CPI AEROSTRUCTURES INC

Basis of Presentation

The Company consists of CPI Aerostructures, Inc. (“CPI Aero”), Welding Metallurgy, Inc. (“WMI”), a wholly owned subsidiary of CPI Aero, and Compac Development Corporation, a wholly owned subsidiary of WMI (collectively, the “Company”, “we”, “us”, or “our”).

The condensed consolidated interim financial statements of the Company as of September 30, 2024 and for the three and nine months ended September 30, 2024 and 2023 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, 2023 has been derived from audited consolidated financial statements, 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, 2023 (the “Form 10-K”). 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.

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 for purposes of making operating decisions and assessing financial performance. The Company has determined that it has a single operating and reportable segment.

The Company maintains its cash in multiple 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, 2024, the Company had $1,476,844 of uninsured balances. The Company limits its credit risk by selecting financial institutions considered to be highly creditworthy.

Recently Issued Accounting Standards – Not Adopted

In December 2023, the FASB issued ASU No. 2023-09, Income Taxes (Topic 740): Improvements to Income Tax Disclosures, which focuses on the rate reconciliation and income taxes paid. ASU No. 2023-09 requires a public business entity (“PBE”) to disclose, on an annual basis, a tabular rate reconciliation using both percentages and currency amounts, broken out into specified categories with certain reconciling items further broken out by nature and jurisdiction to the extent those items exceed a specified threshold. In addition, all entities are required to disclose income taxes paid, net of refunds received disaggregated by federal, state/local, and foreign and by jurisdiction if the amount is at least 5% of total income tax payments, net of refunds received. For PBEs, the new standard is effective for annual periods beginning after December 15, 2024, with early adoption permitted. An entity may apply the amendments in this ASU prospectively by providing the revised disclosures for the period ending December 31, 2025 and continuing to provide the pre-ASU disclosures for the prior periods, or may apply the amendments retrospectively by providing the revised disclosures for all period presented. We expect this ASU to only impact our disclosures with no impacts to our results of operations, cash flows, and financial condition.

In November 2023, the FASB issued ASU No. 2023-07, Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures, which focuses on a PBE to disclose entity-wide and segment information in the notes to financial statements. This includes the measure of profit or loss that the CODM uses to assess segment performance and decide how to allocate resources, as well as certain specified amounts included in that measure – e.g. revenue, depreciation and amortization, interest and income tax expense. For PBEs, the new standard is effective for annual periods beginning after December 15, 2023 and interim periods within fiscal years beginning after December 15, 2024, with early adoption permitted. We expect this ASU to only impact our disclosures with no impacts to our results of operations, cash flows, and financial condition.

Disaggregation of Revenue

The following tables present the Company’s revenue disaggregated by contract type and revenue recognition method:

Favorable/(Unfavorable) Adjustments to Gross Profit

We review our Estimates at Completion (“EAC”) at least quarterly. Due to the nature of the work required to be performed on many of the Company’s performance obligations, the estimation of total revenue and cost at completion is complex, subject to many inputs, and requires significant judgment by management on a contract-by-contract basis. As part of this process, management reviews information including, but not limited to, any outstanding key contract matters, progress towards completion and the related program schedule, identified risks and opportunities, and the related changes in estimates of revenues and costs. The risks and opportunities relate to management’s judgment about the ability and cost to achieve the schedule, consideration of customer-directed delays or reductions in scheduled deliveries, technical requirements, customer activity levels, and related variable consideration. Management must make assumptions and estimates regarding contract revenue and costs, including estimates of labor productivity and availability, the complexity and scope of the work to be performed, the availability and cost of materials including any impact from changing costs or inflation, the length of time to complete the performance obligation, the availability and timing of funding from our customer, and overhead cost rates, among others.

Changes in estimates of net sales, cost of sales, and the related impact to operating profit on contracts recognized over time are recognized on a cumulative catch-up basis, which recognizes the cumulative effect of the profit changes on current and prior periods based on a performance obligation’s percentage-of-completion in the current period. A significant change in one or more of these estimates could affect the profitability of one or more of our performance obligations. Our EAC adjustments also include the establishment of, and changes to, loss provisions for our contracts accounted for on a percentage-of-completion basis.

Net EAC adjustments had the following impact on our gross profit during the nine months ended September 30, 2024 and 2023:

Transaction Price Allocated to Remaining Performance Obligations

As of September 30, 2024, the aggregate amount of transaction price allocated to the remaining performance obligations was approximately $91.5 million. This represents the amount of revenue the Company expects to recognize in the future on contracts with unsatisfied or partially satisfied performance obligations as of September 30, 2024.

Contract assets represent revenue recognized on contracts in excess of amounts invoiced to the customers 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 as well as military contractor 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 and military contract or contracts therefore typically result in revenue recognized in excess of billings, which we present as contract assets. Contract assets are classified as current assets. 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 liabilities.

Revenue recognized for the nine months ended September 30, 2024 and 2023 that was included in the contract liabilities balance as of January 1, 2024 and 2023, respectively, was approximately $5.0 million and $3.0 million, respectively.

The components of inventory consisted of the following:

In 2009, the Company adopted the Performance Equity Plan 2009 (the “2009 Plan”). The 2009 Plan reserved 500,000 common shares for issuance. The 2009 Plan provides for the issuance of either incentive stock options or nonqualified stock options to employees, consultants or others who provide services to the Company. The Company has 2,364 shares available for grant under the 2009 Plan as of September 30, 2024.

In 2016, the Company adopted the 2016 Long Term Incentive Plan (the “2016 Plan”). The 2016 Plan reserved 600,000 common shares for issuance, provided that no more than 200,000 common shares be granted as incentive stock options. Awards may be made or granted to employees, officers, directors and consultants in the form of incentive stock options, non-qualified stock options, stock appreciation rights, restricted stock, restricted stock units and other stock-based awards. Any shares of common stock granted in connection with awards other than stock options and stock appreciation rights are counted against the number of shares reserved for issuance under the 2016 Plan as one and one-half shares of common stock for every one share of common stock granted in connection with such award. Any shares of common stock granted in connection with stock options and stock appreciation rights are counted against the number of shares reserved for issuance under the 2016 Plan as one share for every one share of common stock issuable upon the exercise of such stock option or stock appreciation right awarded. In the fourth quarter of 2020, the Company added 800,000 shares to the 2016 Plan, which increased the number of shares reserved for issuance under the 2016 Plan to 1,400,000 shares. In the second quarter of 2023, the Company added an additional 800,000 shares to the 2016 Plan, which increased the number of shares for reserved for issuance under the 2016 Plan to 2,200,000 shares. The Company has 376,094 shares available for grant under the 2016 Plan as of September 30, 2024.

Stock-based compensation expense for restricted stock in the consolidated statements of operations is summarized as follows:

The Company grants restricted stock units (“RSUs”) to its board of directors as partial compensation. These RSUs vest quarterly on a straight-line basis over aone-year period and will fully vest on October 1, 2024.

The following table summarizes activity related to outstanding RSUs for the nine months ended September 30, 2024:

The Company grants shares of common stock (“Restricted Stock Awards” or “RSAs”) to select employees. These shares have various vesting dates, ranging from vesting on the grant date to as late asfour years from the date of grant. In the event that the employee’s employment is voluntarily terminated prior to certain vesting dates, portions of the shares may be forfeited. At September 30, 2024, the weighted average remaining amortization period was 2.7 years.

The following table summarizes activity related to outstanding Restricted Stock Awards for the nine months ended September 30, 2024:

The Company grants shares of common stock (“Performance Restricted Stock Awards” or “PRSAs”) to select officers as part of our long-term incentive program that will result in that number of PRSAs being paid out if the target performance metric is achieved. The award vesting is based on specific performance metrics related to accounts payable delinquency, debt, and net income during the performance period. The PRSAs vest at 0% or 100% and all three metrics must be met to vest at 100%. The PRSAs granted under this program will vest on the fourth anniversary of the grant date, subject to the aforementioned performance criteria. At September 30, 2024, the weighted average remaining amortization period was 2.6 years.

The following table summarizes activity related to outstanding PRSAs for the nine months ended September 30, 2024:

The fair value of all RSUs, PRSAs and RSAs is based on the closing price of our common stock on the grant date. All RSUs, PRSAs, and Restricted Stock Awards vest and settle in common stock (on a one-for-one basis).

As of September 30, 2024, unamortized stock-based compensation costs related to restricted share arrangements was $284,780.

Basic and diluted income per common share is computed using the weighted average number of common shares outstanding. Diluted income per common share is adjusted for the incremental shares attributed to unvested RSUs and RSAs. Incremental shares of 70,105 and 90,463 were used in the calculation of diluted income per common share for the three and nine months ended September 30, 2024, respectively. Incremental shares of 33,162 were used in the calculation of diluted income per common share for both the three and nine months ended September 30, 2023.

On March 24, 2016, the Company entered into the Amended and Restated Credit Agreement with the lenders named therein and BankUnited N.A. as Sole Arranger, Agent and Collateral Agent (as amended from time to time, the “Credit Agreement” or the “BankUnited Facility”). The BankUnited Facility originally provided for a revolving credit loan commitment of $30 million (the “Revolving Loan”) and a $10 million term loan (“Term Loan”). The Revolving Loan bears interest at a rate based upon a pricing grid, as defined in the Credit Agreement.

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

On November 13, 2024, the Company entered into a Fourteenth Amendment to the Credit Agreement (the “Fourteenth Amendment”). Under the Fourteenth Amendment, the parties amended the Credit Agreement by: (i) extending the maturity date of the Company’s existing revolving line of credit (the “Revolving Credit Loans”) to August 31, 2026; (ii) reducing the Base Rate Margin (as defined in the Credit Agreement) from 3.50% to 2.0%; (iii) resetting the aggregate maximum principal amount of all Revolving Credit Loans to $16,890,000 from January 1, 2025 through March 31, 2025, $16,140,000 from April 1, 2025 through June 30, 2025,$15,390,000 from July 1, 2025 through September 30, 2025,$14,640,000 from October 1, 2025 through December 31, 2025,$13,890,000 from January 1, 2026 through March 31, 2026,$13,140,000 from April 1, 2026 through June 30, 2026, and$12,390,000 from July 1, 2026 onward and for payments to be made by the Company to comply therewith (if any such payments are necessary), on the first day of each such period; and (iv) requiring the Company, if it does not deliver to BankUnited, N.A. by December 31, 2025, a commitment letter with banks and terms and conditions reasonably acceptable to the Lenders for refinancing the obligations under the Credit Agreement, to make a payment by January 31, 2026, equal to 2% of the aggregate outstanding principal amount of the Revolving Credit Loans as of December 31, 2025, with 50% of such payment applied to reduce the aggregate outstanding principal and the remaining 50% retained by the Lenders as an amendment fee with respect to the Fourteenth Amendment.

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

The BankUnited Facility is secured by all of the Company’s assets. Prior to the Fourteenth Amendment, the Revolving Loan bore interest at the Prime Rate +3.50%. The Prime Rate was 8.0% as of September 30, 2024 and as such, the Company’s interest rate on the Revolving Loan was 11.5% as of September 30, 2024.

As of September 30, 2024 and December 31, 2023, the Company had $18,120,000 and $20,040,000 outstanding under the Revolving Loan, respectively. $2,730,000 of the Revolving Loan is payable by September 30, 2025 and the remaining balance of $15,390,000 of the revolving line of credit matures and is payable by August 31, 2026, as amended November 13, 2024.

The Company has cumulatively paid approximately $962,000 of total debt issuance costs in connection with the BankUnited Facility, of which approximately $43,000 and $82,000 is unamortized and is included in other assets at September 30, 2024 and December 31, 2023, respectively.

Also included in long-term debt are financing leases of $34,064 and $70,981 at September 30, 2024 and December 31, 2023, respectively, including a current portion of $31,330 and $44,498, respectively. The maturities of the September 30, 2024 balance of these financing leases are as follows:

During the nine months ended September 30, 2024, our four largest customers accounted for 35%,24%,12%, and 12% of revenue. During the nine months ended September 30, 2023, our four largest customers accounted for 31%,26%,12% and 10% of revenue. During the three months ended September 30, 2024, our three largest customers accounted for 40%,23% and 11% of revenue. During the three months ended September 30, 2023, our four largest customers accounted for 28%,21%,19% and 13% of revenue.

At September 30, 2024,38%,25%, and 13% of our accounts receivable were from three of our largest customers. At December 31, 2023,30%,17%,12%, and 11% of accounts receivable were due from our four largest customers.

At September 30, 2024,27%,26%,15% and 12% of our contract assets were from four of our largest customers. At December 31, 2023,26%,23%,18%, and 15% of our contract assets were related to our four largest customers.

At September 30, 2024,10% of our accounts payable was from one of our largest vendors. At December 31, 2023 no vendors accounted for 10% of our accounts payable.

The Company leases manufacturing and office space under an agreement classified as an operating lease. On November 10, 2021, the Company executed the second amendment to the lease agreement for its manufacturing and office space, which extends the lease agreement’s expiration date to April 30, 2026. The lease agreement does not include any renewal options. The agreement provides for an initial monthly base amount plus annual escalations through the term of the lease. In addition to the monthly base amounts in the lease agreement, the Company is required to pay real estate taxes and operating expenses during the lease terms.

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

For the nine months ended September 30, 2024 and 2023, the Company’s operating lease expense was $1,611,487 and $1,612,713, respectively. For the three months ended September 30, 2024 and 2023, the Company’s operating lease expense was $528,127 and $529,624, respectively.

Future minimum lease payments under non-cancellable operating leases as of September 30, 2024 were as follows:

The following table sets forth the right-of-use assets and operating lease liabilities as of:

The Company’s weighted average remaining lease term for its operating leases is 1.7 years as of September 30, 2024. The Company’s weighted average discount rate for its operating leases is 5.5% as of September 30, 2024.

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.

The provision for income tax for the three months ended September 30, 2024 and 2023 was $154,590 and $205,804, respectively. The provision for income tax for the nine months ended September 30, 2024 and 2023 was $535,634 and $503,850, respectively.

The effective income tax rate for the nine months ended September 30, 2024 is 18.7 %. The difference between the effective income tax rate for the nine months ended September 30, 2024 and the statutory income tax rate of 21.0% for the nine months ended September 30, 2024 is due primarily to the estimated R&D credit, state income taxes and permanent tax differences. The effective income tax rate for the nine months ended September 30, 2023 was 17.1%. The difference between the effective income tax rate for the nine months ended September 30, 2023 and the statutory income tax rate of 21% for the nine months ended September 30, 2023 was due to the estimated R&D credit, the partial release of approximately $122,500 of the Company’s valuation allowance on its deferred tax asset recorded during the nine months ending September 30, 2023, state income taxes and permanent tax differences.

The Company may be involved in various claims, suits, assessments, investigations, and legal proceedings that arise from time to time in the ordinary course of its business. The Company accrues a liability when it is both probable a liability has been incurred and the amount of the loss can be reasonably estimated. The Company reviews these accruals at least quarterly and adjusts them to reflect ongoing negotiations, settlements, rulings, advice of legal counsel, and other relevant information. To the extent new information is obtained and the Company’s views on the probable outcomes of claims, suits, assessments, investigations, or legal proceedings change, changes in the Company’s accrued liabilities would be recorded in the period such determination is made. For some matters, the amount of liability is not probable or the amount cannot be reasonably estimated and, therefore, accruals have not been made.

The Company reached a settlement with the SEC on June 20, 2024 related to the Company’s previously announced and filed restatements of certain of its financial statements for fiscal periods between January 1, 2018 and December 31, 2022. Under the terms of this settlement, if the Company fails to comply with various undertakings, a civil monetary penalty in the amount of $400,000 will be due to the SEC by June 30, 2025 (the “Undertakings”). The Undertakings are as follows: (a) the Company shall fully remediate its outstanding material weaknesses in Internal Controls over Financial Reporting (“ICFR”) and have effective ICFR and disclosure controls and procedures (“DCP”) by December 31, 2024; (b) the Company shall publicly disclose, concurrent with the filing of the 2024 Form 10-K, whether in management’s opinion, the Company has fully remediated its material weaknesses in ICFR and has effective ICFR and DCP; and (c) the Company shall certify, in writing, compliance with the undertaking(s) set forth above. The certification shall be made by the Company’s CEO and identify the undertaking(s), provide written evidence of compliance in the form of a narrative, and be supported by exhibits sufficient to demonstrate compliance. The certification and supporting material shall be submitted to the SEC no later than sixty (60) days from the date of the completion of the undertakings.