CPI AEROSTRUCTURES INC 10-K

Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis includes forward-looking statements involving risks and uncertainties and should be read together with the “Risk Factors” section of this Annual Report on Form 10-K. Such risks and uncertainties could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. Recent Developments On February 20, 2024, the Company entered into a Thirteenth Amendment to the Credit Agreement (the “Thirteenth Amendment”). Under the Thirteenth Amendment, the parties amended the Credit Agreement by (a) extending the maturity date of the Company’s existing revolving line of credit to August 31, 2025; and (b) setting the aggregate maximum principal amount of all revolving line of credit loans to $19,800,000 from January 1, 2024 through March 31, 2024, $19,080,000 from April 1, 2024 through June 30, 2024, $18,360,000 from July 1, 2024 through September 30, 2024, $17,640,000 from October 1, 2024 through December 31, 2024, $16,920,000 from January 1, 2025 through March 31, 2025, $16,200,000 from April 1, 2025 through June 30, 2025 and $15,480,000 thereafter, and for payments to be made by the Company to comply therewith (if any such payments are necessary), on the first day of each such period. Business Operations We are engaged in the contract production of structural aircraft parts for fixed wing aircraft and helicopters in both the commercial and defense markets. We also have a strong and growing presence in the aerosystems sector of the market, with our production of various reconnaissance pod structures and fuel panel systems. Within the global aerostructure and aerosystem supply chain, we are either a Tier 1 supplier to aircraft OEMs or a Tier 2 subcontractor to major Tier 1 manufacturers. We also are a prime contractor to the U.S. DOD, primarily the USAF. In conjunction with our assembly operations, we provide engineering, program management, supply chain management and kitting, and MRO services. Critical Accounting Estimates The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of certain assets and liabilities, revenues and expenses, and disclosure of contingencies during the reporting period. Significant estimates and assumptions include revenue recognition, the valuation of deferred income taxes, and the valuation of inventory. Actual results could differ from those estimates. We believe that the following discussion addresses our critical accounting policies which require management’s most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. For more discussion of these and other significant accounting policies, refer to Part II, Item 8, Note 1 “ Principal Business Activity and Summary of Significant Accounting Policies” in our notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Revenue Recognition In accordance with ASC 606, the Company recognizes revenue when it transfers control of a promised good or service to a customer in an amount that reflects the consideration it expects to be entitled to in exchange for the good or service. The majority of the Company’s performance obligations are satisfied over time as the Company (i) sells products with no alternative use to the Company and (ii) has an enforceable right to recover costs incurred plus a reasonable profit margin for work completed to date. Under the over time revenue recognition model, revenue and gross profit are recognized over the contract period as work is performed based on actual costs incurred and an estimate of costs to complete and resulting total estimated costs at completion. See Part II, Item 8, Note 1 “Principal Business Activity and Summary of Significant Accounting Policies” in the notes to the consolidated financial statements included in this Form 10-K for additional information regarding the Company’s revenue recognition policy. 21 Deferred Income Taxes – Valuation Allowance On a quarterly basis, we assess the likelihood that we will be able to recover our deferred tax assets against future sources of taxable income and reduce the carrying amounts of deferred tax assets by recording a valuation allowance if, based on the available evidence, it is more likely than not (defined as a likelihood of more than 50%) that all or a portion of such assets will not be realized. Assessing the realizability of deferred tax assets requires the determination of whether it is more likely than not that some portion or all the deferred tax assets will not be realized. In assessing the need for a valuation allowance, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, loss carryback and tax-planning strategies. Generally, more weight is given to objectively verifiable evidence, such as a cumulative loss in recent years, as a significant piece of negative evidence to overcome. As of December 31, 2023, the Company achieved three years of consecutive book and taxable income, along with projections of profitability, for which management determined that there is sufficient positive evidence to conclude that it is more likely than not that a portion of the deferred tax assets will be realized. As such, $14,170,891 of the valuation allowance was released during the fourth quarter of 2023, leaving a balance in the valuation allowance of $569,143 as of December 31, 2023. Inventory Inventory is stated at the lower of cost or estimated net realizable value. Cost is determined using the weighted average method. The Company capitalizes labor, material, subcontractor and overhead costs as work-in-process for contracts where control has not yet passed to the customer. The Company regularly reviews inventory quantities on hand, future purchase commitments with its suppliers, and the estimated usability for its inventory. If the Company’s review indicates a reduction in usability below carrying value, it reduces its net inventory to its net realizable value. Results of Operations The following discussion provides an analysis of our results of operations and should be read in conjunction with the accompanying consolidated financial statements and notes thereto. Revenue Revenue for the year ended December 31, 2023 was $86,466,321 compared to $83,335,764 for the year ended December 31, 2022, representing an increase of $3,130,557, or 3.8%. The increase was primarily related to increases in the Raytheon - SDTA program and the T-38 Pacer Classic program, partly offset by decreases in the Sikorsky HIRRS program . Revenue generated from prime government contracts for the year ended December 31, 2023 was $11,842,145 compared to $8,663,308 for the year ended December 31, 2022, an increase of $3,178,837, or 36.7%. This increase is primarily a result of increased revenue recognized on the T-38 Pacer Classic program. Revenue generated from government subcontracts for the year ended December 31, 2023 was $69,672,602 compared to $69,023,729 for the year ended December 31, 2022, an increase of $648,873, or 0.9%. The increase in revenue was primarily related to increases in the Raytheon - SDTA program and the Lockheed Martin F-16 Rudder Island program, partly offset by decreases in the Sikorsky HIRRS program and the NGC E-2D WOWP program. Revenue generated from commercial contracts for the year ended December 31, 2023 was $4,951,574 compared to $5,648,727 for the year ended December 31, 2022, a decrease of $697,153, or 12.3%. The decrease in revenue resulted from decreased revenue recognized on the Gulfstream G650 program, which concluded in 2022. Cost of sales Cost of sales for the year ended December 31, 2023 was $69,400,693 compared to $67,031,502 for the year ended December 31, 2022, an increase of $2,369,191 or 3.5%. The components of cost of sales were as follows: Years ended December 31, 2023 December 31, 2022 Procurement $ 46,020,628 $ 46,094,088 Labor 7,054,308 6,829,405 Factory overhead 16,028,140 15,730,682 Other cost of sales 297,617 (1,622,673 ) Cost of sales $ 69,400,693 $ 67,031,502 22 Procurement for the year ended December 31, 2023 was $46,020,628 compared to $46,094,088 for the year ended December 31, 2022, a decrease of $73,460 or 0.2%. This decrease is primarily the result of a decrease in procurement for the Lockheed Martin F-16 Rudder Island program, the Raytheon - SDTA program, the NGC E-2D MYP II OWP program and the NGC E2D WOWP program, the Bell AH-1Z program, the Gulfstream G650 program and the Raytheon B-52 Radar Rack program, partly offset by increases in the Sikorsky HIRRS program and the Raytheon Next Generation Jammer – Mid-Band pod program. Labor costs for the year ended December 31, 2023 were $7,054,308 compared to $6,829,405 for the year ended December 31, 2022, an increase of $224,903 or 3.3%. The increase is primarily the result of higher labor cost incurred on the Boeing A-10 Warthog program. Factory overhead costs for the year ended December 31, 2023 were $16,028,140 compared to $15,730,682 for the year ended December 31, 2022, an increase of $297,458 or 1.9%. The increase is primarily the result of higher overhead rates incurred on the Raytheon Next Generation Jammer – Mid-Band pod program, the Sikorsky – Gunner Windows program and the Lockheed Martin F-16 Rudder Island program. Other cost of sales relates to items that can increase or decrease cost of sales such as changes in inventory levels, changes in inventory valuation, changes to inventory reserves, changes in loss contract provisions and direct charges to cost of sales. For the year ended December 31, 2023, there were costs in the amount of $297,617 compared to a reduction of costs in the amount of $1,622,673 for the year ended December 31, 2022, an increase of $1,920,290 or 118.3%. The increase is primarily the result of a higher level of cost decrease in 2022 related to changes in inventory levels and loss contract reserve reductions. Gross profit Gross profit for the year ended December 31, 2023 was $17,065,628 compared to $16,304,262 for the year ended December 31, 2022, an increase of $761,366 or 4.7%. Gross profit percentage (“gross margin”) for the year ended December 31, 2023 was 19.7% compared to 19.6% for year ended December 31, 2022. Favorable/(Unfavorable) Adjustments to Gross Profit During the years ended December 31, 2023 and 2022, we made changes in estimates to various contracts. Such changes in estimates resulted in changes in total gross profit as follows: Years Ended December 31, 2023 December 31, 2022 Favorable adjustments $ 2,601,615 $ 4,962,675 (Unfavorable) adjustments (4,052,117 ) (3,207,099 ) Net adjustments $ (1,450,502 ) $ 1,755,576 Selling, general and administrative expenses Selling, general and administrative expenses (“SG&A”) for the year ended December 31, 2023 were $10,758,624 compared to $11,410,067 for the year ended December 31, 2022, a decrease of $651,443 or 5.7%. The decrease was primarily due to decreased insurance expense and legal fees. Interest expense Interest expense for the year ended December 31, 2023 was $2,455,214, compared to $2,271,101 for the year ended December 31, 2022, an increase of $184,113 or 8.1%. The increase is the result of higher year-over-year interest rates charged on our outstanding debt under the Credit Agreement, partially offset by a year-over-year decrease in the amount of our outstanding debt under the Credit Agreement. Income before provision for income taxes Income before provision for income taxes for the year ended December 31, 2023 was $3,851,790 compared to $2,623,094 for the year ended December 31, 2022, an increase of $1,228,696 or 46.8%. The increase was driven by the aforementioned increase in gross profit and decrease in SG&A, partially offset by the increase in interest expense described above. Provision (benefit) for income taxes The income tax (benefit) for the year ended December 31, 2023 was ($13,349,414), which was an effective tax (benefit) rate of (346.6%), as compared to the income tax (benefit) of ($6,553,131) for the year ended December 31, 2022, which was an effective tax (benefit) rate of (249.8%). The income tax (benefit) in 2023 and 2022 was primarily due to reductions of the Company’s deferred tax asset valuation allowance recorded by the Company in the fourth quarter of 2023 and the fourth quarter of 2022 of $14,170,891 and $6,473,532, respectively. 23 Net income Net income for the year ended December 31, 2023 was $17,201,204 compared to $9,176,225 for the year ended December 31, 2022, an increase of $8,024,979 or 87.5%. The increase in net income was driven by the aforementioned increase in gross profit, decrease in SG&A and the 2023 income tax (benefit), partially offset by the aforementioned increase in interest expense. Earnings per share Basic earnings per share was $1.40 for the year ended December 31, 2023 calculating utilizing 12,311,219 weighted average shares outstanding as compared to $0.74 for the year ended December 31, 2022 calculated utilizing 12,389,890 weighted average shares outstanding, an increase of $0.66 per share, or 88.8%. Diluted earnings per share was $1.38 for the year ended December 31, 2023 calculated utilizing 12,471,961 weighted average shares outstanding as compared to $0.74 for the year ended December 31, 2022 calculated utilizing 12,389,890 weighted average shares outstanding, an increase of $0.64 per share, or 86.4%. Business Outlook The statements in the “Business Outlook” section and other forward-looking statements of this Annual Report on Form 10-K are subject to revision during the course of the year in our quarterly earnings releases and SEC filings and at other times. Liquidity and Capital Resources General . At December 31, 2023, we had working capital of $15,402,381 compared to working capital of $12,896,602 at December 31, 2022, an increase of $2,505,779, or 19.4%. This increase is primarily the result of an increase in contract assets and cash, partially offset by an increase in accrued expenses and accounts payable and a decrease in current portion of long-term debt. Cash Flow . A large portion of our cash is used to pay for materials and processing costs associated with contracts that are in process and which do not provide for progress payments. Costs for which we are not able to bill on a progress basis are components of contract assets on our consolidated balance sheet and represent the aggregate costs and related earnings for uncompleted contracts for which the customer has not yet been billed. These costs and earnings are recovered upon shipment of products and presentation of billings in accordance with contract terms. Because ASC 606 requires us to use estimates in determining revenues, costs and profits and in assigning the amounts to accounting periods, there can be a significant disparity between earnings (both for accounting and tax purposes) as reported and actual cash that we receive during any reporting period. Accordingly, it is possible that we may have a shortfall in our cash flow and may need to borrow money or take steps to defer cash outflows 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 experience margin degradation, which may be material for costs that are not recoverable. Such charges and the loss of up-front costs could have a material impact on our liquidity and results of operations. We continue to work to obtain better payment terms with our customers, including accelerated progress payment arrangements, as well as exploring alternative funding sources. At December 31, 2023, our cash balance was $5,094,794 compared to $3,847,225 at December 31, 2022, an increase of $1,247,569, or 32.4%. The increase was driven by $3,928,341 in cash provided by operations, partly offset by our pay down of outstanding debt during 2023 of $2,679,766. BankUnited Facility This information is set forth in Note 8 to our Consolidated Financial Statements, appearing following Item 15 of this Annual Report on Form 10-K which is hereby incorporated by reference. Leases This information is set forth in Note 10 to our Consolidated Financial Statements, appearing following Item 15 of this Annual Report on Form 10-K which is hereby incorporated by reference. Liquidity Our working capital requirements can vary significantly, depending in part on the timing of the conclusion of mature programs and new program awards and the payment terms with our customers and suppliers. There is currently no availability for borrowings under the BankUnited Facility and the Company finances its operations from internally generated cash flow. Note 8 to our consolidated financial statements included in Part II - Item 8 includes a discussion regarding the BankUnited Facility and recent amendments thereto which provide, among other things, for increases in principal payments and the interest rate on the loans provided for therein. Management has (i) negotiated and executed a further amendment to the Credit Agreement which extended the maturity date of the Credit Agreement to August 31, 2025, (ii) obtained and regularly seeks additional progress payment and advance payment customer contract funding provisions, (iii) maintained procedures to minimize investments in inventory and contract assets, (iv) remained focused on its military customer base and (v) maintained its approximately $118.2 million backlog of funded orders, 98% of which are for military programs. Based upon the aforementioned factors, it is management’s estimation that there will likely not be any individual conditions or combination of events that will occur in the coming year which would cause the Company to be unable to meet its obligations or otherwise continue as a going concern. However, there can be no assurance that such plans will accomplish their intended goals. 24 Contractual Obligations The table below summarizes information about our contractual obligations as of December 31, 2023 and the effects these obligations are expected to have on our liquidity and cash flow in the future years. Payments Due By Period Contractual Obligations Total Less than 1 year 1-3 years 4-5 years After 5 years Line of credit $ 20,040,000 $ 2,400,000 $ 17,640,000 $ — $ — Finance Leases 70,981 44,498 26,483 — — Operating Leases 5,482,708 2,228,784 3,244,696 9,228 — Insurance Financing Agreement 280,910 280,910 — — — Total Contractual Cash Obligations $ 25,874,599 $ 4,954,192 $ 20,911,179 $ 9,228 $ — Inflation Inflation historically has not had a material effect on our operations, although the current inflationary environment in the U.S., and its impact on interest rates, the supply chain, the labor market and general economic conditions, are factors that the Company actively monitors in an attempt to mitigate and manage potential negative impacts on and risks faced by the Company. The majority of the Company’s long term contracts with its customers reflect fixed pricing and its long term contracts with its suppliers reflect fixed pricing. When bidding for work, the Company takes inflation risk and supply side pricing risk into account in its proposals. Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Interest Rate Risk We are exposed to interest rate risk on variable-rate credit facilities for which there was $20,040,000 outstanding at December 31, 2023. Additionally, if we were to refinance our long-term debt, it may be refinanced at higher interest rates. Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA This information appears following Item 15 of this Annual Report on Form 10-K and is incorporated herein by reference. Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.