NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
1.
INTERIM
FINANCIAL STATEMENTS
The
condensed financial statements of CPI Aerostructures, Inc. (the “Company”) as of September 30, 2018 and for the three
and nine months ended September 30, 2018 and 2017 have been prepared pursuant to the rules and regulations of the Securities and
Exchange Commission (“SEC”). Certain information and note disclosures normally included in annual financial statements
prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted
pursuant to those rules and regulations, although the Company believes that the disclosures made are adequate to make the information
not misleading.
The
condensed balance sheet at December 31, 2017 has been derived from the audited financial statements at that date, but does not
include all of the information and notes required by accounting principles generally accepted in the United States of America
for complete financial statements. All adjustments that, in the opinion of 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 condensed
financial statements be read in conjunction with the financial statements and notes thereto included in the Company’s Annual
Report on Form 10-K for the year ended December 31, 2017. 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 two financial institutions. The balances are insured by the Federal Deposit Insurance Corporation. From
time to time, the Company’s balances may exceed these limits. As of September 30, 2018, the Company had $748,470 of
uninsured balances. The Company limits its credit risk by selecting financial institutions considered to be highly creditworthy.
Effective
January 1, 2018, the Company adopted Accounting Standards Codification Topic 606
Revenue from Contracts with Customers
(“ASC 606”) using the modified retrospective method for all of its contracts. ASC 606 requires sales and gross profit
to be recognized over the contract period 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 as an asset captioned “Contract assets.” Contracts where billings to date have exceeded
recognized revenues are recorded as a liability captioned “Contract liabilities.” Changes to the original estimates
may be required during the life of the contract. Estimates are reviewed monthly 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 in determining revenues, costs 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 tax purposes) as reported and actual cash received during
any reporting period. The Company continually evaluates all of the issues related to the assumptions, risks and uncertainties
inherent with the process; however, it cannot be assured that estimates will be accurate. If estimates are not accurate or a contract
is terminated, the Company is required to adjust revenue in later periods. Furthermore, even if estimates are accurate, there
may be a shortfall in cash flow and the Company may need to borrow money, or seek access to other forms of liquidity, to fund
its work in process or to pay taxes until the reported earnings materialize as actual cash receipts.
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
When
changes are required for the estimated total revenue on a contract, these changes are recognized with an inception-to-date effect
in the current period. Also, when estimates of total costs to be incurred exceed estimates of total revenue to be earned, a provision
for the entire loss on the contract is recorded in the period in which the loss is determined.
Following
the adoption of ASC 606, the Company’s revenue recognition for all of its contracts remained materially consistent with
historical practice and there was no material impact in the nine months ended September 30, 2018 condensed financial statements
upon adoption.
In compliance with ASC 606, costs and estimated earnings in excess of billings on uncompleted contracts, on
the December 31, 2017 condensed balance sheet, have been reclassified to contract assets. Additionally, billings in excess of costs
and estimated earnings on uncompleted contracts and contract losses, on the December 31, 2017 condensed balance sheet, have been
combined and reclassified to contract liabilities.
2.
aCCOUNTING
STANDARDS
Recently
Issued but not Adopted Accounting Pronouncements
In
February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards
Update (“ASU”) 2016-02,
“Leases (Topic 842).”
The updated guidance requires lessees to
recognize lease assets and lease liabilities for most operating leases. In addition, the updated guidance requires that
lessors separate lease and non-lease components in a contract in accordance with the new revenue guidance in ASC 606. ASU
2016-02 will be effective January 1, 2019, although early adoption is permitted. On July 30, 2018, the FASB issued ASU No.
2018-11, Leases (Topic 842): Targeted Improvements, which, among other things, allows companies to elect an optional
transition method to apply the new lease standard through a cumulative-effect adjustment in the period of adoption. We expect
to adopt the standard on January 1, 2019 using the optional transition method. We are currently evaluating the potential
impact of adopting ASU 2016-02 and expect to have an estimate of the impact of ASU 2016-02 on the Company’s
financial position during the fourth quarter of 2018. Topic ASU 2016-02 also requires expanded disclosure regarding the
amounts, timing and uncertainties of cash flows related to a company’s leases. The Company is evaluating these
disclosure requirements and are incorporating the collection of relevant data into our processes.
3.
REVENUE
RECOGNITION
The
majority of the Company’s revenues are from long-term contracts with the U.S. government and commercial contractors. The
contracts with the U.S. government typically are subject to the Federal Acquisition Regulation (“FAR”) 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 contractors are based on the specific negotiations with each customer.
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.
To
determine the proper revenue recognition method, the Company evaluates whether two or more contracts should be combined and accounted
for as one single contract and whether the combined or single contract should be accounted for as more than one performance obligation.
This evaluation requires significant judgment and the decision to combine a group of contracts or separate the combined or single
contract into multiple performance obligations could change the amount of revenue and profit recorded in a given period.
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
All
of the Company’s current long-term contracts have a single performance obligation as the promise to transfer the goods or
services is not separately identifiable from other promises in the contracts and, therefore, not distinct. 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. All
of the Company’s contract modifications are for goods or services that are not distinct from the existing contract due to
the significant integration service provided in the context of the contract and are accounted for as if they were part of that
existing contract. The effect of a contract modification on the transaction price and the measure of progress for the performance
obligation to which it relates, is recognized as an adjustment to revenue (either as an increase in or a reduction of revenue)
on a cumulative catch-up basis.
Revenues
for the Company’s long-term contracts are recognized over time as the Company performs its obligations because of continuous
transfer of control to the customer. The continuous transfer of control to the customer is supported by clauses in contracts that
either allow the customer to unilaterally terminate the contract for convenience, pay the Company for costs incurred plus a reasonable
profit and the products and services have no alternative use or the customer controls the work in progress.
Because
of control transferring over time, revenue is recognized based on the extent of progress towards completion of the performance
obligation. The selection of the method to measure progress towards completion requires judgment and is based on the nature of
the products or services to be provided. The Company uses the cost-to-cost input method to measure progress for its contracts
because it best depicts the transfer of assets to the customer which occurs as the Company incurs costs on its contracts.
In
applying the cost-to-cost input method, the Company compares the actual costs incurred relative to the total estimated costs to
determine its progress towards contract completion and to calculate the corresponding amount of estimated revenue and estimated
gross profit recognized. For any costs incurred that do not contribute to a performance obligation, the Company excludes such
costs from its input methods of revenue recognition as the amounts are not reflective in transferring control of the asset to
the customer. Costs to fulfill 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 monthly and the effect of any
change in the estimated gross margin for a contract is reflected in revenue in the period the change becomes known. Contract estimates
involve considerable use of estimates in determining revenues, costs 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 tax purposes) as reported and actual
cash received during any reporting period. The Company continually evaluates all of the issues 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, the Company is required to adjust revenue in later
periods. Furthermore, even if estimates are accurate, there may be a shortfall in cash flow and the Company may need to borrow
money, or seek access to other forms of liquidity, to fund its work in process or to pay taxes until the reported earnings materialize
as actual cash receipts.
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
For
the Company’s uncompleted contracts, contract assets include unbilled amounts and when the estimated
revenues recognized exceeds the amount billed to the customer and right to payment is not just subject to the passage of
time. Amounts may not exceed their net realizable value. Contract assets are classified as current. The Company’s
contract liabilities consist of billings in excess of estimated revenues recognized and contract losses. Contract liabilities
are classified as current. The Company’s contract assets and liabilities are reported in a gross position at the end of
each reporting period.
Revenue
recognized for the three and nine months ended September 30, 2018, that was included in the contract liabilities at July 1, 2018
and January 1, 2018 was $151,109 and $399,381, respectively.
The
Company’s remaining performance obligations represents the transaction price of its long-term contracts for which work has
not been performed. As of September 30, 2018, the aggregate amount of transaction price allocated to the remaining performance
obligations was $77,440,322. The Company estimates that it expects to recognize approximately 31% of its remaining performance
obligations in 2018 and 69% in 2019.
In
addition, the Company recognizes revenue for parts supplied for certain maintenance repair and overhaul (“MRO”)
contracts at a point in time following the transfer of control to the customer, which typically occurs upon shipment or
delivery depending on the terms of the underlying contract.
Revenue
from long-term contracts transferred to customers over time and revenue from MRO contracts transferred at a point in time accounted
for approximately 95% and 5%, respectively, for the nine months ended September 30, 2018.
Revenue
by long-term contract type for the three and nine months ended September 30, 2018 is as follows:
|
For the Three Months Ended
|
|
For the Nine Months Ended
|
Government subcontracts
|
$
|
9,516,799
|
|
|
$
|
28,228,457
|
|
Commercial contracts
|
|
7,536,697
|
|
|
|
22,363,979
|
|
Prime government contracts
|
|
2,891,062
|
|
|
|
7,804,984
|
|
|
$
|
19,944,558
|
|
|
$
|
58,397,420
|
|
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
4.
stock-based
compensation
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
January 2018, the Company granted 58,578 restricted stock units (“RSUs”) to its board of directors as partial compensation
for the 2018 year. In January 2017, the Company granted 59,395 RSUs to its board of directors as partial compensation for the
2017 year. RSUs vest quarterly on a straight-line basis over a one-year period. The Company’s net income for the nine months
ended September 30, 2018 and 2017 includes approximately $491,500 and $517,000, respectively, of non-cash compensation expense
related to the RSU grants to the board of directors. This expense is recorded as a component of selling, general and administrative
expenses.
In
January 2018, the Company granted 5,130 shares of common stock to various employees. For the nine months ended September 30, 2018
approximately $10,000 of compensation expense is included in selling, general and administrative expenses and approximately $36,000
of compensation expense is included in cost of revenue for this grant. In January 2017, the Company granted 5,550 shares
of common stock to various employees. For the nine months ended September 30, 2017, approximately $13,300 of compensation expense
is included in selling, general and administrative expenses and approximately $37,500 of compensation expense is included in cost
of revenue for this grant.
In
March 2018, the Company granted 68,764 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 2022 based upon the service and performance thresholds. For the nine
months ended September 30, 2018, approximately $88,100 of compensation expense is included in selling, general and
administrative expenses and approximately $18,400 of compensation expense is included in cost of revenue for this
grant.
In
March 2017, the Company granted 73,060 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 2021 based upon the service and performance thresholds. For the nine months ended September 30, 2017, approximately $208,800
of compensation expense is included in selling, general and administrative expenses and approximately $44,100 of compensation
expense is included in cost of revenue for this grant.
In
March 2018, 12,330 and 9,130 of the shares granted in 2016 and 2017, respectively, were forfeited because the Company failed to
achieve certain performance criteria for the year ended December 31, 2017. In addition, on March 22, 2018, these employees returned
7,552 common shares, valued at approximately $62,000, to pay the employees’ withholding taxes.
In
March 2017, 12,330 of the shares granted in August of 2016 were forfeited because the Company failed to achieve certain
performance criteria for the year ended December 31, 2016. In addition, on March 9, 2017, these employees returned 4,525
common shares, valued at approximately $33,000, to pay the employees’ withholding taxes.
A
summary of the status of the Company’s stock option plans as of September 30, 2018 and changes during the nine months ended
September 30, 2018 is as follows:
|
|
Options
|
|
|
Weighted
average
exercise
price
|
|
|
Weighted
average
remaining
contractual
term (in years)
|
|
|
Aggregate
intrinsic value
|
|
Outstanding
at beginning of period
|
|
|
78,064
|
|
|
$
|
11.05
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
and vested at end of period
|
|
|
78,064
|
|
|
$
|
11.05
|
|
|
|
0.36
|
|
|
$
|
61,250
|
|
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
During
the nine months ended September 30, 2018 and 2017, no stock options were granted or exercised.
5.
Derivative
Instruments and Fair Value
Our
use of derivative instruments has been to hedge interest rates. These derivative contracts are entered into with a financial institution.
We do not use derivative instruments for trading purposes and we have procedures in place to monitor and control their use.
We
record these derivative financial instruments on the condensed balance sheets at fair value. For derivative instruments that are
designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative instrument is reported
as a component of other comprehensive income (loss) and reclassified into earnings in the same period or periods during which
the hedged transaction affects earnings.
Any
ineffective portion of the gain or loss on the derivative instrument for a cash flow hedge is recorded in the results of operations
immediately. For derivative instruments not designated as hedging instruments, the gain or loss is recognized in the results of
operations immediately.
In
May 2016, the Company entered into an interest rate swap with the objective of reducing its exposure to cash flow volatility arising
from interest rate fluctuations associated with certain debt. The notional amount, maturity date, and currency of this contract
match those of the underlying debt. The Company has designated this interest rate swap contract as a cash flow hedge. The Company
measures ineffectiveness by comparing the cumulative change in the forward contact with the cumulative change in the hedged item.
Fair
Value
At
September 30, 2018 and December 31, 2017, the fair values of cash, accounts receivable, accounts payable and accrued expenses
approximated their carrying values because of the short-term nature of these instruments.
|
|
September
30, 2018
|
|
|
|
Carrying
Amount
|
|
|
Fair
Value
|
|
Debt
|
|
|
|
|
|
|
Short-term
borrowings and long-term debt
|
|
$
|
35,694,028
|
|
|
$
|
35,694,028
|
|
|
|
December
31, 2017
|
|
|
|
Carrying
Amount
|
|
|
Fair
Value
|
|
Debt
|
|
|
|
|
|
|
Short-term
borrowings and long-term debt
|
|
$
|
31,893,894
|
|
|
$
|
31,893,894
|
|
We
estimated the fair value of debt using market quotes and calculations based on market rates.
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
The
following table presents the fair values of those financial liabilities measured on a recurring basis as of December 31, 2017:
|
|
|
|
|
Fair
Value Measurements December 31, 2017
|
|
Description
|
|
Total
|
|
|
Quoted
Prices
in Active
Markets for
Identical
Assets (Level 1)
|
|
|
Significant
Other
Observable
Inputs (Level 2)
|
|
|
Significant
Unobservable
Inputs (Level 3)
|
|
Interest
Rate Swap, net
|
|
$
|
18,781
|
|
|
|
—
|
|
|
$
|
18,781
|
|
|
|
—
|
|
Total
|
|
$
|
18,781
|
|
|
|
—
|
|
|
$
|
18,781
|
|
|
|
—
|
|
The
fair value of the Company’s interest rate swap was determined by comparing the fixed rate set at the inception of the transaction
to the “replacement swap rate,” which represents the market rate for an offsetting interest rate swap with the same
notional amounts and final maturity date. The market value is then determined by calculating the present value of the interest
differential between the contractual swap and the replacement swap.
As
of December 31, 2017, $18,781 was included in other liabilities related to the fair value of the Company’s interest rate
swap $15,000, net of tax of approximately $4,000, respectively, was included in accumulated other comprehensive loss.
During
the month of June, the interest rate swap matured and the Company realized a net gain of approximately $7,000.
6.
Contract assets and contract liabilities
Net
Contract assets (liabilities) consist of the following:
|
|
September
30, 2018
|
|
|
|
U.S.
|
|
|
|
|
|
|
|
|
|
Government
|
|
|
Commercial
|
|
|
Total
|
|
Contract
assets
|
|
$
|
49,102,036
|
|
|
$
|
64,992,926
|
|
|
$
|
114,094,962
|
|
Contract
liabilities
|
|
|
(422,666
|
)
|
|
|
(42,157
|
)
|
|
|
(464,823
|
)
|
Net
contract assets (liabilities)
|
|
$
|
48,679,370
|
|
|
$
|
64.950,769
|
|
|
$
|
113,630,139
|
|
|
|
|
December
31, 2017 (1)
|
|
|
|
U.S.
|
|
|
|
|
|
|
|
|
|
|
|
Government
|
|
|
Commercial
|
|
|
Total
|
|
Contract
assets
|
|
$
|
54,591,601
|
|
|
$
|
56,566,950
|
|
|
$
|
111,158,551
|
|
Contract
liabilities
|
|
|
(224,339
|
)
|
|
|
(21,991
|
)
|
|
|
(246,330
|
)
|
Net
contract assets (liabilities)
|
|
$
|
54,367,262
|
|
|
$
|
56,544,959
|
|
|
$
|
110,912,221
|
|
|
(1)
|
On January 1, 2018, as a result of the adoption of ASC 606, the Company reclassified costs and estimated earnings
in excess of billings on uncompleted contracts to contract assets and billings in excess of costs and estimated earnings on uncompleted
contracts to contract liabilities.
|
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
The
increase or decrease in the Company’s net contract assets (liabilities) from January 1, 2018 to September 30, 2018 was primarily
due to costs incurred on newer programs, like the new design of the HondaJet engine inlet ($2.4 million increase), for which the
Company has not begun billing on a steady rate. Additionally, we experienced some delays in shipping on the G650 program which
increased contract assets by $5.8 million. This has been offset by a decrease in contract assets on our E-2D program ($4.2 million
decrease) which is shipping on a regular schedule.
U.S.
government contracts includes contracts directly with the U.S. government and government subcontractors.
Revisions
in the estimated gross profits on contracts and contract amounts are made in the period in which the circumstances requiring
the revisions occur. During the nine months ended September 30, 2018, the effect of such revisions in total estimated
contract profits resulted in a decrease to the total gross profit to be earned on the contracts of approximately $683,000
from that which would have been reported had the revised estimates been used as the basis of recognition of contract profits
in prior years. During the nine months ended September 30, 2017, the effect of such revisions was a decrease to total gross
profit of approximately $1.7 million.
Although
management believes it has established adequate procedures for estimating costs to uncompleted open contracts, it is possible
that additional significant costs could occur on contracts prior to completion.
7.
income
PER COMMON SHARE
Basic
income per common share is computed using the weighted average number of common shares outstanding. Diluted income per common
share for the three and nine months ended September 30, 2018 and 2017 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 49,641 were used in the calculation of diluted income per common share in the three and nine
months ended September 30, 2018. Incremental shares of 43,064 were not used in the calculation of diluted income per common share
in the three and nine months ended September 30, 2018, as their exercise price was in excess of the Company’s average stock
price for the respective period and, accordingly, these shares are not assumed to be exercised for the diluted earnings per share
calculation, as they would be anti-dilutive. Incremental shares of 74,168 were used in the calculation of diluted income per common
share in the three and nine months ended September 30, 2017. Incremental shares of 89,466 were not used in the calculation of
diluted income per common share in the three and nine months ended September 30, 2017, as their exercise price was in excess of
the Company’s average stock price for the respective period and, accordingly, these shares are not assumed to be exercised
for the diluted earnings per share calculation, as they would be anti-dilutive.
8.
Line
of credit
On
March 24, 2016, the Company entered into a Credit Agreement with BankUnited, N.A. as the sole arranger, administrative agent and
collateral agent and Citizens Bank N.A. (the “BankUnited Facility”). The BankUnited Facility provides 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 15, 2018, the Company entered into a Third Amendment and Waiver to the Amended and Restated Credit Agreement (the “Amendment”)
with the Lenders named therein and BankUnited, N.A., as sole arranger, agent, and collateral agent, dated as of March 24, 2016,
as amended by the First Amendment and Waiver to the Amended and Restated Credit Agreement dated as of May 9, 2016, as further
amended by the Second Amendment to the Amended and Restated Credit Agreement dated as of July 13, 2017 (collectively, the “Credit
Agreement”).
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
Under
the Amendment, the parties amended the Credit Agreement by, among other things, (i) extending the maturity date of the Company’s
existing $30 million Revolving Loan and its existing $10 million Term Loan to June 30, 2020, (ii) amending the leverage
ratio covenant, (iii) amending the interest rates corresponding to the leverage ratio, (iv) waiving non-compliance with the leverage
ratio covenant for the trailing four fiscal quarters ended March 31, 2018 and June 30, 2018, and (v) amending provisions relating
to the consummation of a public offering of common stock so that if an offering results in gross proceeds of $7 million or more,
(A) the Company will prepay the loans in an amount equal to 25% of net proceeds of the offering (with $1.2 million applied to
the Term Loan and the remainder applied to the Revolving Loan) and (B) the Company will maintain a minimum of $3 million
in either unrestricted cash in an account with BankUnited, N.A., or in availability under the Revolving Loan.
Pursuant to the Amendment, the Company used an aggregate of $4.1
million of net offering proceeds of its recently completed public offering to make prepayments under the BankUnited Facility. See
Note 12 Subsequent Events for further information.
As
of September 30, 2018, the Company was not in compliance with the leverage ratio financial covenant contained in the BankUnited
Facility, as amended. The Bank has waived the provisions of this covenant as of September 30, 2018.
As
of September 30, 2018, the Company had $27.5 million outstanding under the Revolving Loan bearing interest at 5.75%.
The
BankUnited Facility is secured by all of the Company’s assets.
9.
LONG-TERM
DEBT
In
May 2016, the Company entered into an interest rate swap with the objective of reducing its exposure to cash flow volatility arising
from interest rate fluctuations associated with certain debt. The notional amount, maturity date and currency of this contract
match those of the underlying debt. The Company has designated this interest rate swap contract as a cash flow hedge. The interest
rate swap ended in accordance with its terms as of June 1, 2018.
On
August 15, 2018, the Company entered into a Third Amendment and Waiver to the Amended and Restated Credit Agreement (the “Amendment”)
with the Lenders named therein and BankUnited, N.A., as sole arranger, agent, and collateral agent, dated as of March 24, 2016,
as amended by the First Amendment and Waiver to the Amended and Restated Credit Agreement dated as of May 9, 2016, as further
amended by the Second Amendment to the Amended and Restated Credit Agreement dated as of July 13, 2017 (collectively, the “Credit
Agreement”).
Under
the Amendment, the parties amended the Credit Agreement by, among other things, (i) extending the maturity date of the Company’s
existing $30 million Revolving Loan and its existing $10 million Term Loan to June 30, 2020, (ii) amending the leverage
ratio covenant, (iii) amending the interest rates corresponding to the leverage ratio, (iv) waiving non-compliance with the leverage
ratio covenant for the trailing four fiscal quarters ended March 31, 2018 and June 30, 2018, and (v) amending provisions relating
to the consummation of a public offering of common stock so that if an offering results in gross proceeds of $7 million or more,
(A) the Company will prepay the loans in an amount equal to 25% of net proceeds of the offering (with $1.2 million applied to
the Term Loan and the remainder applied to the Revolving Loan) and (B) the Company will maintain a minimum of $3 million
in either unrestricted cash in an account with BankUnited, N.A., or in availability under the Revolving Loan.
The
Company paid to BankUnited, N.A. commitment and agent fees in the amount of $201,666, together with out of pocket costs, expenses,
and reasonable attorney’s fees incurred by BankUnited, N.A. in connection with the Amendment.
The
Company paid approximately $463,000 of total debt issuance costs in connection with the BankUnited Facility of which approximately
$178,000 is included in other assets and $63,000 is a reduction of long-term debt at September 30, 2018.
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
The
Term Loan had an initial amount of $10 million, payable in monthly installments, as defined in the agreement, which matures on June 30, 2020.
The
maturities of long-term debt (excluding unamortized debt issuance costs) are as follows:
Twelve
months ending
September 30,
|
|
|
|
|
2019
|
|
|
$
|
2,435,559
|
|
2020
|
|
|
|
5,318,604
|
|
2021
|
|
|
|
187,413
|
|
2022
|
|
|
|
108,469
|
|
Thereafter
|
|
|
|
53,429
|
|
|
|
|
$
|
8,103,474
|
|
In
addition to the Term Loan, included in long-term debt at September 30, 2018 are capital leases and notes payable of
$1,007,706 including a current portion of $335,559.
10.
MAJOR
CUSTOMERS
During
the nine months ended September 30, 2018, the Company’s four largest commercial customers accounted for 25% 12%, 12% and
12% of revenue. During the nine months ended September 30, 2017, the Company’s four largest commercial customers accounted
for 28%, 23%, 11% and 10% of revenue. In addition, during the nine months ended September 30, 2018 and 2017, 13% and 5% of revenue,
respectively, was directly from the U.S. government.
At
September 30, 2018, 37%, 14%, 13% and 12% of contract assets were from the Company’s four largest commercial customers.
At December 31, 2017, 32%, 20%, 12% and 10% of contract assets were from the Company’s four largest commercial customers.
At
September 30, 2018 and December 31, 2017, 4% and 4%, respectively, of contract assets were directly from the U.S. government.
At
September 30, 2018, 31%, 23%, 16% and 8% of our accounts receivable were from our four largest commercial customers. At December
31, 2017, 44%, 18% and 13% of accounts receivable were from our three largest commercial customers.
11.
Legal
Proceedings
On July 5, 2018, the Company
filed a complaint in the Supreme Court of the State of New York, County of New York, against Air Industries Group (“Air
Industries”) relating to the previously announced Stock Purchase Agreement, dated as of March 21, 2018 (the
“Agreement”) between the Company and Air Industries, pursuant to which Air Industries agreed to sell to us all of
the shares of capital stock of its subsidiary, Welding Metallurgy, Inc. (“WMI”). The complaint alleges, among
other things, that Air Industries willfully breached its contractual obligation to provide financial information required to
fulfill key conditions for closing under the Agreement. Air Industries’ answer and counterclaims, filed on July 30,
2018, denies the allegations made by the Company in the complaint and alleges that the Company breached the Agreement and
the covenant of good faith and fair dealing.
On July 31, 2018, the Company
filed a motion for preliminary injunction against Air Industries. The motion argued that the failure by Air Industries to
provide financial data and other information necessary to close the transaction contemplated by the Agreement would cause
irreparable injury to the Company. The Company sought an order directing Air Industries to furnish the Company with all previously
requested financial, operating, and other data and information relating to WMI.
See Note 12 Subsequent Events for
further information subsequent to September 30, 2018 related to this litigation. In addition, for a discussion of the risks
and uncertainties associated with this litigation and with the acquisition of WMI. The Company remains committed to
completing the acquisition as soon as practicable.
NOTES
TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
12.
SUBSEQUENT
EVENTS
Litigation
On October 2, 2018, the Company entered
into a court-ordered stipulation (the “Stipulation and Order”) with Air Industries with respect to the litigation
discussed above in Note 11 Legal Proceedings.
As part of the Stipulation and Order,
Air Industries has withdrawn its purported termination of the Agreement. Among other things, the Stipulation and Order requires
Air Industries to deliver to the Company within 45 days audited, unqualified financial statements of WMI for 2017 certified by Air Industries’
auditor. Subject to fulfillment of other conditions to closing set forth in the Agreement, the parties agreed that the acquisition
will close within three weeks after the Company receives the audited financial statements. The Company also agreed to promptly amend the Agreement
to reflect the terms of the Stipulation and Order. The Court will retain jurisdiction of the case for all purposes, including enforcing
the terms of the Stipulation and Order.
On November 9, 2018, the Court ordered an
amendment to the Agreement (the “Amendment”). The Amendment provides that Rotenberg Meril Solomon Bertiger
Gutilla, P.C. (“RM”) will replace CohnReznick LLP as auditors of WMI’s financial statements, consisting of
the balance sheet as at December 31, 2017 and the related statements of income, retained earnings, stockholder’s equity, and
cash flows for the year then ended. The Amendment provides that RM’s auditor’s report shall be delivered on or
before November 16, 2018, and shall be unqualified in all respects, except that a “going concern” opinion will be
considered unqualified. The Company and Air Industries agreed to share equally all fees and expenses charged by RM and all
fees and expenses previously charged by CohnReznick LLP.
Public Offering
On October 19, 2018 the Company completed
an underwritten public offering of 2,760,000 shares of its common stock, including 360,000 shares pursuant to the underwriters’
full exercise of their over-allotment option, at a public offering price of $6.25 per share. The Company’s net proceeds from
the offering, after deducting underwriting discounts, commissions, and other offering expenses, were approximately $16.10 million.
The Company anticipates using the net proceeds for general corporate purposes, which may include working capital, capital expenditures,
debt repayment, or strategic acquisitions.
On October 19, 2018, the Company
used $4.1 million of the net offering proceeds for prepayments of loans under the BankUnited Facility, as amended, including
$1.2 million applied to the term loan and $2.9 million applied to the revolving line of credit.
BankUnited Facility
On November 9, 2018, BankUnited, N.A.,
as Sole Arranger, Administrative Agent, Collateral Agent, and Lender, and Citizens Bank, N.A., as Lender, agreed to waive the Company’s
non-compliance with the leverage ratio financial covenant of the BankUnited Facility as of September 30, 2018.