Item 1A. RISK FACTORS
In
addition to other risks and uncertainties described in this Annual Report on Form 10-K, 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 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, 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, the threat or existence
of a government shutdown and potential downgrades of the United States’ credit rating, and risks relating to the upcoming
U.S. presidential election. 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.
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.
12
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:
Further
consolidation in the aerospace industry could adversely affect our business and financial results.
The
A&D industry has experienced 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, there can be no assurance 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
costs to us.
We
depend upon a select base of large prime defense contractors for the majority of our revenue, which subjects us to unique risks
which may adversely affect us.
We
currently generate a majority of our revenues by producing products for numerous programs under contracts with three prime defense
contractors to the U.S. Government. These significant customers – Lockheed Martin, Raytheon and NGC – constituted
approximately 30%, 26% and 12%, respectively of our 2023 revenue. Our revenues from these customers are diversified over several
different A&D products, programs, and subsidiaries within these customers, however, any significant change in production rates
by any of these customers would have a material effect on our results of operations and cash flows. There is no assurance that
our current significant customers will continue to buy products from us at current levels, that we will retain any or all our
existing significant customers, or that we will be able to form new relationships with other customers upon the loss of one or
more of our existing significant customers.
We
are subject to strict governmental regulations relating to the environment, which could result in fines and remediation expenses
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.
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, our hiring of personnel of a subcontractor, or disputes concerning
payment. 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 fulfill our obligations as the prime contractor.
Subcontractor performance deficiencies could result in a customer eliminating our ability to progress bill or terminate 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.
13
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 and cost of materials, the effect of any delays in performance, availability, and timing of funding from
the customer, natural disasters, pandemics, 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 may 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 for 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.
We
continually evaluate all 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 and results of operations would be adversely
affected.
The
maximum contract value specified under each contract that we enter is not necessarily indicative of the revenues that we will
realize under that contract. 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 could 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 employees
at all levels. Competition for key personnel is intense. Our ability to attract and retain senior officers and experienced, top
rate employees is dependent on several factors, including prevailing market conditions and compensation and benefit packages offered
by companies competing for the same talent and our reputation in the industry. If our reputation is adversely affected, we may
be unable to recruit, hire, and retain talented personnel. The inability to hire and retain these people may adversely affect
our production operations and other aspects of our business.
We
are subject to intense competition for the skilled technicians necessary to manufacture our products.
We
are subject to intense competition for the services of skilled technicians necessary to manufacture our products. The demand for
these individuals may increase as other manufacturers seek to bring to the U.S. manufacturing processes currently outsourced overseas.
If the U.S. economy continues to undergo a period of inflation, our labor costs may increase which could have a material adverse
effect on our business, financial condition, and results of operations.
14
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 inflation 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 the current inflationary and high interest rate environment in the U.S. and the resultant impacts
on the supply chain, the labor market and the general economy, as well 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. If these characteristics and trends adversely affect customers in the commercial aerospace industry, they may reduce
the overall demand for our products.
Our
working capital requirements may negatively affect our liquidity and capital resources.
Our
working capital requirements can vary significantly, depending in part on the timing of new program awards and the payment terms
with our customers and suppliers. If our working capital needs exceed our cash flows from operations, we would look to our cash
balances and availability for borrowings under our credit facility to satisfy those needs, as well as potential sources of additional
capital, which may not be available on satisfactory terms and in adequate amounts, if at all. See “Risks Related to Our
Indebtedness and Liquidity” below.
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.
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 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 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 the North American Industry Classification Systems (“NAICS”) industry
and product specific codes that are regulated in the U.S. by the Small Business Administration (“SBA”). 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, internal system or service failures and technological changes, including the use of machine learning and generative
artificial intelligence, 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.
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-attacks
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 because of any system or operational failure or disruption which could 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.
15
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, 2023, we had approximately
$74.7 million of gross net operating losses (“NOLs”) for federal tax purposes and approximately $17.3 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 $60.3 million; these NOLs will expire in varying amounts from 2034 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 taxable income for tax years before January 1, 2021 and up to 80% of 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 Company completed a Section 382 analysis for the year ended December 31, 2022, and believes that
no ownership change occurred during the relevant lookback period through December 31, 2023 that would limit our ability to use
our NOLs.
Product
liability claims in excess of insurance could adversely affect our financial results and financial condition.
We
face potential liability for property damage, personal injury, or death as a result of the failure of products designed or manufactured
by us. Although we currently maintain product liability insurance (including aircraft product liability insurance), any material
product liability not covered by insurance could have a material adverse effect on our financial condition, results of operations,
and cash flows.
Increased
scrutiny from investors, lenders, regulators and other market participants regarding our environmental, social, governance, sustainability
or climate responsibilities could expose us to additional costs and adversely impact our liquidity, results of operations, reputation,
employee retention, and stock price.
There
is an increasing focus from certain investors, customers, and other key stakeholders concerning corporate responsibility, specifically
related to environmental, social, and governance (“ESG”) factors. Some investors may use ESG criteria to guide their
investment strategies and, in some cases, may choose not to invest in us if they believe our policies relating to corporate responsibilities
are inadequate.
The
ESG factors by which companies’ corporate responsibility practices are assessed may change. This could result in greater
expectations of us and cause us to undertake costly initiatives to satisfy such new criteria. If we are unable to satisfy the
new corporate responsibility criteria, investors may view our policies related to corporate responsibility as inadequate. We risk
damage to our reputation in the event our corporate responsibility procedures or goals do not meet the standards or goals set
by various constituencies. In addition, if our competitors’ corporate responsibility performance is perceived to be greater
than ours, potential or current investors may elect to invest in our competitors instead. Further, in the event we communicate
certain initiatives or goals related to ESG, we could fail, or be perceived to have failed, in our achievement of such initiatives
or goals. If we fail to satisfy the expectations of investors and other key stakeholders, or our initiatives are not executed
as planned, our reputation, employee retention, and willingness of our customers and suppliers to do business with us, financial
results, and stock price could be materially and adversely affected.
Risks
Related to Our Indebtedness and Liquidity
We
obtained amendments to and received waivers of and consents to non-compliance with certain covenants under our credit facility
with BankUnited and there can be no assurance that we will not fall out of compliance with our covenants in the future.
The
Company was not in compliance with certain financial covenants under our credit facility (the “BankUnited Facility”
or the “Credit Agreement”) with BankUnited, N.A. (“BankUnited”) for the quarter ended March 31, 2022,
and financial statement submission covenants for the quarters ended March 31, 2022 and June 30, 2022 and obtained amendments to
and received waivers of and consents to the non-compliance, as described in more detail in Note 8 to our consolidated financial
statements included in Part II Item 8 of this Annual Report on Form 10-K. There can be no assurance that we will be in compliance
with our covenants in the future or that BankUnited will grant further waivers if we fall out of compliance or consents to future
non-compliance. 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.
16
Our
capital requirements, liquidity and financial condition raise significant risks as to our ability to continue as a going concern.
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. Notes 8 and 9 to our consolidated
financial statements included in Part II - Item 8 of this Annual Report on Form 10-K includes a discussion regarding the BankUnited
Facility and recent amendments thereto.
Our
consolidated financial statements have been prepared assuming we will continue to operate as a going concern, which contemplates
the realization of assets and the satisfaction of liabilities in the normal course of business. If we become unable to continue
as a going concern, we may have to liquidate our assets and the values we receive for our assets in liquidation or dissolution
could be significantly lower than the values reflected in our consolidated financial statements. 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 continue as a going concern.
Our
cost of borrowing under the Credit Agreement is based on the Prime Rate of interest per annum published in the Money Rates section
of The Wall Street Journal (the “Prime Rate”) plus the margin charged by our lender, and increases in the Prime Rate
negatively impact our profitability.
Interest
rates under our Credit Agreement are based on the Prime Rate, and as a result, we have exposure to interest rate risk. Certain
central banks, such as the U.S. Federal Reserve, effected multiple interest rate increases in 2022 and 2023. Increases in interest
rates increase our cost of borrowing and/or potentially make it more difficult to refinance our existing indebtedness.
We have identified material weaknesses in our internal control
over financial reporting over a number of years which adversely affected our ability to report our financial condition and results of
operations in a timely and accurate manner. The material weaknesses led to multiple restatements of our consolidated financial statements.
The material weaknesses and restatements have resulted in our failure to meet SEC reporting obligations, affected and may continue to
affect investor confidence, our stock price and our ability to raise capital in the future, and have resulted and may continue to result
in stockholder litigation.
We have reported material weaknesses in
internal control over financial reporting and did not maintain effective disclosure controls and procedures for reporting periods
from 2018 through September 2023. The material weaknesses led to our restatement of our consolidated financial statements for the
nine months ended September 30, 2018 and the years ended December 31, 2018, 2019 and 2020. Although these material weaknesses have
been remediated as of December 31, 2023, these material weaknesses and restatements have affected investor confidence, our stock
price, and resulted in the past in our failure to meet various SEC reporting requirements and stockholder litigation.
As described in Item 9A of this Annual Report
on Form 10-K, we identified a material weakness in our internal control over financial reporting of income taxes, which led to the restatement
within Note 11 “Income Taxes” of the financial statements within this Annual Report on Form 10-K the Company’s December
31, 2022 deferred tax assets and deferred tax liabilities balances. The Company is in the process of remediating this material weakness.
If a future failure in internal control should
occur, it may cause us to fail to meet SEC reporting obligations, negatively affect the accuracy of our financial statements and disclosures,
investor and customer confidence, our ability to raise capital in the future and result in events of default under our banking agreement,
any of which could have a negative effect on the price of our common stock, subject us to regulatory investigations and penalties and
additional stockholder litigation, and have a material adverse impact on our business and financial condition.
17
Risks
Related to Global Events
The
ongoing war between Russia and Ukraine, and the retaliatory measures imposed by the U.S., United Kingdom, European Union and other
countries and the responses of Russia to such measures have caused significant disruptions to domestic and foreign economies.
The
invasion of Ukraine by the Russian Federation had an immediate impact on the global economy resulting in higher prices for oil
and other commodities. The U.S., United Kingdom, European Union, and other countries responded to Russia’s invasion of Ukraine
by imposing various economic sanctions and bans. Russia has responded with its own retaliatory measures. These measures have impacted
the availability and price of certain raw materials and transportation costs. The invasion and retaliatory measures also disrupted
economic markets. The global impact of these measures is continually evolving and cannot be predicted with certainty and there
is no assurance that Russia’s invasion of Ukraine and responses thereto will not further disrupt the global economy and
supply chain. Further, there is no assurance that even when the invasion of Ukraine ceases, that nations will not continue to
impose sanctions and bans on other nations.
While
these events have not interrupted our operations or materially impacted our ability to obtain raw materials, these or future developments
resulting from the invasion of Ukraine such as a cyberattack on the U.S., us or our suppliers, could make it difficult for or
increase the cost of certain raw materials and transportation costs, or make it difficult to access debt and equity capital on
attractive terms, if at all, and impact our ability to fund business activities and repay debt on a timely basis.
Russia’s
invasion of Ukraine may alter countries’ willingness to rely on others as the source of certain products and material.
Historically,
prime contractors and OEMs in the U.S. A&D industry have relied upon suppliers outside the U.S. for products and raw materials.
Russia’s invasion of Ukraine and the economic disruption resulting from retaliatory measures may cause many of these companies
to rethink these strategies and seek sources of supply within the U.S. To the extent they do so, it could disrupt domestic markets
for raw materials and supplies, and the market for the skilled laborers we need to manufacture our products.
We
cannot forecast with any certainty whether the disruptions caused by the Russian invasion of Ukraine, restrictions imposed by
various governments in response thereto and resulting changes in business practices, may materially impact our business and our
consolidated financial position, results of operations, and cash flows.
18
The
conflict between Israel and Hamas, rising tensions between China and Taiwan, the ongoing war between Russia and Ukraine, and terrorist
acts and acts of war may seriously harm our business, results of operations and financial condition.
U.S.
and global responses to actual or potential military conflicts such as Russia’s invasion of Ukraine, terrorism, perceived
nuclear, biological, and chemical threats and other global political crises increase uncertainties with respect to the U.S. and
other business and financial markets. Several factors associated, directly or indirectly, with actual or potential military conflicts,
terrorism, perceived nuclear, biological, and chemical and cyber threats, and other global political crises and responses thereto,
may adversely affect the mix of products purchased by defense departments in the U.S. or other countries to platforms not serviced
by us. A shift in defense budgets to product lines we do not produce could have a material adverse effect on our business, financial
condition and results of operations.
Item 1B. UNRESOLVED STAFF COMMENTS
Not
applicable.
Item 1C. CYBERSECURITY
Cybersecurity
risk management is an important part of our overall risk management efforts. We maintain a cybersecurity program that is comprised
of policies, procedures, controls and plans whose objective is to help us prevent and effectively respond to cybersecurity threats
or incidents. Through our cybersecurity risk management process, we continuously monitor cybersecurity vulnerabilities and potential
attack vectors to company systems. We maintain various measures to safeguard against cybersecurity threats such as monitoring
systems, security controls, policy enforcement, data encryption, employee training, tools and services from third-party providers
and management oversight to assess, identify and mitigate risks from cybersecurity threats. We conduct regular testing of these
controls and systems including vulnerability scanning, penetration testing and simulating the execution of parts of our disaster
recovery plan. All employees are required to pass a mandatory cybersecurity training course on an annual basis and we regularly
conduct phishing simulations to train our employees on how to recognize phishing attempts.
We
have implemented cybersecurity frameworks, policies and practices which incorporate industry-standards and contractual requirements.
We also contractually flow cybersecurity regulatory requirements to our subcontractors as required by the Defense Federal Acquisition
Regulation Supplement and other government agency specific requirements. These contractual flow downs include the requirement
that our subcontractors implement certain information security controls. Additionally, we gather information and review the SOC-2
reports of certain third-parties who integrate with our systems, such as our payroll processor, managed solutions provider and
software as a service providers on an annual basis to identify and manage risk. We continuously evaluate and seek to improve and
mature our cybersecurity processes. We apply lessons learned from our defense and monitoring efforts to help prevent future attacks
and utilize data analytics to detect anomalies and search for cyber threats. Additionally, our Internal Audit function regularly
assesses our program effectiveness through audits of systems and processes to help maintain compliance with policies.
Cybersecurity
threats of all types, such as attacks from computer hackers, cyber criminals, nation-state actors, social engineering and other
malicious internet-based activities, continue to increase. We believe that our current preventative actions and response planning
provide adequate measures of protection against cybersecurity risks. While we have implemented measures to safeguard our information
technology systems, the evolving nature of cybersecurity attacks and vulnerabilities means that these protections may not always
be effective. In 2023, we did not identify any cybersecurity threats that have materially affected or are reasonably likely to
materially affect our business strategy, results of operations, or financial condition. However, despite our efforts, we cannot
eliminate all risks from cybersecurity threats, or provide assurances that we have not experienced undetected cybersecurity incidents.
For additional information about these risks, see Part I, Item 1A, “Risk Factors” in this Annual Report on Form 10-K.
Governance
Our
board of directors has oversight of our strategic and business risk management and oversees management’s execution of our
cybersecurity risk management program. The board receives regular updates from management on our cybersecurity risks. In addition,
management updates the board as necessary, regarding any material cybersecurity incidents, as well as incidents with lesser impact
potential. Management is responsible for identifying, assessing, and managing cybersecurity risks on an ongoing basis, establishing
processes to ensure that such potential cybersecurity risk exposures are monitored, putting in place appropriate mitigation measures,
maintaining cybersecurity policies and procedures, and providing regular reports to our board of directors. In the event of an
incident, we intend to follow our incident response plan, which outlines the steps to be followed from incident detection to mitigation,
recovery and notification, including notifying functional areas (e.g. legal), as well as senior leadership and the board, as appropriate.
Our
Vice President of Human Resources & Administration (“VP HR&A”) leads our cybersecurity program and is responsible
for our overall information security strategy, policy, security engineering, operations and cyber threat detection and response.
The VP HR&A manages a team of information technology professionals with broad experience, including in cybersecurity threat
assessments and detection, mitigation technologies, incident response, insider threats and regulatory compliance.
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Our
cybersecurity program is regularly assessed through management self-evaluation and ongoing monitoring procedures to evaluate our
program effectiveness, including assessments associated with internal controls over financial reporting as well as vulnerability
management through active discovery and testing to validate patching and configuration.
Item 2. PROPERTIES
CPI
Aero’s executive offices and production facility is situated in an approximately 171,000 square foot building located at
91 Heartland Blvd., Edgewood, New York 11717. We use approximately 131,000 square feet of this building for manufacturing space
and 40,000 square feet for offices and laboratories for engineering and design work. CPI Aero occupies this facility under a lease
that expires on April 30, 2026.
Item 3. LEGAL PROCEEDINGS
This
information is set forth in Note 16 to our Consolidated Financial Statements, which is hereby incorporated by reference.
Item 4. MINE SAFETY DISCLOSURES
Not
applicable.
PART
II
Our
shares of common stock are listed on the NYSE American exchange under the symbol “CVU”. On March 28, 2024, there were 171
holders of record of our shares of common stock. We believe there are substantially more beneficial holders of our common stock.
Dividend
Policy
To
date, we have not paid any dividends on our common stock. Any payment of dividends in the future is within the discretion of our
board of directors (subject to the limitation on dividends contained in the BankUnited Facility, as described more fully in Part
II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations) and will depend on our
earnings, if any, our capital requirements and financial condition and other relevant factors. Our board of directors does not
intend to declare any cash or other dividends in the foreseeable future, but intends instead to retain earnings, if any, for use
in our business operations.
Recent
Sales of Unregistered Securities
There
have been no sales of unregistered equity securities for the three months ended December 31, 2023. There have been no repurchases
of our outstanding common stock during the three months ended December 31, 2023.
Securities
Authorized for Issuance under Equity Compensation Plans
The
following table sets forth certain information at December 31, 2023 with respect to our equity compensation plans that provide
for the issuance of options, warrants or rights to purchase our securities:
Equity Compensation Plans Approved by Security Holders — $ — 621,419
Equity Compensation Plans Not Approved by Security Holders — — —
Long-term
equity incentives are an important component of compensation and are designed to align the interests of our executive officers
and directors who receive long-term equity awards with the Company’s long-term performance and to increase shareholder value.
The Company has awarded long-term incentive compensation pursuant to two plans:
2016
Long-Term Incentive Plan. The 2016 Long-Term Incentive Plan, as amended, authorizes the grant of 2,200,000 shares of
our common stock, which may be granted in the form of stock options, stock appreciation rights, restricted stock, deferred stock,
stock reload options, and other stock-based awards, to employees, officers, directors, and consultants of the Company. As of December
31, 2023, we have granted 1,580,945 shares under this plan and 619,055 shares remained available for grant under this plan.
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Performance
Equity Plan 2009. The Performance Equity Plan 2009 authorizes the grant of 500,000 stock options, stock appreciation
rights, restricted stock, deferred stock, stock reload options, and other stock-based awards. As of December 31, 2023, we have
granted 497,636 shares under this plan and 2,364 shares remained available for grant.
Item 6. [RESERVED]
Not
applicable.
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.
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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