CPI Aerostructures, Inc. — Q3 2019 Form 10-Q
Business context and period. The company manufactures structural aircraft parts and provides engineering, assembly, and maintenance services for commercial and defense markets. This unaudited report covers the three and nine months ended September 30, 2019; year-to-date comparisons are against the same 2018 period. 2019 includes Welding Metallurgy, Inc. (WMI), acquired in December 2018, while the 2018 comparative results do not include WMI.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $25.71 million | $19.02 million | $74.45 million | $57.47 million |
| Gross profit / margin | $4.96 million / 19.3% | $3.87 million / 20.4% | $15.34 million / 20.6% | $12.51 million / 21.8% |
| Operating income | $2.37 million | $1.29 million | $7.22 million | $5.31 million |
| Net income | $1.67 million | $0.59 million | $6.04 million | $3.10 million |
| Diluted EPS | $0.14 | $0.07 | $0.51 | $0.35 |
- Revenue rose 35.2% in Q3 and 29.6% year to date. Management attributed the increases to WMI and higher production on defense programs, including E-2D and the Next Generation Jammer pod.
- Gross profit increased with volume, but margins declined year over year, primarily due to WMI’s lower margins. Year-to-date contract estimate changes reduced expected gross profit by a net $327,000, versus $683,000 in 2018.
- Operating cash flow was negative $4.04 million for the first nine months, compared with negative $3.05 million in 2018. Contract assets increased $8.12 million and were a significant use of cash. Investing cash outflow was $0.33 million; financing provided $0.72 million.
- At September 30, cash was $0.47 million and restricted cash was $2.00 million. Working capital was $100.93 million. Net contract assets were $119.63 million, including $121.46 million of contract assets less $1.82 million of contract liabilities.
- Total debt was approximately $31.61 million, including $26.74 million drawn on the revolving facility. The revolver rate was 5.87%; approximately $1.1 million was available under the facility’s combined cash-and-availability requirement. The company reported compliance with its financial covenants. The credit facility is secured by company assets.
Material changes and outlook
- Government-subcontract revenue grew substantially; commercial-subcontract revenue declined 9.7% year to date, mainly due to lower G650 revenue. Direct military revenue also declined, primarily due to lower T-38 kit sales.
- Backlog at September 30 was $533.9 million, up from $457.4 million at December 31, 2018; approximately 91% was government-related. The company cautions that substantially all backlog may be terminated or rescheduled, and unfunded backlog depends on future appropriations and orders.
- Remaining performance obligations were $255.2 million; management estimated recognizing approximately 18% in 2019 and 82% in 2020. The filing provides no earnings or revenue guidance beyond this estimate.
- Management said existing resources and credit availability should meet current working-capital needs for at least 12 months from the filing date. It also noted that contract work-in-process and delayed cash conversion may require borrowing or other liquidity sources.
- WMI acquisition working-capital dispute: BDO’s determination favored CPI and would reduce the purchase price by approximately $4.2 million. In October, about $619,000 was released from escrow for conceded items; approximately $3.6 million remained disputed, and CPI sought court relief. No related purchase-accounting adjustment had been recorded because the outcome was uncertain.
Risks, contingencies, and unusual items
- A potential IRS challenge to a 2014 net-operating-loss carryback remained unresolved. The company had recorded a liability of about $3.1 million in 2018 and reduced it by approximately $1.4 million in Q3 2019 based on further IRS information. The filing reports a $276,000 income-tax benefit for the nine months; management said no formal assessment had been received and the company could appeal.
- Q3 and year-to-date 2019 net income included an approximately $0.09-per-share benefit from the tax-liability reduction, according to management.
- Revenue is recognized over time using cost-to-cost estimates. Changes in estimated costs, contract terminations, delays, or cancellations can require later revenue or profit adjustments and may create liquidity pressure. Up-front costs on certain programs could be impaired if programs are delayed or cancelled.
- The company adopted lease accounting in 2019, recognizing operating lease right-of-use assets of $4.26 million and liabilities of $4.71 million at quarter end.
- Management identified a prior material weakness involving review controls over coding sales invoices to the correct contract type. Corrective controls were implemented in Q1 2019 and management said they provide reasonable assurance against recurrence. Disclosure controls were deemed effective as of September 30, 2019; the internal-control assessment excluded WMI during the permitted acquisition integration period.
Important facts for investors to verify
- Whether contract assets convert to billings and cash as expected, and whether negative operating cash flow persists.
- WMI’s contribution to revenue, gross margin, cash generation, and final purchase accounting; also the resolution and collection of the disputed approximately $3.6 million escrow amount.
- Progress on the IRS matter and the adequacy of the remaining tax reserve.
- Backlog funding, customer orders, and the timing and margins of major government programs; distinguish funded from unfunded backlog.
- Current revolver availability, covenant headroom, and the company’s ability to maintain liquidity amid contract working-capital demands.
- Whether the invoice-coding control remediation remains effective and whether controls have been integrated at WMI.