensive, as well as lower labor on the HondaJet and G650 programs.
Factory overhead for the three months ended September 30, 2020 was $4,596,516 compared to $5,164,788 for the three months ended September 30, 2019, a decrease of $568,272 or 11%. This decrease is primarily due to a decrease in factory supplies and indirect labor.
Factory overhead for the nine months ended September 30, 2020 was $14,507,755 compared to $15,088,391 for the nine months ended September 30, 2019, a decrease of $580,636 or 3.8%. This decrease is primarily due to a decrease in factory supplies.
Changes in inventory for the three months ended September 30, 2020 resulted in a change to cost of sales (COS) of $(1,083,585) compared to $1,647,414 for the three months ended September 30, 2019 primarily due to changes in investment in the WMI product line.
Changes in inventory for the nine months ended September 30, 2020 resulted in a change to COS of $(2,850,707) compared to $(764,898) for the nine months ended September 30, 2019 primarily due to changes in investment in the WMI product line.
Other costs (credit), net for the three months ended September 30, 2020 were $(1,267,458) compared to $36,604 for the three months ended September 30, 2019 primarily the result of changes to loss contract reserves, absorption variances and other direct charges to cost of goods sold.
Other costs (credit), net for the nine months ended September 30, 2020 were $(1,154,236) compared to $791,944 for the nine months ended September 30, 2019 primarily the result of changes to loss contract reserves, absorption variances and other direct charges to cost of goods sold.
22
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
Gross Profit
Gross profit for the three months ended September 30, 2020 was $4,182,475 compared to $1,932,113 for the three months ended September 30, 2019, an increase of $2,250,362 or 116%. This was primarily the result of an increase in revenue on higher margin defense programs.
Gross profit for the nine months ended September 30, 2020 was $7,460,363 compared to $6,659,171 for the nine months ended September 30, 2019, an increase of $801,192 or 12%, primarily driven by a favorable mix of higher margin defense programs offset by lower revenue.
Favorable/Unfavorable Adjustments to Gross Profit (Loss)
During the nine months ended September 30, 2020 and 2019, circumstances required that we make changes in estimates to various contracts. Such changes in estimates resulted in changes in total gross profit as follows:
| Nine months ended | ||||||||
September 30, 2020 | September 30, 2019 | |||||||
| Favorable adjustments | $ | 1,438,896 | $ | 492,210 | ||||
| Unfavorable adjustments | (2,175,163 | ) | (301,977 | ) | ||||
| Net adjustments | $ | (736,267 | ) | $ | 190,233 | |||
For the nine months ended September 30, 2020, we evaluated all contractual data and revised estimated gross profit percentages accordingly. We had 20 contracts with favorable adjustments and 16 contracts with unfavorable adjustments, all due to changes in estimates, representing 1.2% of revenue for the period.
For the nine months ended September 30, 2019, we evaluated all contractual data and revised estimated gross profit percentages accordingly. We had 18 contracts with favorable adjustments and 19 contracts with unfavorable adjustments, all due to changes in estimates, representing 0.3% of revenue for the period.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the three months ended September 30, 2020 were $3,050,644 compared to $2,806,498 for the three months ended September 30, 2019, an increase of $244,146 or 8.7%. This increase was primarily driven by an increase in professional fees related to the restatement of our prior period financial statements, conducted during the first half of 2020.
Selling, general and administrative expenses for the nine months ended September 30, 2020 were $8,958,986 compared to $8,259,945 for the nine months ended September 30, 2019, an increase of $699,041 or 8.5%. This increase was driven by an increase in professional fees related to the restatement, offset by decreases in WMI moving expenses and salaries.
Income (Loss) Before Provision for Income Taxes
Income (Loss) before provision for income taxes for the three months ended September 30, 2020 was $822,823 compared to $(1,252,580) for the same period last year, an increase in income of $2,075,403 or 166%. The increase was driven by a combination of an increase in gross profit as a result of an increase in revenue and a favorable program mix, an increase in SG&A expenses as a result of increased accounting and legal fees related to the restatement and a decrease in interest expense.
Income (Loss) before provision for income taxes for the nine months ended September 30, 2020 was $(2,584,427) compared to $(3,065,150) for the same period last year, a decrease in loss of $480,723 or 16%. The decrease in loss is a combination of an increase in gross profit as a result of favorable program mix, an increase in SG&A expenses as a result of increased accounting and legal fees related to the restatement and a decrease in interest expense.
23
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
Provision for Income Taxes
Provision for income taxes was $9,714 for the nine months ended September 30, 2020, compared to a provision for income taxes of $5,784 for the nine months ended September 30, 2019. The tax provision relates to state minimum and franchise taxes for the year.
Net Income (Loss)
Net income (loss) for the three months ended September 30, 2020 was $815,209 or $0.07 per basic share, compared to a loss of $(1,255,051) or $(0.11) per basic share, for the same period last year. Diluted income (loss) per share was $0.07 for the three months ended September 30, 2020 calculated utilizing 11,894,469 weighted average shares outstanding. Diluted income (loss) per share was $(0.11) for the three months ended September 30, 2019 calculated utilizing 11,838,862 weighted average shares outstanding. The decrease in net loss was primarily driven by an increase in gross profit, as well as an increase in SG&A.
Net loss for the nine months ended September 30, 2020 was $(2,594,141) or $(0.22) per basic share, compared to a loss of $(3,070,934) (restated) or $(0.26) per basic share, for the same period last year. Diluted income (loss) per share was $(0.22) for the nine months ended September 30, 2020 calculated utilizing 11,862,506 weighted average shares outstanding. Diluted loss per share was $(0.26) for the nine months ended September 30, 2019 calculated utilizing 11,796,580 weighted average shares outstanding. The decrease in net loss was primarily driven by an increase in gross profit, an increase in SG&A, offset by lower interest expense.
Liquidity and Capital Resources
General
At September 30, 2020, we had working capital of $12,485,031 compared to working capital of $13,851,719 at December 31, 2019, a decrease of $1,366,688 or 9.9%.
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.
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.
24
Item 2 – Management’s Discussion and Analysis of Financial Condition 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 alternate funding sources.
At September 30, 2020, we had a cash balance of $3,589,095 compared to $4,052,109 at December 31, 2019. The cash balance as of September 30, 2020 excluded an administratively delayed cash receipt from the U.S. Government of $2.6 million that was received October 5, 2020. Additionally, at September 30, 2020 and December 31, 2019, we had $1,380,684 of restricted cash, which is cash held in escrow pursuant to the WMI acquisition and the determination of a final working capital adjustment. As disclosed elsewhere in this Quarterly Report on Form 10-Q, as of December 23, 2020, the Company and Air Industries entered into the Settlement Agreement, which resolves the post-closing working capital adjustment dispute in exchange for the release to the Company of the $1,381,000 cash remaining in escrow. Such amount was released from escrow to the Company on December 28, 2020. The BankUnited Facility contains a minimum liquidity covenant that requires the Company to maintain at all times a minimum amount of $3 million in either unrestricted cash or revolving credit availability or any combination thereof.
We believe that our existing resources, as of September 30, 2020, which includes $3.3 million of 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.
Bank Credit Facilities
Credit Agreement and Term Loan
On March 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 agreement.
On August 24, 2020, we entered into the Sixth Amendment, as described more fully in Note 10 “Debt” above. In connection with the Sixth Amendment, BankUnited agreed to prospectively waive the covenant violation for late delivery of our financial statements for the first three quarters of 2020 and agreed not to test our compliance with the financial covenants under the Credit Agreement for the first half of 2020. As of September 30, 2020, and after taking into account the Sixth Amendment, the Company was in compliance with all tested covenants contained in the Credit Agreement.
As of September 30, 2020, the Company had $20.7 million outstanding under the Revolving Loan bearing interest at 4%.
The Term Loan, as amended, had an initial aggregate principal amount of $7,933,000, payable in monthly installments, as defined in the agreement, which after giving effect to the Sixth Amendment matures on May 2, 2022. The maturities of the Term Loan are included in the maturities of long-term debt.
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, 2019.
Item 3 – Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
Item 4 – Controls and Procedures
Evaluation of Disclosure Controls and Procedures
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; |
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Item 4 – Controls and Procedures
| ● | 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 based on criteria established in Internal Control- Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on this evaluation, management concluded that the Company’s internal control over financial reporting was not effective as of December 31, 2019 or December 31, 2018 because of the material weaknesses described below. Our evaluation excluded WMI which was acquired on December 20, 2018. On a pro forma basis, as of and for the year ended December 31, 2018, WMI represented approximately 14% of revenue and 23% of assets. 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 with acquired operations.
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.
In connection with management’s evaluation of the Company’s internal control over financial reporting described above, management has identified the deficiencies described below that constituted material weaknesses in our internal control over financial reporting as of December 31, 2019 and December 31, 2018. One of these deficiencies led to material errors in our previously issued consolidated financial statements, which in turn led to the restatement of those previously issued consolidated financial statements, as described in Note 18 to our consolidated financial statements included in the Annual Report on Form 10-K.
Control Environment, Risk Assessment, Control Activities and Monitoring
We did not maintain effective internal control over financial reporting related to the following areas: control environment, risk assessment, control activities and monitoring:
| ● | Management did not effectively execute a strategy to hire and retain a sufficient complement of personnel with an appropriate level of knowledge, experience, and training in certain areas important to financial reporting. |
| ● | Management lacked sufficient technical proficiency and training to provide adequate oversight of accounting and financial reporting activities in implementing certain accounting practices and calculations to conform to the Company’s policies and U.S. GAAP. |
| ● | There were insufficiently documented Company accounting policies and insufficiently detailed Company procedures to put policies into effective action. |
Revenue Recognition Accounting
We identified material weaknesses from revenue recognition accounting controls that resulted in material errors, as we did not appropriately design, or effectively operate, internal control over certain aspects of accurate recording, presentation, and disclosure of revenue and related costs. The following were contributing factors to the material weaknesses in revenue recognition accounting:
| ● | Our internal control lacked procedures for ensuring the period of performance or value of the accounting contract were properly determined. |
| ● | Our internal control lacked procedures for ensuring revenue was constrained to funded contract values. |
Accounting for Significant Non-Routine Complex Transactions
We identified a material weakness in our accounting for significant, non-routine, complex transactions. No controls existed and we failed to hire qualified external resources with the appropriate accounting expertise. While no material errors were identified, the lack of controls caused a reasonable possibility that a material error could have occurred.
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Item 4 – Controls and Procedures
Information Technology General Controls (ITGC)
There were ineffective ITGCs, specifically in testing and documenting the areas of access to programs and data, program change-management and computer operations. As a result, business process automated and manual controls that were dependent on the affected ITGCs may be ineffective because they could have been adversely impacted. These control deficiencies were a result of: 1) IT control processes that lacked sufficient testing and documentation; 2) risk-assessment processes inadequate to identify and assess changes in IT environments and 3) user access reviews that could impact internal control over financial reporting. While no material errors were identified, the insufficiency of our testing caused a reasonable possibility that a material error could have occurred.
The effectiveness of our internal control over financial reporting as of December 31, 2019 and December 31, 2018, has been audited by CohnReznick, an independent registered public accounting firm, as stated in their reports, which were adverse due to the material weaknesses.
Remediation Efforts to Address Material Weaknesses
We are currently working to remediate the material weaknesses described above, including assessing the need for additional remediation steps and implementing additional measures to remediate the underlying causes that gave rise to the material weaknesses. As we continue to evaluate and work to improve our internal control over financial reporting, we may take additional measures to address control deficiencies with the overall objective to design and operate internal controls that mitigate identified risks and enable an effective system of internal control over external financial reporting.
Management regards successful completion of our remediation actions as an important priority. Some of the more significant remediation activities include:
| ● | In 2019 we hired experienced professionals to fill several key positions within our finance leadership team, including Chief Financial Officer, Controller, and Director of Financial Planning & Analysis. These new individuals possess technical proficiency, training, and experience that were partially responsible for identifying the material weaknesses identified herein. The Director of Financial Planning & Analysis, now our Acting Chief Financial Officer, and the Controller remain with the Company and we continue to assess current staffing levels and competencies in our finance team to ensure the optimal complement of personnel with appropriate qualifications and skill sets. |
| ● | Management, with advice from a leading global accounting and advisory firm, reviewed and updated its revenue recognition policy in the second quarter of 2020. Accordingly, the Company has updated its revenue recognition procedures and now constrains revenue recognition to funded contract values and continues to assess its accounting contract values. We continue to perform a comprehensive review of current accounting processes to ensure compliance of the Company’s accounting policies with U.S. GAAP, and to ensure sufficient specificity in procedures. With assistance from our consultants, we continue to evaluate and revise our Sarbanes-Oxley compliance program (our “SOX Program”), and make improvements to our SOX Program governance, risk assessment processes, testing methodologies and corrective action mechanisms. |
| ● | We continue to redesign and implement necessary changes to the existing system of internal controls and then testing of sufficient instances of the performance of controls to determine operational effectiveness. |
| ● | The Company has established a policy wherein prior to any future requirement for accounting for significant, non-routine, complex transactions, the Company will engage experienced professionals and outline and execute a set of controls to ensure that the non-routine, complex transaction is recorded in a proper manner. |
| ● | For years subsequent to 2019, we will implement an improved 404 compliant ITGC testing program. We have engaged experienced professionals to assist with its continued implementation and execution. |
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, 2020. Based on this evaluation and considering the material weaknesses in internal control over financial reporting described above, we concluded as of September 30, 2020, that our disclosure controls and procedures were not effective at the reasonable assurance level.
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Item 4 – Controls and Procedures
Changes in Internal Control Over Financial Reporting
Other than the remediation efforts underway, there were no changes in our internal control over financial reporting during the quarter ended September 30, 2020 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Part II: Other Information
Item 1 – Legal Proceedings
See Footnote 14 – Commitments and Contingencies.
Item 1A – Risk Factors
The following material risk factors 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. As a result of the risk factors set forth below, actual results did and could continue to differ materially from those projected in any forward-looking statements.
Risks Related to the Restatement of our Prior Period Consolidated Financial Statements and Material Weaknesses in our Internal Controls
We have restated our consolidated financial statements for several prior periods, which has affected and may continue to affect investor confidence, our stock price, our ability to raise capital in the future, and our reputation with our customers, which has resulted and may continue to result in stockholder litigation and may reduce customer confidence in our ability to complete new contract opportunities.
The restatement of our consolidated financial statements as described in our Annual Report on Form 10-K for the year ended December 31, 2019, primarily reflects the correction of certain errors relating to our recognition of revenue, which errors resulted from an incorrect application of U.S. GAAP, as described in more detail in the Annual Report on Form 10-K for the year ended December 31, 2019. Such restatement has had and may continue to have the effect of eroding investor confidence in the Company and our financial reporting and accounting practices and processes, has negatively impacted and may continue to negatively impact the trading price of our common stock, has resulted and may continue to result in stockholder litigation, may make it more difficult for us to raise capital on acceptable terms, if at all, and may negatively impact our reputation with our customers and cause customers to place new orders with other companies.
We have identified material weaknesses in our internal control over financial reporting, which, if not remediated, could adversely affect our ability to report our financial condition and results of operations in a timely and accurate manner.
We have concluded that our internal control over financial reporting was not effective as of September 30, 2020 due to the existence of material weaknesses in such controls, and we have also concluded that our disclosure controls and procedures were not effective as of September 30, 2020 due to material weaknesses in our internal control over financial reporting, all as described in Part I, Item 4, “Controls and Procedures” of this Quarterly Report on Form 10-Q. We previously concluded that our internal control over financial reporting was not effective as of December 31, 2019 or December 31, 2018, due to the material weaknesses as described in Part I, Item 4 of this Quarterly Report on Form 10-Q. Although we have initiated remediation measures to address the identified weaknesses, we cannot provide assurance that our remediation efforts will be adequate to allow us to conclude that such controls will be effective in the future. We also cannot assure you that additional material weaknesses in our internal control over financial reporting will not arise or be identified in the future, either with respect to the Non-Reliance Periods or other periods. Management previously identified a material weakness in our internal control over financial reporting in February 2019 in connection with the failure to identify, in a timely manner, the miscoding of an invoice in the Company’s records and the resulting overstatement of revenue in the Company’s Quarterly Report on Form 10-Q for the nine months ended September 30, 2018, by $927,257. We reviewed our financial closing process and identified corrective action to remediate the prior operating effectiveness of controls and, while we believe the implementation of the new control procedures was successful, we cannot assure you that our remediation of the revenue recognition error with respect to the Non-Reliance Periods will be similarly successful.
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Item 1A – Risk Factors
We intend to continue our remediation activities and to continue to improve our overall control environment and our operational and financial systems and infrastructure, as well as to continue to train, retain and manage our personnel who are essential to effective internal control. In doing so, we will continue to incur expenses and expend management’s time on compliance-related issues. However, we cannot ensure that the steps that we have taken or will take will successfully remediate the errors. If we are unable to successfully complete our remediation efforts or favorably assess the effectiveness of our internal control over financial reporting, our operating results, financial position, ability to accurately report our financial results and timely file our SEC reports, and stock price could be adversely affected. Additionally, beginning in the fourth quarter of 2019, the Company and WMI are now operating as a consolidated entity, and the Company is using inventory valuation and cost collection software not previously required to be used. While we are confident in the accuracy of our December 31, 2019 inventory value using the new functionality of the current software and that controls over the valuation of inventory will be improved, there can be no assurance that these controls will be adequate to address all potential valuation issues that may arise in the future relating to the use of the new software, and new internal controls may need to be developed.
Moreover, because of the inherent limitations of any control system, material misstatements due to error or fraud may not be prevented or detected and corrected on a timely basis, or at all. If we are unable to provide reliable and timely financial reports in the future, our business and reputation may be further harmed. Further, restated financial statements and failures in internal control may also cause us to fail to meet reporting obligations, negatively affect investor and customer confidence in our management and the accuracy of our financial statements and disclosures, result in events of default under the BankUnited Facility, or result in adverse publicity and concerns from investors and customers, any of which could have a negative effect on the price of our common stock, subject us to regulatory investigations and penalties or additional stockholder litigation, and have a material adverse impact on our business and financial condition.
The restatement of our consolidated financial statements for the Non-Reliance Periods has diverted, and our ongoing efforts to remediate our internal controls may continue to divert management from the operation of our business. The absence of timely and accurate financial information has hindered and may in the future hinder our ability to effectively manage our business.
The restatement of our consolidated financial statements for the Non-Reliance Periods has diverted, and our ongoing efforts to remediate our internal controls may continue to divert management from the operation of our business. The Board of Directors, members of management, and our accounting and other staff have spent significant time on the restatement and remediation and will continue to spend significant time on remediation of internal control over our financial reporting. These resources have been, and will likely continue to be, diverted from the strategic and day-to-day management of our business and may have an adverse effect on our ability to accomplish our strategic objectives.
We have incurred and expect to continue to incur significant expenses related to the restatement and remediation of deficiencies in our internal control over financial reporting and disclosure controls and procedures, and any resulting litigation.
We have devoted and expect to continue to devote substantial internal and external resources towards remediation efforts relating to the restatement of our financial statements for the Non-Reliance Periods, the management review process and other efforts to implement effective internal controls. Because of these efforts, we have incurred and expect that we will continue to incur significant fees and expenses for legal, accounting, financial and other consulting and professional services, as well as the implementation and maintenance of systems and processes that will need to be updated, supplemented or replaced. As described in the Annual Report on Form 10-K for the year ended December 31, 2019, filed on August 25, 2020, we have taken a number of steps in order to strengthen our accounting function so as to allow us to be able to provide timely and accurate financial reporting. However, we cannot assure you that these steps will be successful. To the extent these steps are not successful, we could be required to incur significant additional time and expense. The expenses we are incurring in this regard, as well as the substantial time devoted by our management towards identifying and addressing the internal control deficiencies, could have a material adverse effect on our business, results of operations and financial condition.
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Item 1A – Risk Factors
We were in violation of various covenants under our credit facility with BankUnited as of March 31, 2018 through September 30, 2019, due to the errors in our Non-Reliance Periods consolidated financial statements. BankUnited has waived the covenant violations as part of the amended and extended bank agreement as of August 26, 2020, and has amended certain financial covenants, but there can be no assurance that we will not fall out of compliance with the amended covenants in the future.
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 certain of the covenants under the BankUnited Facility as of and after March 31, 2018. We have entered into the Sixth Amendment to the BankUnited Facility, which includes, among other things, a waiver of the covenant violations and certain amendments to the financial covenants going forward. 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 resumed for the quarter ending September 30, 2020. As of September 30, 2020, and after taking into account the Sixth Amendment, the Company was in compliance with all tested covenants contained in the Credit Agreement. However, there can be no assurance that we will remain in compliance with the amended banking covenants in future periods. If we fall out of compliance with our banking covenants, BankUnited may declare a default under the BankUnited Facility and, among other remedies, could declare the full amount of the BankUnited Facility immediately due and payable and could foreclose against our collateral. If this were to occur, we may be unable to secure outside financing, if needed, to fund ongoing operations and for other capital needs. Any sources of financing that may be available to us could also be at higher costs and require us to satisfy more restrictive covenants, which could limit or restrict our operations, cash flows and earnings. We cannot ensure that additional financing would be available to us, or be sufficient or available on satisfactory terms.
We are currently ineligible to use our existing shelf registration statement on Form S-3 or file a new registration statement on Form S-3 to register the offer and sale of securities, which could adversely affect our ability to raise future capital.
We did not file our Annual Report for the year ended December 31, 2019 or our Quarterly Reports for the quarters ended March 31, June 30, or September 30, 2020 within the respective timeframes required by the SEC. We will regain status as a current filer upon the filing of this Quarterly Report. However, we will not be considered a timely filer and will not be eligible to offer and sell securities using our existing shelf registration statement on Form S-3 or file a new short-form registration statement on Form S-3 to register the offer and sale of our securities until 12 full calendar months from the date we regain status as a current filer. If we wish to register the offer and sale of our securities to the public prior to such time, we will be required to use the long-form registration statement, Form S-1, which may increase both our transaction costs and the amount of time required to complete the transaction. This may adversely affect our ability to raise funds, if we choose to do so.
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Item 1A – Risk Factors
If our common stock is delisted from the NYSE American exchange, our business, financial condition, results of operations and stock price could be adversely affected, and the liquidity of our stock and our ability to obtain financing could be impaired.
On April 17, 2020, we received a notice from NYSE Regulation, Inc. stating that we were not in compliance with the NYSE American exchange’s continued listing standards because we failed to timely file restated financial statements for the Non-Reliance Periods, and granting us a six-month initial cure period. We filed restated financial statements for the Non-Reliance Periods on August 25, 2020 and filed our quarterly report on Form 10-Q for the quarter ended March 31, 2020 on September 30, 2020, and for the quarter ended June 30, 2020 on November 16, 2020. On October 15, 2020, we were granted an additional three-month period, or until January 15, 2021, in which to file this quarterly report for the quarter ended September 30, 2020, and to regain compliance with the exchange’s timely filing criteria. As of the date of the filing of this Quarterly Report, we expect to regain compliance with the exchange’s timely filing criteria.
However, once we regain compliance, there can be no assurance that we will maintain such compliance or that we will not be delinquent in the future. Any such further delinquency could result in the delisting of our common stock from the NYSE American exchange, which would adversely affect our ability to attract new investors, decrease the liquidity of our outstanding shares of common stock, reduce our flexibility to raise additional capital, reduce the price at which our common stock trades, and increase the transaction costs inherent in trading such shares with overall negative effects for our stockholders. It would primarily affect our business and results of operations by preventing us from raising capital for the purposes of acquiring another company.
Risks Related to COVID-19
The impact of the coronavirus (COVID-19) pandemic on our operations, supply chain, and customers has impacted and could have a material adverse effect on our business, financial position, results of operations and/or cash flows.
It is possible that the continued spread of COVID-19 could cause disruption in our supply chain or significantly increase the costs required to meet our contractual commitments, cause delay, or limit the ability of the U.S. Government and other customers to perform, including making timely payments to us, negotiating contracts, performing quality inspections, accepting delivery of finished products, and cause other unpredictable events. The disruption of air travel has impacted demand for the commercial air industry. Commercial aircraft manufacturers are reducing production rates due to fewer expected aircraft deliveries and, as a result, may reduce demand for our products. There have been and may continue to be changes in our government and commercial customers’ priorities and practices, as our customers confront competing budget priorities and more limited resources. These changes may impact current and future programs, procurements, and funding decisions, which in turn could impact our results of operations.
The COVID-19 pandemic could also impact our liquidity. Slower production schedules, potential inability of our customers to make timely payments to us, and similar factors could impact our cash flows. A period of generating lower cash from operations could adversely affect our financial position. We are currently considering a range of options, including progress payments from our customers and longer payment terms to our suppliers; however, we may not be successful in these efforts. The extent to which COVID-19 impacts our cash flow will determine whether we need to obtain additional funding, which could be difficult to obtain. Due to uncertainty related to COVID-19 and its impact on us and the aerospace industry, and the volatility in the capital markets in general, access to financing may be reduced and we may have difficulty obtaining financing on terms acceptable to us or at all.
The extent to which COVID-19 affects our operations will depend on future developments, which are highly uncertain, including the duration of the outbreak, new information which may emerge concerning the severity of the coronavirus and the actions to contain the coronavirus or address its impact, among others. For instance, although the Company was classified as an “essential business” by New York State and was therefore exempt from the state’s mandate that all non-essential New York businesses close during the first quarter, the Company’s accounting staff and outside advisors 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 about March 19, 2020. Access to records, the inability to perform tasks efficiently, and IT connectivity issues, along with similar measures taken by the Company’s outside advisors, have hindered and may continue to hinder timely preparation of our financial statements. Additionally, even though our facility remains open, we have experienced and may continue to experience additional operating costs due to social distancing, securing personal protective equipment, and sanitizing workspaces, worker absences, and lower productivity. If significant portions of our workforce or our suppliers’ workforces are unable to work effectively, including because of illness, quarantines, government actions, facility closure or other restrictions in connection with the COVID-19 pandemic, our operations will likely be impacted. We may be unable to perform fully on our contracts and our costs may increase as a result of the COVID-19 outbreak. These cost increases may not be fully recoverable or adequately covered by insurance. In addition, the impact on our accounting staff and outside advisors may hamper our efforts to comply with our filing obligations with the SEC.
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Item 1A – Risk Factors
We continue to monitor the situation, to assess further possible implications to our business, supply chain and customers, and to take actions in an effort to mitigate adverse consequences. We cannot at this time predict the impact of the COVID-19 pandemic, but it has had and could continue to have an adverse effect on our business, financial position, results of operations and/or cash flows.
If we do not meet the standards for forgiveness of our PPP Loan, we may be required to repay the loan over a period of two years.
On April 10, 2020, we entered into the PPP Loan, in an aggregate principal amount of $4,795,000, with BNB Bank as Lender. The PPP Loan has an initial term of two years, and is unsecured and guaranteed by the Small Business Administration (“SBA”). Subject to the terms of the Note, the PPP Loan bears interest at a fixed rate of one percent (1%) per annum, with the interest deferred until the Small Business Administration determines whether the PPP Loan will be forgiven. The amount of the PPP Loan which may be forgiven is 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 on April 10, 2020, calculated in accordance with the terms of the CARES Act, as modified by the Paycheck Protection Flexibility Act. On October 16, 2020, the Company applied to the Lender for full forgiveness of the PPP Loan. On November 2, the Company was notified that the Lender approved the application and submitted it to the SBA for final approval in accordance with the applicable provisions of the CARES Act. While we believe we meet the standards for full forgiveness of the PPP Loan, there can be no assurance that the amount of the PPP Loan will be forgiven. If the PPP Loan is not forgiven, we would be required to repay the PPP Loan over a period of two years.
Risks Related to Legal Proceedings
We face litigation and regulatory action relating to the restatement of the Non-Reliance Period consolidated financial statements.
Our Company and certain of our current and former executive officers and directors, and the underwriters of our October 16, 2018 securities offering, are defendants in litigation arising out of our disclosure of an error in our revenue recognition and material weaknesses in our internal control over financial reporting and the related impact on our stock price. Please see Part II, Item 1, “Legal Proceedings.” These proceedings may result in significant expenses and the diversion of management attention from our business. We cannot ensure that additional litigation or other claims by shareholders will not be brought in the future arising out of the same subject matter.
Additionally, the Company received a letter and subpoena from the SEC Division of Enforcement seeking the production of documents in connection with a non-public fact finding inquiry relating to, among other things, the errors in and restatement of our financial statements, our October 16, 2018 equity offering, and the recent separation of our former Chief Financial Officers. The SEC letter states that the investigation and subpoena do not mean that the SEC has concluded that the Company or anyone else has violated the federal securities laws. We intend to fully cooperate with the SEC staff. However, we cannot predict the length, scope, or results of the investigation or the impact, if any, of the investigation on our results of operations. Please see Part II, Item 1, “Legal Proceedings.” We may also be subject to further examinations, investigations, proceedings and orders by regulatory authorities, including a cease and desist order, suspension of trading of our securities, delisting of our securities and/or the assessment of possible civil monetary penalties. Any such further actions could be expensive and damaging to our business, results of operations and financial condition.
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Item 1A – Risk Factors
General Risks Related to our Business
We depend on government contracts for a significant portion of our revenues.
We are a supplier, either directly or as a subcontractor, to the U.S. Government and its agencies. We depend on government contracts for a significant portion of our business. If we are suspended or barred from contracting with the U.S. Government, if our reputation or relationship with individual federal agencies were impaired, whether due to the restatement and errors in the Non-Reliance Period financial statements or otherwise, or if the U.S. Government otherwise ceased doing business with us or significantly decreased the amount of business it does with us, our business, prospects, financial condition and operating results would be materially adversely affected.
We face risks relating to government contracts.
The funding of U.S. Government programs is subject to congressional budget authorization and appropriation processes. For many programs, the U.S. Congress appropriates funds on a fiscal year basis even though a program may extend over several fiscal years. Consequently, programs are often only partially funded initially and additional funds are committed only as Congress makes further appropriations. Appropriations are driven by numerous factors, including geopolitical events, macroeconomic conditions, the ability of the U.S. Government to enact relevant legislation, such as appropriations bills and continuing resolutions, and the threat or existence of a government shutdown. U.S. Government appropriations for our programs and for defense spending generally may be impacted or delayed by the COVID-19 pandemic as governmental priorities and finances change. We cannot predict the extent to which total funding and/or funding for individual programs will be included, increased or reduced in budgets approved by Congress or be included in the scope of separate supplemental appropriations. In the event that appropriations for any of our programs becomes unavailable, or is reduced or delayed, our contract or subcontract under such program may be terminated or adjusted by the U.S. Government, which could have a material adverse effect on our future sales under such program, and on our financial position, results of operations and cash flows.
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Item 1A – Risk Factors
We also cannot predict the impact of potential changes in priorities due to military transformation and planning and/or the nature of war-related activity on existing, follow-on or replacement programs. A shift of government priorities to programs in which we do not participate and/or reductions in funding for or the termination of programs in which we do participate, unless offset by other programs and opportunities, could have a material adverse effect on our financial position, results of operations and cash flows.
In addition, the U.S. Government generally has the ability to terminate contracts, completely or in part, without prior notice, for convenience or for default based on performance. In the event of termination for the U.S. Government’s convenience, contractors are generally protected by provisions covering reimbursement for costs incurred on the contracts and profit on those costs but not the anticipated profit that would have been earned had the contract been completed. Termination by the U.S. Government of a contract for convenience could also result in the cancellation of future work on that program. Termination by the U.S. Government of a contract due to our default could require us to pay for re-procurement costs in excess of the original contract price, net of the value of work accepted from the original contract. Termination of a contract due to our default may expose us to liability and could have a material adverse effect on our ability to compete for contracts. Additionally, we are a subcontractor on some U.S. Government contracts. In these arrangements, the U.S. Government could terminate the prime contract for convenience or otherwise, without regard to our performance as a subcontractor. We can give no assurance that we would be awarded new U.S. Government contracts to offset the revenues lost as a result of the termination of any of our U.S. Government contracts.
We have risks associated with competing in the bidding process for contracts.
We obtain many of our contracts through a competitive bidding process. In the bidding process, we face the following risks:
| ● | we must bid on programs in advance of their completion, which may result in unforeseen technological difficulties or cost overruns; |
| ● | we must devote substantial time and effort to prepare bids and proposals for competitively awarded contracts that may not be awarded to us; and |
| ● | awarded contracts may not generate sales sufficient to result in profitability. |
Further consolidation in the aerospace industry could adversely affect our business and financial results.
The aerospace and defense industry is experiencing significant consolidation, including among our customers, competitors and suppliers. While we believe we have positioned our Company to take advantage of opportunities to market to a broad customer base, which we believe will reduce the potential impact of industry consolidation, we cannot assure you that industry consolidation will not impact our business. Consolidation among our customers may result in delays in the awarding of new contracts and losses of existing business. Consolidation among our competitors may result in larger competitors with greater resources and market share, which could adversely affect our ability to compete successfully. Consolidation among our suppliers may result in fewer sources of supply and increased cost to us.
We are subject to strict governmental regulations relating to the environment, which could result in fines and remediation expense in the event of non-compliance.
We are required to comply with extensive and frequently changing environmental regulations at the federal, state and local levels. Among other things, these regulatory bodies impose restrictions to control air, soil and water pollution, to protect against occupational exposure to chemicals, including health and safety risks, and to require notification or reporting of the storage, use and release of certain hazardous substances into the environment. This extensive regulatory framework imposes significant compliance burdens and risks on us. In addition, these regulations may impose liability for the cost of removal or remediation of certain hazardous substances released on or in our facilities without regard to whether we knew of, or caused, the release of such substances. Furthermore, we are required to provide a place of employment that is free from recognized and preventable hazards that are likely to cause serious physical harm to employees, provide notice to employees regarding the presence of hazardous chemicals and to train employees in the use of such substances. Our operations require the use of a limited amount of chemicals and other materials for painting and cleaning that are classified under applicable laws as hazardous chemicals and substances. If we are found not to comply with any of these rules, regulations or permits, we may be subject to fines, remediation expenses and the obligation to change our business practice, any of which could result in substantial costs that would adversely affect our business operations and financial condition.
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Item 1A – Risk Factors
We may be subject to fines and disqualification for non-compliance with Federal Aviation Administration (“FAA”) regulations.
We are subject to regulation by the FAA under the provisions of the Federal Aviation Act of 1958, as amended. The FAA prescribes standards and licensing requirements for aircraft and aircraft components. We are subject to inspections by the FAA and may be subjected to fines and other penalties (including orders to cease production) for noncompliance with FAA regulations. Our failure to comply with applicable regulations could result in the termination of or our disqualification from some of our contracts, which could have a material adverse effect on our operations and financial condition.
If our subcontractors or suppliers fail to perform their contractual obligations, our contract performance and our ability to obtain future business and our profitability could be materially and adversely impacted.
Most of our contracts involve subcontracts with other companies upon which we rely to perform a portion of the services that we must provide to our customers. There is a risk that we may have disputes with our subcontractors, including disputes regarding the quality and timeliness of work performed by the subcontractor, customer concerns about the subcontract, our failure to extend existing task orders or issue new task orders under a subcontract, or our hiring of personnel of a subcontractor. A failure by one or more of our subcontractors to satisfactorily provide on a timely basis the agreed-upon supplies or perform the agreed-upon services may materially and adversely affect our ability to perform our obligations as the prime contractor. Subcontractor performance deficiencies could result in a customer eliminating our ability to progress bill or terminating our contract for default. A prohibition on progress billing may have an adverse effect upon our cash flow and profitability and a default termination could expose us to liability and have a material adverse effect on our ability to compete for future contracts and orders. In addition, a delay in our ability to obtain components and equipment parts from our suppliers may affect our ability to meet our customers’ needs and may have a material adverse effect upon our profitability. For example, the COVID-19 pandemic has impacted, and continues to impact, our supply chain, as described above.
Due to fixed contract pricing, increasing contract costs exposes us to reduced profitability and the potential loss of future business.
Operating margin is adversely affected when contract costs that cannot be billed to customers are incurred. This cost growth can occur if estimates to complete a contract increase due to technical challenges or if initial estimates used for calculating the contract price were incorrect. The cost estimation process requires significant judgment and expertise. Reasons for cost growth may include unavailability and productivity of labor, the nature and complexity of the work to be performed, the effect of change orders, the availability of materials, the effect of any delays in performance, availability and timing of funding from the customer, natural disasters, and the inability to recover any claims included in the estimates to complete. A significant increase in cost estimates on one or more programs could have a material adverse effect on our financial position or results of operations.
We use estimates when accounting for contracts. Changes in estimates could affect our profitability and our overall financial position.
We primarily recognize revenue from our contracts over the contractual period pursuant to ASC 606. Pursuant to ASC 606, revenue and gross profit are recognized 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 on our consolidated balance sheet as an asset captioned “Contract assets.” Contracts where billings to date have exceeded recognized revenues are recorded on our consolidated balance sheet as a liability captioned “Contract liabilities.” Changes to the original estimates may be required during the term of the contract. Estimates are reviewed quarterly and the effect of any change in the estimated gross margin percentage for a contract is reflected in the consolidated financial statements in the period the change becomes known. ASC 606 requires the use of considerable estimates in determining revenues 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 taxes) as reported and actual cash received by us during any reporting period.
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Item 1A – Risk Factors
For the periods ended September 30, 2020 and 2019, we made changes to the original estimates on certain of our contracts. Such changes resulted in net adjustments to gross profits of $(736,267) and $190,233 for the nine months ended September 30, 2020 and 2019, respectively. We continually evaluate all of the issues related to the assumptions, risks and uncertainties inherent with the application of ASC 606; however, there is no assurance that our estimates will be accurate. If our estimates are not accurate or a contract is terminated, we will be forced to adjust revenue in later periods. Furthermore, even if our estimates are accurate, we may have a shortfall in our cash flow and we may need to borrow money to pay for costs until the reported earnings materialize to actual cash receipts.
If the contracts associated with our backlog were terminated, our financial condition could be adversely affected.
The maximum contract value specified under each contract that we enter into is not necessarily indicative of the revenues that we will realize under that contract. For example, our IDIQ contracts do not obligate the purchaser to purchase any goods or services. Because we may not receive the full amount we expect under a contract, we may not accurately estimate our backlog because the earnings of revenues on programs included in backlog may never occur or may change. Cancellations of pending contracts or terminations or reductions of contracts in progress would have a material adverse effect on our business, prospects, financial condition or results of operations.
We may be unable to attract and retain personnel who are key to our operations.
Our success, among other things, is dependent on our ability to attract and retain highly qualified senior officers and engineers. Competition for key personnel is intense. Our ability to attract and retain senior officers and experienced, top rate engineers is dependent on a number of factors, including prevailing market conditions and compensation packages offered by companies competing for the same talent and our reputation in the industry. If our reputation is adversely affected, for instance due to the errors in the Non-Reliance Period financial statements or due to our handling of the COVID-19 pandemic, we may be unable to recruit, hire, and retain talented personnel. The inability to hire and retain these persons may adversely affect our production operations and other aspects of our business.
We are subject to the cyclical nature of the commercial aerospace industry, and any future downturn in the commercial aerospace industry or general economic conditions, including related to COVID-19, could adversely impact the demand for our products.
Our business may be affected by certain characteristics and trends of the commercial aerospace industry or general economic conditions that affect our customers, such as fluctuations in the aerospace industry’s business cycle, varying fuel and labor costs, intense price competition and regulatory scrutiny, certain trends, including a possible decrease in aviation activity and a decrease in outsourcing by aircraft manufacturers or the failure of projected market growth to materialize or continue. In the event that these characteristics and trends adversely affect customers in the commercial aerospace industry, they may reduce the overall demand for our products. For example, the COVID-19 pandemic has significantly impacted, and continues to impact, the commercial aerospace industry, as described above.
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Item 1A – Risk Factors
We incur risks associated with new programs.
New programs with new technologies typically carry risks associated with design changes, development of new production tools, increased capital and funding commitments, ability to meet customer specifications, delivery schedules and unique contractual requirements, supplier performance, ability of the customer to meet its contractual obligations to us, and our ability to accurately estimate costs associated with such programs. In addition, any new program may not generate sufficient demand or may experience technological problems or significant delays in the regulatory or other certification or manufacturing and delivery schedule. If we were unable to perform our obligations under new programs to the customer’s satisfaction, if we were unable to manufacture products at our estimated costs, or if a new program in which we had made a significant investment was terminated or experienced weak demand, delays or technological problems, then our business, financial condition and results of operations could be materially adversely affected. This risk includes the potential for default, quality problems, or inability to meet specifications, as well as our inability to negotiate final pricing for program changes, and could result in low margin or forward loss contracts, and the risk of having to write off contract assets if they were deemed to be unrecoverable. In addition, beginning new work on existing programs also carries risk associated with the transfer of technology, knowledge and tooling.
In order to perform on new programs, we may be required to expend up-front costs which may not have been negotiated in our selling price. Additionally, we may have made margin assumptions related to those costs, that in the case of significant program delays and/or program cancellations, or if we are not successful in negotiating favorable margin on scope changes, could cause us 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 adverse impact on our liquidity.
We are presently classified as a small business and the loss of our small business status may adversely affect our ability to compete for government contracts.
We are presently classified as a small business under certain of the codes under the North American Industry Classification Systems (“NAICS”) industry and product specific codes that are regulated in the United States by the Small Business Administration. We are not considered a small business under all NAICS codes. While we do not presently derive a substantial portion of our business from contracts that are set-aside for small businesses, we are able to bid on small business set-aside contracts as well as contracts that are open to non-small business entities. As the NAICS codes are periodically revised, it is possible that we may lose our status as a small business. The loss of small business status would adversely affect our eligibility for special small business programs and limit our ability to collaborate with other business entities which are seeking to team with small business entities as may be required under a specific contract.
Cyber security attacks and internal system or service failures may adversely impact our business and operations.
Any system or service disruptions, including those caused by projects to improve our information technology systems, if not anticipated and appropriately mitigated, could disrupt our business and impair our ability to effectively provide products and related services to our customers and could have a material adverse effect on our business. We could also be subject to systems failures, including network, software or hardware failures, whether caused by us, third-party service providers, intruders or hackers, computer viruses, natural disasters, power shortages or terrorist attacks. Cyber security threats are evolving and include, but are not limited to, malicious software, phishing and other unauthorized attempts to gain access to sensitive, confidential or otherwise protected information related to us or our products, customers or suppliers, or other acts that could lead to disruptions in our business. The COVID-19 pandemic has forced many of our non-manufacturing employees to shift to work-from-home arrangements, which increases our vulnerability to email phishing, social engineering or “hacking” through our remote networks, and similar cyber-attacks aimed at employees working remotely. Because the techniques used by cyber-attackers to access or sabotage networks change frequently and may not be recognized until launched against a target, we may be unable to anticipate these tactics. Any such failures to prevent or mitigate cyber-attack could cause loss of data and interruptions or delays in our business, cause us to incur remediation costs or subject us to claims and damage our reputation. In addition, the failure or disruption of our communications or utilities could cause us to interrupt or suspend our operations or otherwise adversely affect our business. Although we utilize various procedures and controls to monitor and mitigate the risk of these threats, including contracting with an outside cyber security firm to provide constant monitoring of our systems, and training our employees to recognize attacks, there can be no assurance that these procedures and controls will be sufficient. Our property and business interruption insurance may be inadequate to compensate us for all losses that may occur as a result of any system or operational failure or disruption which would adversely affect our business, results of operations and financial condition. Moreover, expenditures incurred in implementing cyber security and other procedures and controls could adversely affect our results of operations and financial condition.
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Item 1A – Risk Factors
Our financial results may be adversely impacted by the failure to successfully execute or integrate acquisitions and joint ventures.
The Company may evaluate potential acquisitions or joint ventures that align with our strategic objectives. The success of such activity depends, in part, upon our ability to identify suitable sellers or business partners, perform effective assessments prior to contract execution, negotiate contract terms, and, if applicable, obtain customer and government approval. These activities may present certain financial, managerial, staffing and talent, and operational risks, including diversion of management’s attention from existing core businesses, difficulties integrating or separating businesses from existing operations, and challenges presented by acquisitions or joint ventures which may not achieve sales levels and profitability that justify the investments made. If the acquisitions or joint ventures are not successfully implemented or completed, there could be a negative impact on our financial condition, results of operations and cash flows.
Our ability to utilize our tax benefits could be substantially limited if we fail to generate sufficient income or if we experience an “ownership change.”
As of December 31, 2019, we had approximately $93 million of gross net operating loss carryforwards (“NOLs”) for federal tax purposes and approximately $38.6 million of post-apportionment NOLs for state tax purposes. As a result of the Tax Cuts and Jobs Act of 2017 and the Coronavirus Aid, Relief, and Economic Security Act of 2020, NOLs arising before January 1, 2018, and NOLs arising after January 1, 2018, are subject to different rules. Our pre-2018 NOLs totaled approximately $78.8 million; these NOLs will expire in varying amounts from 2030 through 2039, if not utilized, and can offset 100% of future taxable income for regular tax purposes. Our NOLs arising in 2018, 2019 and 2020 can generally be carried back five years, carried forward indefinitely and can offset 100% of future taxable income for tax years before January 1, 2021 and up to 80% of future taxable income for tax years after December 31, 2020. Any NOLs arising on or after January 1, 2021, cannot be carried back, can generally be carried forward indefinitely and can offset up to 80% of future taxable income.
Our ability to fully recognize the benefits from our NOLs is dependent upon our ability to generate sufficient income prior to their expiration. In addition, our NOL carryforwards may be limited if we experience an ownership change as defined by Section 382 of the Internal Revenue Code (“Section 382”). In general, an ownership change under Section 382 occurs if 5% shareholders increase their collective ownership of the aggregate amount of our outstanding shares by more than 50 percentage points over a relevant lookback period. The equity securities we sold in October 2018 may trigger an ownership change under Section 382 which could significantly limit our ability to utilize our tax benefits. See Note 13 to the financial statements filed with the Annual Report on Form 10-K for more information. The sale of additional equity securities may trigger an ownership change under Section 382 which will significantly limit our ability to utilize our tax benefits. In order to avoid limitations imposed by Section 382, we may be limited in the amount of additional equity securities we are able to sell to raise capital. We have engaged outside professionals to assist in this evaluation.
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3 – Defaults Upon Senior Securities
None.
Item 4 – Mine Safety Disclosures
Not applicable.
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Item 5 – Other Information
None.
Item 6 – Exhibits
| Exhibit 31.1 | Section 302 Certification by Chief Executive Officer and President |
| Exhibit 31.2 | Section 302 Certification by Chief Financial Officer (Principal Accounting Officer) |
| Exhibit 32 | Section 906 Certification by Chief Executive Officer and Chief Financial Officer |
| Exhibit 101.INS | Inline XBRL Instance Document. The instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.* |
| Exhibit 101.SCH | Inline XBRL Taxonomy Extension Schema Document.* |
| Exhibit 101.CAL | Inline XBRL Taxonomy Extension Calculation Linkbase Document.* |
| Exhibit 101.DEF | Inline XBRL Taxonomy Extension Definition Linkbase Document.* |
| Exhibit 101.LAB | Inline XBRL Taxonomy Extension Label Linkbase Document.* |
| Exhibit 101.PRE | Inline XBRL Taxonomy Extension Presentation Linkbase Document. |
| Exhibit 104 | Cover Page Interactive Data File. The cover page XBRL tags are embedded within the Inline XBRL document. |
| * | Submitted electronically herewith. |
Attached as Exhibit 101 to this report are the following formatted in Inline XBRL (Extensible Business Reporting Language): (i) Condensed Consolidated Statement of Operations for the three and nine months ended September 30, 2020 and 2019, (ii) Condensed Consolidated Statement of Comprehensive Income for the three and nine months ended September 30, 2020 and 2019, (iii) Condensed Consolidated Balance Sheet as of September 30, 2020 and December 31, 2019, (iv) Condensed Consolidated Statement of Cash Flows for the nine months ended September 30, 2020 and 2019, (v) Condensed Consolidated Statement of Changes in Equity for the three and nine months ended September 30, 2020 and 2019 and (vi) Notes to Condensed Consolidated Financial Statements.
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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.
| CPI AEROSTRUCTURES, INC. | |||
| Dated: December 31, 2020 | By. | /s/ Douglas J. McCrosson | |
| Douglas J. McCrosson | |||
Chief Executive Officer and President (Principal Executive Officer) |
|||
| Dated: December 31, 2020 | By. | /s/ Thomas Powers | |
| Thomas Powers | |||
Acting Chief Financial Officer (Principal Financial and Accounting Officer) |
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