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EX-31.2 - EXHIBIT 31.2 - LMI AEROSPACE INCex31_2.htm

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2014.
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _________ to __________

Commission file number: 000-24293

LMI AEROSPACE, INC.
(Exact name of registrant as specified in its charter)
Missouri
 
43-1309065
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
411 Fountain Lakes Blvd.
 
 
St. Charles, Missouri
 
63301
(Address of principal executive offices)
 
(Zip Code)
(636) 946-6525
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x                  No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x                  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
o
 
Accelerated filer
x
Non-accelerated filer
o
 
Smaller reporting company
o
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o                    No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

On November 3, 2014, there were 12,698,070 shares of our common stock, par value $0.02 per share, outstanding.
 



LMI AEROSPACE, INC.

QUARTERLY REPORT ON FORM 10-Q
FOR THE FISCAL QUARTER ENDING SEPTEMBER 30, 2014

PART I.  FINANCIAL INFORMATION
 
Page
No.
 
 
Item 1.
Financial Statements (Unaudited).
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
PART II.  OTHER INFORMATION
 
 
 
 
Item 1.
 
 
 
Item1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
 
 



2


 PART I
FINANCIAL INFORMATION
Item 1.
Financial Statements.
LMI Aerospace, Inc.
Condensed Consolidated Balance Sheets
(Amounts in thousands, except share and per share data)
(Unaudited)
 
September 30,
2014
 
December 31,
2013
Assets



Current assets:



Cash and cash equivalents
$
2,460


$
1,572

Accounts receivable, net
64,739


72,853

Inventories
111,099


113,178

Prepaid expenses and other current assets
7,077


4,411

Deferred income taxes
3,228


2,693

Total current assets
188,603


194,707







Property, plant and equipment, net
96,477


103,375

Goodwill
113,223


113,223

Intangible assets, net
52,072


55,465

Other assets
13,851


13,281

Total assets
$
464,226


$
480,051







Liabilities and shareholders’ equity



Current liabilities:



Accounts payable
$
20,620


$
19,388

Accrued expenses
23,793


19,082

Current installments of long-term debt and capital lease obligations
3,142


5,242

Total current liabilities
47,555


43,712







Long-term liabilities:





Long-term debt and capital lease obligations, less current installments
269,571


285,369

Other long-term liabilities
2,997


3,915

Deferred income taxes
3,944


2,911

Total long-term liabilities
276,512


292,195







Shareholders’ equity:



Common stock, $0.02 par value per share; authorized 28,000,000 shares; issued 13,089,600, and 12,873,208 shares at September 30, 2014 and December 31, 2013, respectively
261


257

Preferred stock, $0.02 par value per share; authorized 2,000,000 shares; none issued at either date



Additional paid-in capital
94,941


92,692

Accumulated other comprehensive income (loss)
(89
)

(507
)
Treasury stock, at cost, 32,162 and 22,321 shares at September 30, 2014 and December 31, 2013, respectively
(401
)

(202
)
Retained earnings
45,447


51,904

Total shareholders’ equity
140,159


144,144

Total liabilities and shareholders’ equity
$
464,226


$
480,051


See accompanying notes to condensed consolidated financial statements.

3


LMI Aerospace, Inc.
Condensed Consolidated Statements of Comprehensive Income (Loss)
(Amounts in thousands, except share and per share data)
(Unaudited)

 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
Sales and service revenue
 
 
 
 
 
 
 
Product sales
$
81,693

 
$
81,076

 
$
245,349

 
$
246,343

Service revenue
15,642

 
23,580

 
53,674

 
69,844

Net sales
97,335

 
104,656

 
299,023

 
316,187

Cost of sales and service revenue

 

 
 
 
 
Cost of product sales
61,535

 
63,579

 
195,170

 
192,309

Cost of service revenue
13,757

 
20,659

 
45,215

 
61,565

Cost of sales
75,292

 
84,238

 
240,385

 
253,874

Gross profit
22,043

 
20,418

 
58,638

 
62,313




 


 
 
 
 
Selling, general and administrative expenses
14,615

 
13,783

 
41,770

 
41,862

Contingent consideration write-off

 

 

 
(7,950
)
Intangible asset impairment

 

 

 
4,222

Restructuring expense
765

 

 
2,288

 

Income from operations
6,663

 
6,635

 
14,580

 
24,179



 

 
 
 
 
Other (expense) income:

 

 
 
 
 
Interest expense
(5,946
)
 
(4,328
)
 
(23,800
)
 
(12,485
)
Other, net
(75
)
 
49

 
205

 
449

Total other expense
(6,021
)
 
(4,279
)
 
(23,595
)
 
(12,036
)



 


 
 
 
 
Income (loss) before income taxes
642

 
2,356

 
(9,015
)
 
12,143

(Benefit) provision for income taxes
(754
)
 
281

 
(2,557
)
 
3,567




 


 
 
 
 
Net income (loss)
1,396

 
2,075

 
(6,458
)
 
8,576

Other comprehensive income (expense):

 

 
 
 
 
Change in foreign currency translation adjustment
(112
)
 
118

 
(18
)
 
(19
)
Reclassification adjustment for losses on interest rate hedges included in net earnings, net of tax of $0, $0, $157 and $0

 

 
278

 

Unrealized gain/(loss) arising during period from interest rate hedges, net of tax of $0, ($89), $0 and ($93)

 
(153
)
 

 
(163
)
Total comprehensive income (loss)
$
1,284

 
$
2,040

 
$
(6,198
)
 
$
8,394




 


 
 
 
 
Amounts per common share:

 

 
 
 
 
Net income (loss) per common share
$
0.11

 
$
0.16

 
$
(0.51
)
 
$
0.68




 


 
 
 
 
Net income (loss) per common share assuming dilution
$
0.11

 
$
0.16

 
$
(0.51
)
 
$
0.67




 


 
 
 
 
Weighted average common shares outstanding
12,740,034

 
12,617,121

 
12,704,568

 
12,604,033




 


 
 
 
 
Weighted average dilutive common shares outstanding
12,887,363

 
12,718,807

 
12,704,568

 
12,710,396


See accompanying notes to condensed consolidated financial statements.

4


 LMI Aerospace, Inc.
Condensed Consolidated Statements of Cash Flows
(Amounts in thousands)
(Unaudited)

 
Nine Months Ended 
 September 30,
 
2014
 
2013
Operating activities:
 
 
 
Net (loss) income
$
(6,458
)

$
8,576

Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities:



Depreciation and amortization
17,002


15,230

Stock based compensation
1,442


1,204

Intangible asset impairment

 
4,222

Contingent consideration write-off

 
(7,950
)
Debt issuance cost write-off
8,464

 

Payments to settle interest rate derivatives
(793
)
 

Deferred taxes
147

 
3,091

Other noncash items
(87
)

(326
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
8,187


(17,835
)
Inventories
2,079


(22,698
)
Prepaid expenses and other assets
2,003


233

Current income taxes
(2,899
)

(29
)
Accounts payable
785


(4,951
)
Accrued expenses
6,144


2,637

Net cash provided (used) by operating activities
36,016


(18,596
)
Investing activities:



Additions to property, plant and equipment
(10,302
)

(21,230
)
Proceeds from sale of property, plant, and equipment
981


1,942

Net cash used by investing activities
(9,321
)

(19,288
)
Financing activities:



Proceeds from issuance of debt
250,000


6,160

Principal payments on long-term debt and notes payable
(231,898
)

(4,766
)
Advances on revolving line of credit
60,000


112,000

Payments on revolving line of credit
(96,000
)

(78,000
)
Payments for debt issuance cost
(7,881
)
 

Other, net
(28
)

(304
)
Net cash (used) provided by financing activities
(25,807
)

35,090

Net increase (decrease) in cash and cash equivalents
888


(2,794
)
Cash and cash equivalents, beginning of period
1,572


4,347

Cash and cash equivalents, end of period
$
2,460


$
1,553

Supplemental disclosure of noncash transactions:



Purchase adjustment of acquisition

 
1,219

Defined contribution plan funding in Company stock
$
848


$
901


See accompanying notes to condensed consolidated financial statements.

5

LMI Aerospace, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollar amounts in thousands, except share and per share data)
(Unaudited)
September 30, 2014




1.
Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.  The year-end condensed balance sheet data was derived from audited financial statements but does not include all disclosures required by accounting principles generally accepted in the United States of America.  In the opinion of management, all adjustments considered necessary for a fair representation have been included.  Operating results for the nine months ended September 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014.  These financial statements should be read in conjunction with the consolidated financial statements and accompanying footnotes included in the  Annual Report on Form 10-K of LMI Aerospace, Inc. (the "Company”) for the year ended December 31, 2013, as filed with the Securities and Exchange Commission on March 17, 2014.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make certain estimates and assumptions. These estimates and assumptions affect the reported amounts in the financial statements and accompanying notes.  Actual results could differ from these estimates.

Reclassification

Certain reclassifications have been made to prior period data within the footnotes in order to conform to current period presentation.

Recent Accounting Standards

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606). The standard is effective for reporting periods beginning after December 15, 2016 and early adoption is not permitted. The standard will supersede existing revenue recognition guidance, including industry-specific guidance, and will provide companies with a single revenue recognition model for recognizing revenue from contracts with customers. The standard requires revenue to be recognized when promised goods or services are transferred to customers in amounts that reflect the consideration to which the company expects to be entitled in exchange for those goods or services. Adoption of the new rules could affect the timing of revenue recognition for certain transactions. The two permitted transition methods under the new standard are the full retrospective method, in which case the standard would be applied to each prior reporting period presented, or the modified retrospective method, in which case the cumulative effect of applying the standard would be recognized at the date of initial application. The provisions of this new guidance are effective as of the beginning of the Company’s first quarter of 2017. The Company is currently evaluating the transition method to be used and the impact of adoption of this standard on its consolidated financial statements.

In April 2014, the FASB issued ASU 2014-08, "Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity." The amendments in this update change the requirements for reporting discontinued operations. A discontinued operation may include a component of an entity or a group of components of an entity, or a business or nonprofit activity. A disposal of a component of an entity or a group of components of an entity is required to be reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity's operations and financial results and when the component or group of components meets the criteria to be classified as held for sale, is disposed by sale or is disposed of by other than by sale (for example, by abandonment or in a distribution to owners in a spinoff). ASU 2014-8 is effective prospectively for fiscal years, and interim reporting periods within those years, beginning after December 15, 2014.  The Company has no present activity that would be impacted by this new standard.

In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. Under the new guidance, management will be required to assess an entity’s ability to continue as a going concern, and to provide related footnote disclosures in

6

LMI Aerospace, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollar amounts in thousands, except share and per share data)
(Unaudited)
September 30, 2014



certain circumstances. The provisions of this ASU are effective for annual periods beginning after December 15, 2016, and for annual and interim periods thereafter. This ASU is not expected to have an impact on our financial statements or disclosures.
2.
Accounts Receivable, Net

Accounts receivable, net consists of the following:
 
September 30, 2014
 
December 31, 2013
Trade receivables
$
54,980

 
$
66,292

Unbilled revenue
7,368

 
4,671

Other receivables
2,636

 
2,070

 
64,984

 
73,033

Less: Allowance for doubtful accounts
(245
)
 
(180
)
Accounts receivable, net
$
64,739

 
$
72,853


Under contract accounting, unbilled revenues arise when the sales or revenues based on performance attainment, though appropriately recognized, cannot be billed yet under terms of the contract as of the balance sheet date. Included in unbilled revenue at September 30, 2014 and December 31, 2013 are $424 and $2,034, respectively, related to unpriced change orders or claims that are subject to negotiation. The final resolution of these unpriced items could result in a change in the revenue recognized to date on the associated contracts.

Accounts receivable expected to be collected after one year is not material.

The Company records changes in contract estimates using the cumulative catch-up method in accordance with the Revenue Recognition topic of the FASB Accounting Standards Codification.  Cumulative catch-up adjustments had the following impacts to operating income for the periods presented:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
2013
 
2014
2013
Favorable adjustments
$
4,898

$
397

 
$
5,620

$
106

Unfavorable adjustments
(545
)
(522
)
 
(727
)
(1,155
)
Net favorable (unfavorable) operating income adjustments
$
4,353

$
(125
)
 
$
4,893

$
(1,049
)

The Company was engaged in a contract at December 31, 2013 where estimated costs exceeded total contract revenue. A change has been agreed to that resulted in the favorable settlement of an unpriced change order related to this contract. In addition, the Company secured more favorable future material pricing with respect to this contract as engineering changes to the related assemblies had stabilized. As a result, contract costs are no longer expected to exceed revenue and the remaining related loss reserve, which was originally recorded as an adjustment to goodwill on the Valent acquisition, was reversed in the quarter ended September 30, 2014, resulting in a favorable cumulative catch up adjustment. The impact of reversing the loss reserve was $4,602 and $5,267 for the three and nine months ended September 30, 2014 and was recorded in the cost of goods sold section of the Consolidated Statements of Comprehensive Income (Loss).
3.
Inventories

Inventories consist of the following:

7

LMI Aerospace, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollar amounts in thousands, except share and per share data)
(Unaudited)
September 30, 2014



 
September 30, 2014
 
December 31, 2013
Raw materials
$
17,569

 
$
17,099

Work in progress
21,729

 
21,605

Manufactured and purchased components
22,323

 
21,675

Finished goods
29,789

 
40,572

Product inventory
91,410

 
100,951

Capitalized contract costs (1)
19,689

 
12,227

Total inventories
$
111,099

 
$
113,178

(1) Net of a loss reserve on long-term production contracts of $0 and $2,057 as of September 30, 2014 and December 31, 2013 respectively.

Inventories include capitalized contract costs relating to programs and contracts with long-term production cycles, substantially all of which are not expected to be realized within one year.   The Company believes these amounts will be fully recovered over the life of the contracts. Anticipated losses on contracts are recognized, when required, and reported as a reduction of related contract costs recorded in inventory and as additional cost of sales. The Company was engaged in a contract at December 31, 2013 where estimated costs exceeded the total contract revenue. At December 31, 2013, a provision for the remaining estimated loss on this contract of $5,222 was reported as a reduction to inventory of $2,057 and an increase in accrued expenses of $3,165 in the Condensed Consolidated Balance Sheet. As discussed in Note 2, this loss reserve was reversed in the quarter ended September 30, 2014. At September 30, 2014 the Company is no longer engaged in any contracts that would require it to record a loss reserve.


4.
Goodwill and Intangible Assets

Goodwill

The following table summarizes the net carrying amount of goodwill by segment at September 30, 2014 and December 31, 2013, respectively:
 
 
 
 
 
Engineering
 
 
 
 
 
Aerostructures
 
Services
 
Total
 
September 30,
 
December 31,
 
September 30,
 
December 31,
 
September 30,
 
December 31,
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
Balance at:
 
 
 
 
 
 
 
 
 
 
 
Gross Goodwill
$
141,953

 
$
141,953

 
$
50,741

 
$
50,741

 
$
192,694

 
$
192,694

Accumulated impairment loss
(79,471
)
 
(79,471
)
 

 

 
(79,471
)
 
(79,471
)
Net Goodwill
$
62,482

 
$
62,482

 
$
50,741

 
$
50,741

 
$
113,223

 
$
113,223

 
The December 2012 acquisition of Valent Aerostructures, LLC ("Valent") accounted for $56,288 of the net goodwill balance at September 30, 2014 and December 31, 2013. A goodwill impairment charge of $73,528 was recorded in the fourth quarter of 2013 related to the Valent acquisition. The fair value for the remaining net goodwill in the Aerostructures segment of $6,194 exceeded its carrying value at December 31, 2013. Net goodwill at September 30, 2014 and December 31, 2013 also included an impairment charge of $5,943, for an acquisition that was fully impaired.

The fair value of the net goodwill in Engineering Services exceeded its carrying value at December 31, 2013.

The carrying value of goodwill is assessed at least annually, during the fourth quarter, unless a triggering event occurs, and an impairment charge is recorded if appropriate.  In the quarter and nine months ended September 30, 2014, no triggering event occurred that would cause the Company to assess the carrying value of goodwill.



8

LMI Aerospace, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollar amounts in thousands, except share and per share data)
(Unaudited)
September 30, 2014



 Intangible Assets

Intangible assets primarily consist of trademarks and customer intangibles.  The carrying values were as follows:
 
September 30, 2014
 
December 31, 2013
Trademarks
$
778

 
$
778

Customer intangible assets
68,991

 
68,991

Other
1,274

 
1,481

Accumulated amortization
(18,971
)
 
(15,785
)
Intangible assets, net
$
52,072

 
$
55,465


Intangibles amortization expense was $1,131 and $1,162 for the three months ended September 30, 2014 and 2013, respectively and $3,393 and $3,485 for the nine months ended September 30, 2014 and 2013, respectively. The accumulated amortization balances at September 30, 2014 and December 31, 2013, respectively, were $628 and $475 for trademarks, $17,675 and $14,555 for customer intangible assets, and $668 and $755 for other intangible assets.   Valent intangible assets are amortized on the straight-line method as this approximates the pattern of economic benefit of each intangible asset.  All other remaining intangible assets are not material.

The Company has experienced a slowdown in the demand for design engineering services over the past few quarters, which the Company believes is cyclical in nature.  This cyclical demand has led to lower than originally expected revenue. Despite the reduction in revenue, this segment realized growth in profitability in the first two quarters of 2014 as the Company removed, and continues its efforts to remove, costs from the segment.  The segment also generated significant cash flow during the first nine months of 2014. However, in the quarter ended September 30, 2014, the segment recognized significantly lower sales and gross margin when compared to each of the last four quarters. If the segment were to continue to recognize the revenues and margins experienced in the third quarter of 2014, it could lead to a triggering event and potential impairment for intangible assets and goodwill.

Further, our Valent acquisition has not achieved the sales and profitability we originally expected due, in substantial part, to delays in customer awards and longer ramp up times on new contracts as they migrate to full production.  Although we believe this lower sales growth is temporary, continued lower sales growth could lead to a triggering event and potential additional impairment to intangible assets and goodwill. See Note 7 to Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended December 31, 2013 for additional discussion on the goodwill impairment charge recorded in the fourth quarter of 2013.


5.
Other Assets

Other assets consist of the following:
 
September 30, 2014
 
December 31, 2013
Debt issuance cost, net (1)
$
8,929

 
$
11,094

Asset held for sale (2)
2,925

 

Other
1,997

 
2,187

  Total other assets
$
13,851

 
$
13,281


(1) In the nine months ended September 30, 2014, the Company refinanced its texisting long term indebtedness, which resulted in the settlement and termination of its then existing credit agreement. As a result of this refinancing and other retirements of debt, unamortized debt issuance costs of $124 and $8,464 were written off and recognized as interest expense in the three and nine months ending September 30, 2014. As part of the refinancing, the Company issued second priority senior secured notes and concurrently modified its revolving credit agreement. Debt issuance costs of $7,954 were incurred as a result of these transactions and are being amortized over the term of the notes and revolving credit agreement, which is five years.

9

LMI Aerospace, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollar amounts in thousands, except share and per share data)
(Unaudited)
September 30, 2014




(2) Represents the fair value, less costs to sell, of the Company aircraft. The aircraft was recorded in property, plant, and equipment, net in prior periods. The carrying value of the aircraft was reduced to its net realizable value of $2,925 with a charge of $421 in the quarter ended September 30, 2014, which is reflected in selling, general, and administration expenses in the Condensed Consolidated Statement of Comprehensive Income (Loss).
6.
Long-term Debt and Capital Lease Obligations

Long-term debt and capital lease obligations consist of the following:
 
September 30, 2014
 
December 31, 2013
 
 
 
 
Second priority senior secured notes at a fixed rate of 7.375% at September 30, 2014
$
245,000

 
$

Term loan under credit agreement, variable

 
222,750

Revolver under credit agreement, variable

 
36,000

Missouri IRBs at fixed rate of 2.80% at September 30, 2014 and December 31, 2013
7,441

 
7,756

Capital leases, at fixed rates ranging from 2.04% to 7.73% at September 30, 2014 and December 31, 2013, respectively
13,605

 
14,572

Notes payable, principal and interest payable monthly, at fixed rates up to 3.60% at September 30, 2014 and December 31, 2013, respectively (1)
6,667

 
9,533

Total debt
$
272,713

 
$
290,611

Less current installments
3,142

 
5,242

Total long-term debt and capital lease obligations
$
269,571

 
$
285,369


(1) During the quarter ended September 30, 2014, the Company settled a mortgage in cash in the amount of $2,109.


On June 19, 2014, the Company issued $250,000 in second-priority senior secured notes maturing on June 19, 2019. During the quarter ended September 30, 2014, the Company repurchased and retired $5,000 of the outstanding notes at a premium of 1.125%, plus accrued interest. Obligations under these notes are secured by substantially all of the Company’s assets and bear interest at 7.375%, paid semi-annually in January and July, with interest payments commencing in January of 2015. Also, on June 19, 2014, the Company used the proceeds from the issuance of these notes to settle and terminate its existing term loan and also modified its revolving credit agreement.

The modified revolving credit agreement provides for a revolving credit facility of up to $90,000.  Under the agreement, the co-collateral agents may establish a reserve against the facility. At September 30, 2014, the reserve established was $15,000, which reduced the maximum availability to $75,000. Based on the amount of eligible assets at September 30, 2014, available borrowings were further reduced to $60,385. The maximum amount, less reserves, available for borrowing at levels below $30,000 are based on a sum of 45% of eligible receivables, 30% of eligible inventories and an additional amount of eligible equipment up to 20% of total borrowings under the facility. The maximum amount, less reserves, available for borrowing at levels above $30,000 are based on a sum of 75% of eligible receivables, 45% of eligible inventories and an additional amount of eligible equipment up to 20% of total borrowings under the facility. Borrowings under the facility are secured by a first lien on substantially all of the Company’s assets and bear interest at either the LIBOR rate plus a margin of 3.00% to 3.50% or the alternate base rate (“ABR”) which is the highest of the following plus a margin of 2.00% to 2.50%, respectively, with the applicable margins for the revolving credit facility subject to a grid based on the average availability ratio of the Company for the most recently completed quarter:

Prime rate,
Federal funds rate plus 0.5%, or,
The adjusted Eurodollar rate for an interest period of one month plus 1%.

For the quarter ended September 30, 2014, the actual interest rate incurred for the revolving credit facility was 4.1%.


10

LMI Aerospace, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollar amounts in thousands, except share and per share data)
(Unaudited)
September 30, 2014



The Company is required to pay a commitment fee of between 0.375% and 0.5% per annum on the unused portion of the revolving credit facility, depending on the average revolver usage during the period as compared to the total available borrowings under the facility. At September 30, 2014, the commitment fee required was 0.5%.

The revolving credit loan facility matures on the earlier of the fifth year anniversary date of June 19, 2019 or the date that is 91 days prior to the maturity date of the senior secured notes unless the notes are repaid, refinanced or otherwise satisfied in full. The maturity dates are subject to acceleration upon occurrence of an event of default. An event of default under the revolving credit agreement includes, among other things, failure to pay any material indebtedness, acceleration of payments by any lender prior to scheduled maturity, or judgments rendered against the Company requiring payments at or above certain levels.

The credit agreement contains a covenant that requires us to comply with a maximum first priority debt to EBITDA ratio on a quarterly basis. In addition, the agreement also contains certain restrictive covenants that limit and in some circumstances prohibit, our ability to, among other things, incur additional debt, sell, lease or transfer our assets, make investments, guarantee debt or obligations, create liens, and enter into certain merger, consolidation or other reorganization transactions.  These restrictive covenants prohibit the Company from paying dividends. These restrictions could limit our ability to obtain future financing, make acquisitions or needed capital expenditures, withstand the current or future downturns in our business or the economy in general, conduct operations or otherwise take advantage of business opportunities that may arise, any of which could place us at a competitive disadvantage relative to our competitors that have less debt and are not subject to such restrictions.

At September 30, 2014, the Company was in compliance with all of its covenants and expected to be in compliance with its covenants in future periods.  If the Company fails to meet any covenants in the credit facility, the Company would not be in compliance with its credit agreement and the lenders would be entitled to exercise various rights, including causing the amounts outstanding under the revolving credit facility to become immediately due and payable.

7.
Assets and Liabilities Measured at Fair Value

Fair value is the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  A fair value hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy are described below:
Level 1:
Quoted prices in active markets for identical assets or liabilities.
Level 2:
Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3:
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The asset or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.  The valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs.

There were no transfers between levels during the three months ended September 30, 2014 and the year ended December 31, 2013.

The Company terminated and settled its interest rate derivatives on June 19, 2014 in conjunction with the settlement of its then existing credit agreement, which had a variable interest rate.

At September 30, 2014, the Company aircraft was listed for sale. The fair value of the aircraft was recorded in other assets in the Condensed Consolidated Balance Sheet at September 30, 2014.

11

LMI Aerospace, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollar amounts in thousands, except share and per share data)
(Unaudited)
September 30, 2014



 
 
Assets/Liabilities at Fair Value as of September 30, 2014
Recurring Fair Value Measurements:
 
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Asset:
 
 
 
 
 
 
 
 
Interest rate derivatives (1)
 
$

 
$

 
$

 
$

   Asset held for sale (2)
 
$
2,925

 
$

 
$
2,925

 
$

Liabilities:
 
 

 
 

 
 

 
 

Interest rate derivatives (1)
 
$

 
$

 
$

 
$

 
 
 
 
 
 
 
 
 
 
 
 
Assets/Liabilities at Fair Value as of December 31, 2013
Recurring Fair Value Measurements:
 
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Asset:
 
 
 
 
 
 
 
 
Interest rate derivatives (1)
 
$
18

 
$

 
$
18

 
$

 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
Interest rate derivatives (1)
 
$
392

 
$

 
$
392

 
$

 
 
 
 
 
 
 
 
 
(1)
The fair values of interest rate derivatives are the amount the Company would receive or pay to terminate the contracts, considering quoted market prices of comparable agreements. (Also see Note 8)
(2)
Represents the fair value, less costs to sell, of the Company aircraft.
8.
Derivative Financial Instruments

On June 19, 2014, the Company terminated and settled its interest rate derivatives in conjunction with the settlement of its then existing credit agreement, which had a variable interest rate. This settlement resulted in a charge of $793 to interest expense in the Condensed Consolidated Statements of Comprehensive Income (Loss) in the nine months ended September 30, 2014. Prior to this termination and in compliance with the credit agreement, the Company purchased option and swap derivative contracts to hedge against the potential impact on earnings from an increase in market interest rates associated with the interest payments on its variable rate term credit facility.  The objective of the hedge transactions was to reduce the variability of cash flows due to changes in the designated benchmark interest rate on the term debt.  The derivatives were recognized in the Condensed Consolidated Balance Sheet as current assets and liabilities at fair value as follows:
Derivative Asset and Liability
 
Location in Condensed
Consolidated Balance Sheet
 
September 30,
2014
 
December 31,
2013
Derivative designated as hedging instrument:
 
 
 
 
 
 
Interest rate purchased option fair value
 
Other current assets
 
$

 
$
18

Derivative designated as hedging instrument:
 
 
 
 
 
 
Interest rate swap fair value
 
Other long term liabilities
 
$

 
$
392


The Company designated and accounted for these swaps and purchased options as cash flow hedges of interest rate risk.  The Company reported the gain or loss, net of taxes, from the effective portion of the hedge as a component of Accumulated Other Comprehensive Income (“AOCI”) deferring it and reclassifying it into earnings in the same period or periods in which the hedged transaction affects earnings and in the same line item on the Condensed Consolidated Statements of Comprehensive Income (Loss) as the impact of the hedged transaction.  The cumulative amounts reported in AOCI related to these derivatives were reclassified from AOCI to interest expense on the Condensed Consolidated Statements of Comprehensive Income (Loss) in the quarter ended June 30, 2014. The Company did not use these derivative instruments for trading or speculative purposes.

The following amounts are included in OCI and earnings for the three and nine months ended September 30, 2014:

12

LMI Aerospace, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollar amounts in thousands, except share and per share data)
(Unaudited)
September 30, 2014



Derivatives in Cash Flow Hedging Relationship
 
Amount of Gain (Loss) Recognized in AOCI, net of tax, on Derivative (Effective Portion)
 
Amount of
(Gain) Loss Reclassified
from AOCI
into
Income (Effective Portion)
Three Months Ended September 30, 2014
 
 
 
 
Interest rate derivatives
 
$

 
$

 
 
 
 
 
Nine Months Ended September 30, 2014
 
 

 
 

Interest rate derivatives
 
$

 
$
793


9.
Earnings Per Common Share

Basic net income per common share is based upon the weighted average number of common shares outstanding.  Diluted net income per common share is based upon the weighted average number of common shares outstanding, including the dilutive effect of restricted stock, using the if-converted methods.  The following table shows a reconciliation of the numerators and denominators used in calculating basic and diluted earnings per share.
 
Three months ended
 
Nine months ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Numerators
 
 
 
 
 
 
 
Net income (loss)
$
1,396

 
$
2,075

 
$
(6,458
)
 
$
8,576

Denominators
 

 
 

 
 
 
 
Weighted average common shares - basic
12,740,034

 
12,617,121

 
12,704,568

 
12,604,033

 
 
 
 
 
 
 
 
Dilutive effect of restricted stock
147,329

 
101,686

 

 
106,363

 
 
 
 
 
 
 
 
Weighted average common shares - diluted
12,887,363

 
12,718,807

 
12,704,568

 
12,710,396

 
 
 
 
 
 
 
 
Basic earnings (loss) per share
$
0.11

 
$
0.16

 
$
(0.51
)
 
$
0.68

 
 
 
 
 
 
 
 
Diluted earnings (loss) per share
$
0.11

 
$
0.16

 
$
(0.51
)
 
$
0.67

    
For the nine months ended September 30, 2014, 145,710 shares are not included in the calculation of diluted earnings per share, as their inclusion would have been anti-dilutive. These securities could be dilutive in future periods.

13

LMI Aerospace, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollar amounts in thousands, except share and per share data)
(Unaudited)
September 30, 2014



10.
Stock-Based Compensation

On July 7, 2005, the Company’s shareholders approved the LMI Aerospace, Inc. 2005 Long-term Incentive Plan (the “Plan”). The Plan provides for the grant of non-qualified stock options, incentive stock options, shares of restricted stock, restricted stock units, stock appreciation rights, performance awards and other share-based grants and cash bonus awards to employees and directors.  All share-based grants or awards are subject to a time-based vesting schedule.

A summary of the activity for non-vested restricted stock awards under the Plan is presented below:
 
 
 
Restricted Stock Awards
 
Shares
 
Weighted
Average Grant Date Fair Value
Outstanding at January 1, 2014
 
219,751

 
$
19.74

Granted
 
172,611

 
14.07

Vested
 
(69,046
)
 
18.58

Forfeited
 
(34,091
)
 
17.95

Outstanding at September 30, 2014
 
289,225

 
$
16.85


Common stock compensation expense related to restricted stock awards granted under the Plan was $765 and $451 for the three months ended September 30, 2014 and 2013, respectively, and $1,442 and $1,204 for the nine months ended September 30, 2014 and 2013, respectively.

Total unrecognized compensation costs related to non-vested, share-based awards granted or awarded under the Plan were $2,560 and $1,857 at September 30, 2014 and December 31, 2013, respectively.  These costs are expected to be recognized over a weighted average period of 1.7 years and 1.2 years, respectively.


14

LMI Aerospace, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollar amounts in thousands, except share and per share data)
(Unaudited)
September 30, 2014



11.
Business Segment Information
The Company is organized into two reportable segments: the Aerostructures segment and the Engineering Services segment.  Through its Aerostructures segment, the Company primarily fabricates, machines, finishes, integrates, assembles and kits formed close tolerance aluminum, specialty alloy and composite components and higher level assemblies for use by the aerospace and defense industries. It manufactures more than 40,000 products for integration into a variety of aircraft platforms manufactured by leading original equipment manufacturers and Tier 1 aerospace suppliers. Through its Engineering Services segment, the Company provides a complete range of design, engineering and program management services, supporting aircraft product lifecycles from conceptual design, analysis and certification through production support, fleet support and service life extensions via a complete turnkey engineering solution.

Corporate assets, liabilities and expenses related to the Company's corporate offices, except for interest expense and income taxes, primarily support, and are recorded in, the Aerostructures segment. The table below presents information about reported segments on the same basis used internally to evaluate segment performance:
 
Three months ended September 30,
 
Nine months ended September 30,
 
2014
 
2013
 
2014
 
2013
Net sales:
 
 
 
 
 
 
 
Aerostructures
$
82,914

 
$
85,075

 
$
249,101

 
$
252,844

Engineering Services
14,714

 
20,206

 
51,235

 
65,373

Eliminations
(293
)
 
(625
)
 
(1,313
)
 
(2,030
)
 
$
97,335

 
$
104,656

 
$
299,023

 
$
316,187

 
 
 
 
 
 
 
 
Income from operations:
 

 
 

 
 

 
 

Aerostructures
$
7,888

 
$
6,015

 
$
14,010

 
$
27,095

Engineering Services
(1,216
)
 
742

 
666

 
(2,933
)
Eliminations
(9
)
 
(122
)
 
(96
)
 
17

 
$
6,663

 
$
6,635

 
$
14,580

 
$
24,179

12.
Customer Concentration

Direct sales, through both of the Company’s business segments, to our largest customer, Spirit Aerosystems (“Spirit”), accounted for 34.4% and 28.4% of the Company’s total revenues for the three months ended September 30, 2014 and 2013, respectively. Direct sales to Spirit accounted for 33.7% and 28.8% of the Company's total revenues for the nine months ended September 30, 2014 and 2013, respectively. Accounts receivable balances related to Spirit were 33.1% and 27.8% of the Company’s total accounts receivable balance at September 30, 2014 and December 31, 2013, respectively.

Direct sales, through both of the Company’s business segments, to our second largest customer, Gulfstream Aerospace Corporation, a General Dynamics company (“Gulfstream”), accounted for 14.3% and 10.9% of the Company’s total revenues for the three months ended September 30, 2014 and 2013, respectively. Direct sales to Gulfstream accounted for 15.3% and 14.8% of the Company's total revenues for the nine months ended September 30, 2014 and 2013, respectively.  Accounts receivable balances related to Gulfstream were 11.6% and 8.5% of the Company’s total accounts receivable balance at September 30, 2014 and December 31, 2013, respectively.

Direct sales, through both of the Company’s business segments, to our third largest customer, The Boeing Company (“Boeing”), accounted for 10.0% and 12.8% of the Company’s total revenues for the three months ended September 30, 2014 and 2013, respectively. Direct sales to Boeing accounted for 10.9% and 15.2% of the Company's total revenues for the nine months ended September 30, 2014 and 2013, respectively.  Accounts receivable balances resulting from direct sales to Boeing were 5.7% and 5.7% of the Company’s total accounts receivable balance at September 30, 2014 and December 31, 2013, respectively.


15

LMI Aerospace, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollar amounts in thousands, except share and per share data)
(Unaudited)
September 30, 2014



13.
Income Taxes

The Company recognized an income tax benefit, net for the three and nine months ended September 30, 2014 of $754 and $2,557, respectively. The Company recognized income tax expense for the three and nine months ended September 30, 2013 of $281 and $3,567, respectively. The Company's tax benefit in the three and nine months ended September 30, 2014 reflects the tax benefit of $295 and $2,877, respectively, anticipated with the decision to carry back the net operating loss recognized in 2013. The Company has established a valuation allowance on tax benefits generated in the current year, which is adjusted on a quarterly basis. The tax expense recorded in the current year periods reflects the taxes due in states where the Company generated taxable income and an increase in deferred tax liabilities related to an indefinite lived intangible asset.
14.
Restructuring

During the fourth quarter of 2013, the Company committed to a restructuring plan that resulted in the closure of its Precise Machine facility located in Fort Worth, Texas. As a result, the Company recognized severance expense of $453 in the year ended December 31, 2013 related to the closure. A restructuring benefit of $18 and expense of $287 were recognized by the Company in the three and nine months ended September 30, 2014. These restructuring benefits and expenses were reflected in the selling, general, and administrative section on a separate line of the Condensed Consolidated Statements of Comprehensive Income (Loss). The Company completed this restructuring plan in the second quarter of 2014.

In addition, on January 23, 2014, the Company announced plans to relocate the work performed relative to machining operations at its Savannah, Georgia facility to other locations within the company. As a result, severance expense of $0 and $47 was recognized in the three and nine months ended September 30, 2014. These restructuring expenses were reflected in the selling, general, and administrative section on a separate line of the Consolidated Statements of Comprehensive Income (Loss). The Company completed this restructuring plan in the second quarter of 2014.

In the three and nine months ended September 30, 2014, the Company recognized additional severance expense of $783 and $1,954 relative to other employment separation activities. These activities are part of the Company's overall reorganization and cost reduction initiatives. These restructuring expenses were reflected in the selling, general, and administrative section on a separate line of the Consolidated Statements of Comprehensive Income (Loss).

Cash payments were made associated with these restructuring plans of $253 and $1,441 in the three and nine months ended September 30, 2014, respectively.

The following table summarizes the incurred and expected charges associated with these restructuring activities:

Expense

Remaining

Total Expense

Incurred through

Expense to be

Expected to be

September 30, 2014

Incurred

Incurred



(In Thousands)


Employee severance arrangement - Precise closure
$
615


$


$
615

Employee severance arrangement - Savannah
47




47

Other employee severance arrangements
1,954




1,954

Lease termination costs - Precise closure
124




124

  Total
$
2,740


$


$
2,740


In addition to the restructuring expenses detailed in the table above, the Company incurred and recognized additional project expenses of approximately $364 as of September 30, 2014, associated with the integration of work previously performed at the Precise Machine facility. The Company also incurred and recognized approximately $500 in other project costs as of September 30, 2014, largely related to accelerated depreciation on property, plant and equipment at its Savannah facility. These expenses are recognized in the cost of sales and selling, general, and administrative expense in the Consolidated Statements of Comprehensive Income (Loss).

The following table summarizes restructuring activity related to the Precise Machine facility closure, the Savannah machining relocation, and other employee separation activities:

16

LMI Aerospace, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollar amounts in thousands, except share and per share data)
(Unaudited)
September 30, 2014




 
Employee
 
Severance
 
 
Accrued restructuring balance as of December 31, 2013
$
422

  Accrual additions
2,281

  Cash payments
(1,441
)
Accrued restructuring balance as of September 30, 2014
$
1,262


Accrued restructuring of $1,262 at September 30, 2014 is expected to be paid over the next three quarters.

15.
Legal Contingencies

The Company has been named as a defendant in certain pending lawsuits in the normal course of business (the “Pending Lawsuits”). It is the policy of management to disclose the amount or range of reasonably possible losses. In the opinion of management, after consulting with legal counsel, any losses resulting from Pending Lawsuits should not have a material effect on the Company’s financial position, cash flows or results of operations.

As of September 30, 2014, the Company is the subject of proceedings by the Environmental Protection Agency (“EPA”) and Department of Justice ("DoJ") as a result of allegations of low pH wastewater releases at the facility of Ozark Mountain Technologies ("OMT"), a subsidiary of the Company located in Cuba, Missouri, (the "Waste Water Allegations") and could become the subject of proceedings by the EPA as a result of the Voluntarily Disclosed Matters (as defined in the Company's 2013 Form 10-K, Part I, Item 1. Business, Governmental Regulations and Environmental Compliance) related to OMT.

On May 6, 2014, the Company first received information from DoJ that indicated DoJ is prepared to move forward with a one count indictment naming OMT as a defendant with respect to the Waste Water Allegations. DoJ also advised that the alleged violations may subject the Company to fines. The full extent of the actions to be taken by DoJ related to the Waste Water Allegations remains uncertain, but it is probable the Company will incur losses related to these issues.

Based on more recent discussions with the DoJ, the Company believes that an updated reasonable range for the fines, penalties and related legal fees associated with the Waste Water Allegations is from $761 to $1,000. However, there are still significant uncertainties related to the final outcome and therefore, the Company recognized the minimum value of the range of possible outcomes in the quarter ended September 30, 2014, and has established a loss contingency of $761. The Company is continuing to work with the DoJ to reach a resolution of this matter. The extent of the actions, if any, to be taken by the EPA with respect to the Voluntarily Disclosed Matters remain uncertain and the losses, if any, cannot be estimated.

As further disclosed in the Company's 2013 Form 10-K, Item 3 - Legal Proceedings, the Company believes a proceeding by the Missouri Attorney General is contemplated with respect to alleged violations of certain state environmental regulations by OMT. After consulting with legal counsel and based on the discussions the Company has had with the Missouri Attorney General’s office, the Company has established a loss contingency of $175 which represents management’s current estimate of the penalty the Missouri Attorney General is contemplating assessing on the Company.

Legal expenses, fines, and penalties recorded relative to the above matters were $462 and $996 for the three and nine months ended September 30, 2014, respectively. These expenses are reflected in selling, general, and administrative expenses in the Condensed Consolidated Statement of Comprehensive Income (Loss).

OMT became a subsidiary of the Company as a result of the Company’s acquisition of Valent in December 2012. The Company believes certain environmental representations set forth in the purchase agreement pursuant to which Valent acquired OMT, and the purchase agreement pursuant to which the Company acquired Valent, provide the Company with certain rights of indemnification with respect to the matters disclosed herein. The Company also has insurance policies that it believes covers various environmental

17

LMI Aerospace, Inc.
Notes to Condensed Consolidated Financial Statements
(Dollar amounts in thousands, except share and per share data)
(Unaudited)
September 30, 2014



issues at Valent and its subsidiaries, including OMT, and breaches by Valent and OMT of their respective environmental representations and warranties in each of the purchase agreements. As a result, the Company believes its rights of indemnification and insurance coverage may provide for a recovery of some of the costs associated with the matters disclosed herein. We cannot provide any assurance, however, that we will ultimately prevail in any claim for indemnification or secure insurance proceeds from our insurance policies.
16.
Subsequent Events
On November 5, 2014, the Company committed to a restructuring plan (the “Plan”) that will result in relocation of the St. Charles machine part operations to other facilities within the Company. As part of the Plan, the St. Charles machine part operations are expected to cease in the second quarter of 2015. Necessary equipment and assets used in these machining operations will be relocated to other facilities.
The Company estimates that it will incur aggregate pre-tax charges of between $900 and $1,100 to implement the Plan, which includes (i) anticipated expenditures of between $300 and $400 in employee severance and retention costs and (ii) approximately $600 to $700 in other shut-down related expenditures. The Company expects to pay these charges in cash. The Company will record charges starting in the fourth quarter of 2014 continuing into the second quarter of 2015. The Plan is expected to generate over $1,500 in recurring annual savings.
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. The Company makes forward-looking statements in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this Quarterly Report on Form 10-Q, which represent the Company’s expectations or beliefs about future events and financial performance.  When used in this report, the words “expect,” “believe,” “anticipate,” “goal,” “plan,” “intend,” “estimate,” “may,” “will” or similar words are intended to identify forward-looking statements.  These forward-looking statements are based on estimates, projections, beliefs and assumptions and are not guarantees of future events or results.  Such statements are subject to known and unknown risks, uncertainties and assumptions, including those referred to under “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013 (the “2013 Form 10-K”) and otherwise described in the Company’s periodic filings and current reports filed with the Securities and Exchange Commission (the “SEC”).

In light of these risks, uncertainties and assumptions, the forward-looking events discussed may not occur.  In addition, actual results could differ materially from those suggested by the forward-looking statements.  Accordingly, investors are cautioned not to place undue reliance on the forward-looking statements.  Except as required by law, the Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.  Investors should, however, review additional disclosures made by the Company from time to time in its periodic filings with the SEC.

This Quarterly Report on Form 10-Q should be read completely, in conjunction with our 2013 Annual Report on Form 10-K and with the understanding that the Company’s actual future results may be materially different from what the Company expects.  All forward-looking statements made by the Company in this Quarterly Report on Form 10-Q and in the Company’s other filings with the SEC are qualified by these cautionary statements.

The condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America, which require the Company to make estimates and assumptions.  (See Note 1 of the Condensed Consolidated Financial Statements included as part of this Quarterly Report on Form 10-Q.)

The Company believes that certain significant accounting estimates have the potential to have a more significant impact on the financial statements either because of the significance of the financial statements to which they relate or because they involve a higher degree of judgment and complexity.  A summary of such critical accounting estimates can be found in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in the  2013 Form 10-K.
Overview

We are a leading supplier of structural assemblies, kits and components and design engineering services to the aerospace and defense markets.  We primarily sell our products and services to the large commercial, corporate and regional, and military aircraft markets.    We believe that OEMs and Tier 1 aerospace companies will continue the trend of selecting their suppliers based upon

18


the breadth of more complex and sophisticated design and manufacturing capabilities and value-added services and the ability of their suppliers to manage large production programs.

The Company is organized into two reportable segments: the Aerostructures segment and the Engineering Services segment.  Through its Aerostructures segment, the Company primarily fabricates, machines, finishes, integrates, assembles and kits formed close tolerance aluminum, specialty alloy and composite components and higher level assemblies for use by the aerospace and defense industries. It manufactures more than 40,000 products for integration into a variety of aircraft platforms manufactured by leading original equipment manufacturers and Tier 1 aerospace suppliers. Through its Engineering Services segment, the Company provides a complete range of design, engineering and program management services, supporting aircraft product lifecycles from conceptual design, analysis and certification through production support, fleet support and service life extensions via a complete turnkey engineering solution.

Results of Operations

Three months ended September 30, 2014 compared to three months ended September 30, 2013

Consolidated Operations

Cost of goods sold for the Aerostructures segment consists primarily of direct labor, materials, subcontract costs and manufacturing overhead, including indirect labor costs, depreciation, rent, supplies and other indirect costs.  Cost of goods for the Engineering Services segment consists primarily of direct labor, subcontract costs and overhead, including rent, maintenance, and indirect costs. Selling, general, and administrative expenses for both segments consist primarily of labor, rent, depreciation and amortization, professional services and other administrative expenses.

The following table is a summary of our operating results for the three months ended September 30, 2014 and 2013, respectively:
 
Three Months Ended 
 September 30, 2014
 
($ in millions)
 
Aerostructures
 
Engineering Services
 
Elimination
 
Total
Net sales
$
82.9

 
$
14.7

 
$
(0.3
)
 
$
97.3

Cost of sales
62.5

 
13.1

 
(0.3
)
 
75.3

Gross profit
20.4

 
1.6

 

 
22.0

S, G, & A
12.5

 
2.8

 

 
15.3

Income from operations
$
7.9

 
$
(1.2
)
 
$

 
$
6.7

  
Three Months Ended 
 September 30, 2013
  
($ in millions)
  
Aerostructures
 
Engineering Services
 
Elimination
 
Total
Net sales
$
85.1

 
$
20.2

 
$
(0.6
)
 
$
104.7

Cost of sales
67.8

 
16.9

 
(0.5
)
 
84.2

Gross profit
17.3

 
3.3

 
(0.1
)
 
20.5

S, G, & A
11.3

 
2.5

 

 
13.8

Income from operations
$
6.0

 
$
0.8

 
$
(0.1
)
 
$
6.7


Aerostructures Segment

Net Sales.  Net sales were $82.9 million for the third quarter of 2014, a 2.6% decrease from $85.1 million in the third quarter of 2013.  The following table specifies the amount of the Aerostructures segment’s net sales by category for the third quarter of 2014 and 2013 and the percentage of the segment’s total net sales for each period represented by each category:


19


 
 
Three Months Ended September 30,
Category
 
2014
 
% of Total
 
2013
 
% of Total
 
 
($ in millions)
Large commercial aircraft
 
$
41.6

 
50.2
%
 
$
41.6

 
48.9
%
Corporate and regional aircraft
 
21.4

 
25.8
%
 
20.5

 
24.1
%
Military
 
13.0

 
15.7
%
 
16.4

 
19.3
%
Other
 
6.9

 
8.3
%
 
6.6

 
7.7
%
Total
 
$
82.9

 
100.0
%
 
$
85.1

 
100.0
%

Overall, net sales of large commercial aircraft products were unchanged in the third quarter of 2014 when compared to the third quarter of 2013. The most significant increase in revenue in the category was attributable to higher production rates on the Boeing 737 platform, which generated $24.1 million in the third quarter of 2014 compared to $22.4 million in the third quarter of 2013. Due to the ramp up in production on the Boeing 787 platform, net sales increased to $3.5 million in the third quarter of 2014 from $1.9 million in the third quarter of 2013. These increases were partially offset by decreases in the sale of 767 wing modification products which generated revenue of $5.0 million in the third quarter of 2013 compared to $1.7 million in the third quarter of 2014. In addition, revenue on the Boeing 747 platform decreased from $4.4 million in the third quarter of 2013 to $2.8 million in the third quarter of 2014.

Net sales of components for corporate and regional aircraft increased 4.4% during the third quarter of 2014. The increase was primarily attributable to higher production rates on the Gulfstream G650 aircraft which generated $8.5 million in the third quarter of 2014 compared to $6.0 million in the third quarter of 2013. This increase in revenue was partially offset by sales on the Gulfstream G450/G550 program, which contributed $7.3 million in the third quarter of 2014 compared to $8.5 million in the third quarter of 2013.

Net sales of military products decreased 20.7% during the third quarter of 2014.  The decrease is primarily due to a reduction in Embraer KC390 program revenues which contributed $0.4 million in the third quarter of 2014 compared to $3.7 million in the third quarter of 2013.

Cost of Goods Sold.  Cost of goods sold for the third quarter of 2014 was $62.5 million compared to $67.8 million for the third quarter of 2013. In the third quarter of 2014, the Company reversed a loss reserve of $4.6 million due to prices increases received for engineering changes and improved hardware costs. This reduction in cost of goods sold in the third quarter of 2014 was partially offset by accelerated depreciation on assets requiring replacement in our Cuba, Missouri facility of $0.5 million in addition to unfavorable product mix.

Gross Profit.  Gross profit for the third quarter of 2014 was $20.4 million (24.6% of net sales) compared to $17.3 million (20.3% of net sales) in the third quarter of 2013. The increase in gross profit margin was primarily the result of a loss reserve reversal on a long-term contract. This increase was partially offset by the previously mentioned accelerated depreciation and unfavorable product mix.

Selling, General and Administrative Expenses.  Selling, general and administrative expenses were $12.5 million (15.1% of net sales) for the third quarter of 2014 compared to $11.3 million (13.3% of net sales) for the third quarter of 2013.  The increase in selling, general and administrative expenses primarily related to increases of $0.4 million of restructuring expenses, $0.5 million of environmental expense, and $0.4 million of expense to reduce an asset held for sale to its realizable value in the third quarter of 2014.

Engineering Services Segment

Net Sales.  Net sales for the Engineering Services segment were $14.7 million for the third quarter of 2014 as compared to $20.2 million for the third quarter of 2013, a decrease of 27.2%.  The Engineering Services segment generates revenue primarily through the billing of employee time spent on customer projects.  The following table specifies the amount of the Engineering Services segment’s net sales by category for the third quarter of 2014 and 2013 and the percentage of the segment’s total net sales represented by each category.


20


 
 
Three Months Ended September 30,
Category
 
2014
 
% of Total
 
2013
 
% of Total
 
 
($ in millions)
Large commercial aircraft
 
$
6.6

 
44.9
%
 
$
9.9

 
49.0
%
Corporate and regional aircraft
 
4.4

 
29.9
%
 
4.0

 
19.8
%
Military
 
2.7

 
18.4
%
 
4.8

 
23.8
%
Other
 
1.0

 
6.8
%
 
1.5

 
7.4
%
Total
 
$
14.7

 
100.0
%
 
$
20.2

 
100.0
%

Net sales of services for large commercial aircraft were $6.6 million in the third quarter of 2014, down 33.3% from $9.9 million in the third quarter of 2013. The decrease in this category was primarily attributable to a decline in sales relates to the Goodrich Nacelle program, which contributed $0.0 million in the third quarter of 2014 compared to $1.7 million in the third quarter of 2013. In addition, sales on the Airbus 350 platform decreased from $1.6 million in the third quarter of 2013 to $0.4 million in the third quarter of 2014.

Net sales of services related to corporate and regional aircraft were $4.4 million in the third quarter of 2014 compared to $4.0 million for the third quarter of 2013, an increase of 10.0%.  

Net sales of services for military programs were $2.7 million in the third quarter of 2014, down 43.8% from $4.8 million in the third quarter of 2013.  This decrease was primarily related to a $1.8 million reduction on the Boeing Tanker program as the program design phase is complete.

Net sales related to design and delivery of tooling on various programs supporting commercial aircraft were $1.0 million for the third quarter of 2014, down 33.3%, from $1.5 million in the third quarter of 2013.

Cost of Goods Sold. Cost of goods sold for the third quarter of 2014 was $13.1 million compared to $16.9 million for the third quarter of 2013.  The decrease in cost of goods sold was primarily due to reductions in direct labor, which is the result of lower demand for this segment.

Gross Profit.  Gross profit for the third quarter of 2014 was $1.6 million (10.9% of net sales) compared to $3.3 million (16.3% of net sales) in the third quarter of 2013.  The decrease in gross profit was primarily attributable to the decline in sales, as fixed costs are spread over lower volume. The third quarter of 2014 was also unfavorably impacted by a cumulative catch up adjustment of $0.4 million.

Selling, General and Administrative Expenses.  Selling, general and administrative expenses for the third quarter of 2014 were $2.8 million, or 19.0% of net sales, compared to $2.5 million, or 12.4% of net sales, for the third quarter of 2013. The increase in selling, general and administrative expenses primarily related to increases of $0.4 million of restructuring expenses.

Non-segment Expenses

Interest Expense.  Interest expense was $5.9 million for the third quarter of 2014 and $4.3 million for the third quarter of 2013.  The increase in interest expense is primarily related to increased average interest rates. During the third quarter of 2014, the Company's primary borrowing source was senior notes accruing interest at 7.375%. During the third quarter of 2013, the Company's primary borrowing source was a term loan accruing interest at 4.75%.

Income Tax Expense.  During the third quarter of 2014, the Company recorded an income tax benefit of $0.8 million compared to expense of $0.3 million in the third quarter of 2013.  The Company's tax benefit in the three months ended September 30, 2014 reflects the tax benefit of approximately $0.3 million anticipated with the decision to carry back the net operating loss recognized in 2013 and a tax benefit of $0.5 million related to adjustment of the Company's valuation allowance on its 2014 tax benefit. The Company continues to record a valuation allowance on tax benefits generated in the current year period.

Results of Operations

Nine months ended September 30, 2014 compared to nine months ended September 30, 2013



21


Consolidated Operations

Cost of goods sold for the Aerostructures segment consists primarily of direct labor, materials, subcontract costs and manufacturing overhead, including indirect labor costs, depreciation, rent, supplies and other indirect costs.  Cost of goods for the Engineering Services segment consists primarily of direct labor, subcontract costs and overhead, including rent, maintenance, and indirect costs. Selling, general, and administrative expenses for both segments consist primarily of labor, rent, depreciation and amortization, professional services and other administrative expenses.

The following table is a summary of our operating results for the nine months ended September 30, 2014 and 2013, respectively:
 
Nine Months Ended 
 September 30, 2014
 
($ in millions)
 
Aerostructures
 
Engineering Services
 
Elimination
 
Total
Net sales
$
249.1

 
$
51.2

 
$
(1.3
)
 
$
299.0

Cost of sales
198.5

 
43.1

 
(1.2
)
 
240.4

Gross profit
50.6

 
8.1

 
(0.1
)
 
58.6

S, G, & A
36.6

 
7.4

 

 
44.0

Income from operations
$
14.0

 
$
0.7

 
$
(0.1
)
 
$
14.6

  
Nine Months Ended 
 September 30, 2013
  
($ in millions)
  
Aerostructures
 
Engineering Services
 
Elimination
 
Total
Net sales
$
252.8

 
$
65.4

 
$
(2.0
)
 
$
316.2

Cost of sales
199.9

 
56.0

 
(2.0
)
 
253.9

Gross profit
52.9

 
9.4

 

 
62.3

S, G, & A
25.8

 
12.3

 

 
38.1

Income from operations
$
27.1

 
$
(2.9
)
 
$

 
$
24.2


Aerostructures Segment

Net Sales.  Net sales were $249.1 million for the first nine months of 2014, a 1.5% decrease from $252.8 million in the first nine months of 2013. The following table specifies the amount of the Aerostructures segment’s net sales by category for the first nine months of 2014 and 2013, and the percentage of the segment’s total net sales for each period represented by each category:

 
 
Nine months ended September 30,
Category
 
2014
 
% of Total
 
2013
 
% of Total
 
 
($ in millions)
Large commercial aircraft
 
$
122.9

 
49.3
%
 
$
120.3

 
47.6
%
Corporate and regional aircraft
 
69.7

 
28.0
%
 
69.5

 
27.5
%
Military
 
36.8

 
14.8
%
 
43.9

 
17.4
%
Other
 
19.7

 
7.9
%
 
19.1

 
7.5
%
Total
 
$
249.1

 
100.0
%
 
$
252.8

 
100.0
%

Large commercial aircraft generated net sales of $122.9 million for the first nine months of 2014 compared to $120.3 million for the first nine months of 2013, an increase of 2.2%.  The most significant increase was attributable to higher production rates on the Boeing 737 platform which generated $72.0 million in the first nine months of 2014 compared to $65.2 million in the first nine months of 2013. Due to the ramp up in production on the Boeing 787 platform, net sales increased to $11.0 million in the first nine months of 2014 from $5.5 million in the first nine months of 2013. These increases were partially offset by decreases in the Boeing 747 and Boeing 767 wing modification products which generated $8.4 million and $5.1 million, respectively, in the first nine months of 2014 compared to $15.0 million and $9.4 million, respectively, in the first nine months of 2013
 
Net sales of components for corporate and regional aircraft were $69.7 million for the first nine months of 2014 compared to $69.5


22


million for the first nine months of 2013, an increase of 0.3%.  Revenue increased on the Gulfstream G650 program which contributed $22.5 million in the first nine months of 2014 compared to $17.7 million in the first nine months of 2013. This increase was offset by decreases on the Gulfstream G450/550 and G500/600 programs, which generated revenue in the first nine months of 2014 of $24.5 million and $10.5 million, respectively, compared to $28.0 million and $11.7 million in the first nine months of 2013.

Military products generated $36.8 million of net sales for the first nine months of 2014 compared to $43.9 million for the first nine months of 2013, a decrease of 16.2%.  The decrease is primarily due to a reduction in Black Hawk helicopter and Embraer KC390 revenues, which contributed $16.5 million and $1.6 million, respectively, in the first nine months of 2014 compared to $20.6 million and $5.5 million, respectively, in the first nine months of 2013.

Other products generated $19.7 million in net sales in the first nine months of 2014 compared to $19.1 million in the first nine months of 2013, an increase of 3.1%.

Cost of Goods Sold.  Cost of goods sold for the first nine months of 2014 was $198.5 million compared to $199.9 million for the first nine months of 2013.   In the first nine months of 2014, the Company reversed a loss reserve of $5.3 million due to price increases received for engineering changes and improved hardware costs. This reduction in cost of goods sold was partially offset by accelerated depreciation of $1.0 million on assets disposed of at several facilities. Cost of goods sold was also unfavorably impacted by product sales mix, lower production levels and inefficiencies associated with facilities being restructured. The first nine months of 2013 was unfavorably impacted by $2.5 million of fair value step-up on acquired inventories from acquisitions.

Gross Profit.  Gross profit for the first nine months of 2014 was $50.6 million (20.3% of net sales) compared to $52.9 million (20.9% of net sales) in the first nine months of 2013. Accelerated depreciation and inefficiencies associated with restructuring activities unfavorably impacted gross profit margin in the first nine months of 2014. Gross profit margin was also unfavorably impacted by product sales mix and lower production levels. Gross profit margin was favorably impacted by the previously mentioned $5.3 million for a loss reserve reversal on a long-term contract in the first nine months of 2014. The first nine months of 2013 was unfavorably impacted by the previously mentioned $2.5 million of fair value step-up on acquired inventories from acquisitions.
Selling, General and Administrative Expenses.  Selling, general and administrative expenses were $36.6 million (14.7% of net sales) for the first nine months of 2014 compared to $25.8 million (10.2% of net sales) for the first nine months of 2013. The difference in selling, general and administrative expenses primarily related to a favorable one-time write off of a contingent consideration liability of $8.0 million in the third quarter of 2013. In the first nine months of 2014, increases in restructuring expenses and environmental expenses of $1.8 million and $1.0 million, respectively, also contributed to the change in selling, general, and administrative expenses when compared to the prior-year period.
Engineering Services Segment

Net Sales.  Net sales for the Engineering Services segment were $51.2 million for the first nine months of 2014 as compared to $65.4 million for the first nine months of 2013, a decrease of 21.7%.  The Engineering Services segment generates revenue primarily through the billing of employee time spent on customer projects. The following table specifies the amount of the Engineering Services segment’s net sales by category for the first nine months of 2014 and 2013 and the percentage of the segment’s total net sales represented by each category:

 
 
Nine months ended September 30,
Category
 
2014
 
% of Total
 
2013
 
% of Total
 
 
($ in millions)
Large commercial aircraft
 
$
25.1

 
49.0
%
 
$
26.4

 
40.4
%
Corporate and regional aircraft
 
12.8

 
25.0
%
 
14.6

 
22.3
%
Military
 
7.2

 
14.1
%
 
16.9

 
25.8
%
Other
 
6.1

 
11.9
%
 
7.5

 
11.5
%
Total
 
$
51.2

 
100.0
%
 
$
65.4

 
100.0
%

Net sales of services for large commercial aircraft were $25.1 million in the first nine months of 2014, down 4.9% from $26.4 million in the first nine months of 2013. The decrease in this category was primarily attributable to a decline in sales related to the


23


Goodrich Nacelle program, which contributed $1.4 million in the first nine months of 2014 compared to $3.8 million in the first nine months of 2013. In addition, sales related to the Boeing 747 program decreased $1.2 million over the prior-year period. These decreases were partially offset by an increase of $1.8 million in maintenance, repair, and overhaul services.

Net sales for services supporting corporate and regional aircraft were $12.8 million in the first nine months of 2014 compared to $14.6 million for the first nine months of 2013, a decrease of 12.3%. This decrease in sales was primarily related to reductions of $1.2 million in support of the Bombardier Learjet L-85 and $0.6 million on other Bombardier programs.

Net sales of services for military programs were $7.2 million in the first nine months of 2014, down 57.4% from $16.9 million in the first nine months of 2013.  This decrease was primarily from a $8.4 million reduction on the Boeing Tanker program due to project maturation. In addition, support of the Embraer KC-390 program declined, with revenues of $1.0 million in the first nine months of 2014 compared to $2.8 million in the first nine months of 2013. These decreases were partially offset by revenue on the Bell V280 Valor program of $1.3 million.

Net sales related to design and delivery of tooling on various programs supporting commercial aircraft were $6.1 million for the first nine months of 2014, down 18.7%, from $7.5 million in the first nine months of 2013. The decrease was primarily due to reductions on the 787 shipping fixture program, with revenues of $0.1 million in the first nine months of 2014 compared to $1.3 million in the first nine months of 2013. In addition, G500 and G600 tooling revenue decreased from $2.1 million in the first nine months of 2013 to $0.8 million in the first nine months of 2014. These decreases were partially offset by an increase in revenue to Nordam, from $0.2 million in the first nine months of 2013 to $1.8 million in the first nine months of 2014.

Cost of Goods Sold.  Cost of goods sold consists primarily of labor and benefit costs and for the first nine months of 2014 was $43.1 million compared to $56.0 million for the first nine months of 2013.  A decrease in demand for engineering services in the first nine months of 2014 drove the decline in cost of good sold, when compared to the prior year period.

Gross Profit.  Gross profit for the first nine months of 2014 was $8.1 million (15.8% of net sales) compared to $9.4 million (14.4% of net sales) in the first nine months of 2013. The change in gross profit margin was primarily attributable to a $1.5 million unfavorable cumulative catch-up adjustment booked in the first nine months of 2013. Gross profit margin was also impacted by a reduction in sales in the first nine months of 2014.

Selling, General and Administrative Expenses.  Selling, general and administrative expenses for the first nine months of 2014 were $7.4 million, or 14.5% of net sales, compared to $12.3 million, or 18.8% of net sales, for the first nine months of 2013. The decrease in expense was primarily attributable to a one-time intangible asset impairment write-off of $4.2 million that was recognized in the second quarter of 2013 in addition to increases in restructuring expense of $0.5 million in the first nine months of 2014.

Non-segment Expenses

Interest Expense.  Interest expense was $23.8 million for the first nine months of 2014 and $12.5 million for the first nine months of 2013. The increase in interest expense was primarily due to a $8.5 million write-off of debt financing costs related to the termination of the Company's long term credit agreement and the modification of the Company's revolving credit agreement during the nine months ended September 30, 2014. Increased average interest rates also contributed to the increase in interest expense in the first nine months of 2014 due to the refinancing of the primary debt source from a term loan to higher interest rate notes.

Income Tax Expense.  During the first nine months of 2014, the Company recorded an income tax benefit of $2.6 million compared to $3.6 million of income tax expense in the first nine months of 2013. The Company's tax benefit in the nine months ended September 30, 2014 reflects the tax benefit of approximately $2.9 million anticipated with the decision to carry back the net operating loss recognized in 2013 offset by tax expense of $0.3 million. The Company continues to record a valuation allowance on tax benefits generated in the period. The tax expense reflects the taxes due in states where the Company generated income or where the tax liability is determined based on non-income related items such as gross sales.

Non-GAAP Financial Measures

When viewed with the financial results prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and accompanying reconciliations, the Company believes earnings before interest, taxes, depreciation and amortization (“EBITDA”) and Adjusted EBITDA provide additional useful information to clarify and enhance the understanding of the factors and trends affecting past performance and future prospects. The Company defines these measures, explains how they are calculated and provides reconciliations of these measures to the most comparable GAAP measure in the tables below.


24


EBITDA and Adjusted EBITDA, as presented in this Form 10-Q, are supplemental measures of performance that are not required by, or presented in accordance with, GAAP.  They are not measurements of financial performance under GAAP and should not be considered as alternatives to net income or any other performance measures derived in accordance with GAAP, or as alternatives to net cash provided by operating activities as measures of liquidity.  The presentation of these measures should not be interpreted to mean that future results will be unaffected by unusual or nonrecurring items.
 
The Company uses EBITDA and Adjusted EBITDA non-GAAP operating performance measures internally as complementary financial measures to evaluate the performance and trends of the business.  The Company presents EBITDA and Adjusted EBITDA because it believes that measures such as these provide useful information with respect to its ability to meet future debt service, capital expenditures, working capital requirements and overall operating performance.

EBITDA and Adjusted EBITDA have limitations as analytical tools, and you should not consider them in isolation or as substitutes for analysis of the Company’s results as reported under GAAP.  Some of these limitations are:
They do not reflect the Company’s cash expenditures, future expenditures for capital expenditures or contractual commitments;
They do not reflect changes in, or cash requirements for, working capital needs;
They do not reflect the significant interest expense or the cash requirements necessary to service interest or principal payments on debt;
Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and EBITDA and Adjusted EBITDA do not reflect any cash requirements for such replacements;
They are not adjusted for all non-cash income or expense items that are reflected in the statement of cash flows;
They do not reflect the impact on earnings of charges resulting from matters unrelated to ongoing operations; and
Other companies in the Company’s industry may calculate EBITDA and Adjusted EBITDA differently, limiting their usefulness as comparative measures.

Because of these limitations, EBITDA, Adjusted EBITDA and the related financial ratios should not be considered as measures of discretionary cash available to the Company to invest in the growth of the business or as a measure of cash that will be available to meet the Company’s obligations.  Furthermore, the definitions of EBITDA and adjusted EBITDA calculated here are different than those contained in the Company’s credit agreement.  You should compensate for these limitations by relying primarily on the GAAP results and using EBITDA and Adjusted EBITDA only supplementary.
 
However, in spite of the above stated limitations, the Company believes that EBITDA and Adjusted EBITDA are useful to an investor in evaluating the results of operations because these measures:
Are widely used by investors to measure a company’s operating performance without regard to items excluded from the calculation of such terms, which can vary substantially from company to company depending upon accounting methods and book value of assets, capital structure and the method by which assets were acquired, among other factors;
Help investors to evaluate and compare the results of operations from period to period by removing the effect of the capital structure from operating performance; and
Are used by the management team for various other purposes in presentations to the Board of Directors as a basis for strategic planning and forecasting.
 
Adjusted EBITDA excludes acquisition and integration charges, as applicable, and provides meaningful information about the operating performance of the businesses apart from the acquisition-related expenses, as well as interest and tax expenses.
 
The following financial items have been added back to net income when calculating EBITDA:
Interest expense;


25


Income tax expense;
Depreciation; and
Amortization.
 
The following additional financial items have been added back to net income when calculating Adjusted EBITDA:
Stock-based compensation;
Acquisition and integration–related expenses;
Contingent consideration write-off;
Fair value step-up on acquired inventories;
Restructuring expenses;
Other (net).

Reconciliations of net income to EBITDA and Adjusted EBITDA were as follows:
 
(In Thousands)
 
(In Thousands)
 
Three Months Ended September 30,
 
Nine months ended September 30,
 
2014
 
2013
 
2014
 
2013
Net income (loss)
$
1,396


$
2,075

 
$
(6,458
)
 
$
8,576

Depreciation and amortization (1)
5,998


5,496

 
17,002

 
15,230

Intangible Asset impairment (2)

 

 

 
4,222

Interest expense (3)
5,946


4,328

 
23,800

 
12,485

Income tax (benefit) expense
(754
)

281

 
(2,557
)
 
3,567

EBITDA
12,586


12,180

 
31,787

 
44,080

Stock-based compensation (4)
1,007


638

 
2,031

 
1,842

Acquisition and integration expenses (5)
64


207

 
557

 
969

Restructuring expenses (6)
765



 
2,288

 

Contingent consideration write-off (7)

 

 

 
(7,950
)
Fair Value step-up on acquired inventories

 

 

 
2,497

Other, net
537


(49
)
 
791

 
(449
)
Adjusted EBITDA
$
14,959


$
12,976

 
$
37,454

 
$
40,989

(1)
Includes amortization of intangibles and depreciation expense.
(2)
In the quarter ended June 30, 2013, a triggering event occurred which resulted in the impairment of the definite lived D3 trade name asset of $4,222.
(3)
In the nine months ended September 30, 2014, interest expense includes $793 related to the termination of interest rate derivatives and $8,464 related to the write-off of debt issuance cost associated with the modification of the Company's revolving credit facility and the termination of its long-term credit agreement.
(4)
Includes restricted stock compensation and defined benefit plan expense funded in stock.
(5)
Includes accounting, legal, and other expenses for acquisitions and integration.
(6)
Includes expenses associated with severance related to the Precise Machine facility closure, relocation of the Savannah, Georgia machining operations, and other employment separation activities.
(7)
The nine months ended September 30, 2013 included a $7,950 benefit related to the write-off of contingent consideration associated with an acquisition.


26


Liquidity and Capital Resources

On June 19, 2014, the Company issued $250.0 million in notes and modified its revolving credit agreement while concurrently terminating its long-term credit agreement. The Company believes that the borrowings under these new facilities will provide the financial flexibility necessary to achieve its long-range strategic goals.

The modified revolving credit facility provides for borrowings up to $90.0 million and matures June19, 2019.  Under the agreement, the co-collateral agents may establish a reserve against the facility. At September 30, 2014, the reserve established was $15.0 million, which reduced the maximum availability to $75.0 million. Based on the amount of eligible assets at September 30, 2014, available borrowings were further reduced to $60.4 million. As of September 30, 2014, a total of $0.0 million was outstanding under the credit facility and the Company had available borrowings of approximately $60.4 million. The credit agreement for our revolving credit facility requires us to comply with certain restrictive covenants that limit our ability to incur additional debt, guarantee debt or obligations, create liens, enter into certain merger, consolidation or other reorganization transactions, make investments, sell, and lease or transfer our assets and prohibit our ability to pay dividends. The Company was in compliance with all of its covenants as of September 30, 2014.

For more information on the Company's debt structure, please see Note 6 - Long-term Debt and Capital Lease Obligations in the Notes to the Condensed Consolidated Financial Statements under Part 1, Item 1 of this Quarterly Report on Form 10-Q.

During the first nine months of 2014, operating activities provided $36.0 million in cash, compared to $18.6 million of cash used by operating activities in the first nine months of 2013.  Net cash provided by operating activities for the first nine months of 2014 was favorably impacted by collection of a $13.5 million milestone payment on the KC-390 program and decreases in inventory of $2.1 million primarily related to a decrease in overall inventory spend. In addition, interest payments on the Company's outstanding $245 million in notes are due semi-annually, the first semi-annual payment due on January 15, 2015. As a result, cash flow related to interest increased $2.4 million in the nine months ended September 30, 2014 when compared to the first nine months of 2013. Net cash used by operating activities for the first nine months of 2013 was unfavorably impacted by increases in unbilled revenue, trade accounts receivable, capitalized contract costs and product inventories in addition to a decline in accounts payable. Increases of $17.8 million in unbilled revenue and $12.0 million in capitalized contract costs in 2013 reflected additional investments in tooling for the Gulfstream G500 program. Increases of $7.4 million in trade receivables in 2013 were due to continued sales growth. A $10.9 million increase in product inventories was necessary to meet expected delivery rate increases later in 2013 and into 2014.

Net cash used for investing activities was $9.3 million for the first nine months of 2014, compared to $19.3 million for the first nine months of 2013.  Cash used in the first nine months of 2014 included $4.2 million on machinery and equipment in support of new production contracts. Cash used in the first nine months of 2013 funded construction of a building in Tulsa, Oklahoma in support of a new program and the purchase a corporate aircraft.

The Company used free cash flow in the first nine months of 2014 to pay down debt of $17.9 million and to pay debt issuance costs of $7.9 million. This compares to net cash provided of $35.1 million in the first six months of 2013, which primarily resulted from borrowings against the Company's revolving credit facility of $28.0 million, proceeds from issuance of debt related to the Company financing of a building in Tulsa, Oklahoma and purchase of a corporate aircraft.


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Contractual Obligations and Commitments

For information concerning contractual obligations, see the caption “Contractual Obligations and Commitments” in “Item 7.  Management’s Discussion and Analysis of Financial Condition and Results” in the Company’s 2013 Form 10-K.

Item 3.
Quantitative and Qualitative Disclosures about Market Risk.

No material changes have taken place in the quantitative and qualitative information about market risk since the end of the most recent fiscal year.  For further information, see Part II, Item 7A of the Company’s 2013 Form 10-K.
Item 4.
Controls and Procedures.

 Disclosure Controls and Procedures

Our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined by Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of September 30, 2014. Based upon and as of the date of this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that such disclosure controls and procedures were effective to ensure that the information required to be disclosed by us in the reports that we file or submit under the Exchange Act (a) is recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms and (b) is accumulated and communicated to our management, including our principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure.

 
Changes in Internal Control over Financial Reporting

No change in our internal control over financial reporting occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 


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PART II

OTHER INFORMATION
Item 1.
Legal Proceedings.

We are involved in various legal proceedings that arise in the ordinary course of our business, as well as other matters that are or could become material under SEC regulations. Information regarding these other matters is disclosed in Note 15 - Legal Contingencies in the Notes to the Condensed Consolidated Financial Statements under Part I, Item 1 of this Quarterly Report on Form 10-Q, which is incorporated herein by reference. Other than as set forth in Note 15- Legal Contingencies in the Notes to the Condensed Consolidated Financial Statements under Part 1, Item 1 of this Quarterly Report on Form 10-Q, during the period covered by this Quarterly Report on Form 10-Q, there were no material developments with respect to the matters previously reported in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2014 or in our Annual Report on Form 10-K for the year ended December 31, 2013.


Item 1A.
Risk Factors.

This Form 10-Q should be read together with Part I, Item 1A “RISK FACTORS” in our 2013 Form 10-K, and in subsequent reports we have filed with the SEC, which describes various risks and uncertainties to which we are or may become subject. The following includes material changes to, and amends [and supplements], such risks and uncertainties previously disclosed in our 2013 Form 10-K and other period reports filed with the SEC. These risks and uncertainties could, directly or indirectly, adversely affect our business, financial condition, results of operations, cash flows, strategies and/or prospects.

Risks Related to the Company and Industry

We may not be able to generate sufficient cash to service all of our indebtedness and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.

Our ability to make scheduled payments on or to refinance our debt obligations, including the notes, depends on our financial condition and operating performance, which are subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We may be unable to maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on the notes or any other indebtedness we may assume from time to time.

If our cash flows and capital resources are insufficient to fund our debt service obligations, we could face substantial liquidity problems and could be forced to reduce or delay investments and capital expenditures or to dispose of material assets or operations, seek additional debt or equity capital or restructure or refinance our indebtedness. We may not be able to effect any such alternative measures, if necessary, on commercially reasonable terms or at all and, even if successful, such alternative actions may not allow us to meet our scheduled debt service obligations. Our current revolving credit facility restricts our ability to dispose of assets and use the proceeds from any such dispositions. We may not be able to consummate those dispositions or to obtain proceeds in an amount sufficient to meet any debt service obligations then due.

Demand for our defense-related products depends upon government spending.

A material portion of our sales are derived from the military market. The military market is largely dependent upon government budgets, particularly the U.S. defense budget. The funding of government programs is subject to Congressional appropriation and the possibility of sequestration. Although multi-year contracts may be authorized in connection with major procurements, the U.S. Congress generally appropriates funds on a fiscal year basis even though a program may be expected to continue for several years. Consequently, programs, including those that require our components, may be only partially funded or may never enter full-scale production as expected. As a result, future U.S. defense spending may not be allocated to programs that would benefit our business or at levels that we had anticipated. A decrease in levels of defense spending or the government's termination of, or failure to fully fund, one or more of the contracts for the programs in which we participate would adversely impact our revenues and cash flow.

Most U.S. government contracts for which we subcontract can be terminated by the U.S. government either for its convenience or if the prime contractor defaults by failing to perform under the contract. In addition, the prime contractor typically has the


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right to terminate our subcontract for its convenience or if we default by failing to perform under the subcontract. Termination for convenience provisions generally permit us to recover only our costs incurred or committed, plus settlement expenses and a reasonable profit, which may be different from what we bid or our historical profit rates, on the work completed prior to termination.

We are subject to the cyclical nature of the aerospace industry, and any future downturn in the aerospace industry or general economic conditions could cause our sales and operating income to decrease.

We derived the majority of our revenue from the sale of services and components for the aerospace industry. Consequently, our business is directly affected by certain characteristics of and trends in the aerospace industry or general economic conditions that affect our customers, such as:

fluctuations in the aerospace industry’s business cycle;

new programs in commercial, military, and general aviation have historically experienced significant delays and engineering changes which adversely impact our net sales, results of operations and cash flow;

varying fuel and labor costs;

intense price competition and regulatory scrutiny;

certain trends, including a possible decrease in aviation activity, a decrease in outsourcing by aircraft manufacturers or the failure of projected market growth to materialize or continue;

changes in military budgeting, sequestration and procurement for certain military aircraft;

sequestration may result in excess capacity potentially putting additional pressure on prices; and

military trend toward utilizing more Unmanned Aerial Vehicles, reducing the demand for more traditional military aircraft (e.g. Boeing F-18, General Dynamics F-16 and Lockheed Martin F-35).

In the event that these characteristics and trends adversely affect customers in the aerospace industry, they will reduce the overall demand for our products and services, thereby decreasing our sales and operating income.

Compliance with and changes in environmental, health and safety laws and other laws that regulate the operation of our business and industry standards could increase the cost of production and expose us to regulatory claims.

Our operations are subject to extensive and frequently changing federal, state and local laws and substantial regulation by government agencies, including the U.S. Environmental Protection Agency (“EPA”), the U.S. Occupational Safety and Health Administration (“OSHA”), the FAA, and the DoD. Among other matters, these agencies impose requirements that:

regulate the operation, handling, transportation and disposal of hazardous materials generated or used by us during the normal course of our operations;

govern the health and safety of our employees; and

require that we meet standards and licensing requirements for aerospace components.

In particular, we use and generate hazardous waste in our operations. Consequently, we monitor hazardous waste management and applicable environmental permitting and reporting for compliance with applicable laws at our locations in the ordinary course of our business. We may be subject to potential material liabilities relating to any investigation and cleanup of any contamination at our locations or properties where we deliver hazardous waste for handling or disposal and to claims alleging personal injury. In addition, we have incurred, and expect to continue to incur, costs to comply with environmental laws and regulations. The adoption of new laws and regulations, stricter enforcement of existing laws and regulations, the discovery of previously unknown contamination or the imposition of new cleanup requirements could require us to incur costs and become subject to new or increased liabilities that could increase our operating costs and adversely affect the manner in which we conduct our business.



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We are involved with the Attorney General of the State of Missouri with respect to allegations of violations of certain state environmental regulations by Ozark Mountain Technologies (“OMT”), our subsidiary located in Cuba, Missouri. We are involved with the EPA and Missouri Department of Natural Resources with respect to other possible instances of environmental non-compliance that we voluntary reported following our voluntary, comprehensive internal audit of OMT’s facility.

We are involved with the EPA and the U.S. Department of Justice (“DoJ”) with respect to an investigation into allegations of low pH wastewater releases at OMT’s facility (the “Waste Water Allegations”). On May 6, 2014, we received information from DoJ that DoJ is prepared to move forward with a one count indictment naming OMT as a defendant. DoJ has also advised that the alleged violations may subject us to fines. The Company continues to work with DoJ to reach a resolution of this matter. Any charges filed, monetary sanctions imposed or other actions taken by any of these agencies could result in a material adverse effect on us.

For more information on the matters discussed above, please see Note 15 - Legal Contingencies in the Notes to the Condensed Consolidated Financial Statements under Part 1, Item 1 of this Quarterly Report on Form 10-Q.

We are also subject to U.S. Export Regulations, including the Arms Export Control Act, associated International Traffic in Arms Regulations and Export Administration Regulations and the Foreign Corrupt Practices Act. Failure to comply with such regulations could result in substantial fines, significant time and costs related to training personnel for cause and corrective action, penalties and limit our ability to export certain products.

While we require FAA certifications only to a limited extent, we typically are required to maintain third-party registrations with respect to industry specification standards, such as AS9100 and NADCAP, for our quality systems and processes. In fact, many individual OEMs and Tier 1 suppliers require certifications or approvals of our work based on third-party registrations in order to engineer and serve the systems and components used in specific aircraft models. If material OEM certifications or approvals were to be revoked or suspended, OEMs might cease purchasing our products.

Moreover, if in the future new or more stringent governmental regulations are adopted, or industry oversight heightened, such action could result in our incurrence of significant additional costs and have an adverse effect on our financial condition or results of operation.

 

Risks Related to our Indebtedness

Our substantial level of indebtedness may adversely affect our cash flow and our ability to operate our business.

As of September 30, 2014, we had $272.7 million of total debt outstanding, including the notes of $245.0 million and $0.0 million of borrowings under our current revolving credit facility.

Our substantial level of indebtedness could have important consequences to you and significant effects on our business, including the following:

we must use a substantial portion of our cash flow from operations to pay interest on the notes and our other indebtedness, which will reduce the funds available to use for operations and other purposes including our other financial obligations;

our ability to obtain additional financing for working capital, capital expenditures, strategic acquisitions or general corporate purposes may be impaired;

we could be at a competitive disadvantage compared to our competitors that may have proportionately less debt;

our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate may be limited;

our ability to fund a change of control offer may be limited; and

we may be more vulnerable to economic downturns and adverse developments in our business.

 


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We expect to obtain the funds to pay our expenses and to repay our indebtedness primarily from our operations. Our ability to meet our expenses and make these payments therefore depends on our future performance, which will be affected by financial, business, economic and other factors, many of which we cannot control. Our business may not generate sufficient cash flow from operations in the future, and our currently anticipated growth in revenue and cash flow may not be realized, either or both of which could result in our being unable to repay indebtedness, including the notes, or to fund other liquidity needs. If we do not have enough funds, we may be required to refinance all or part of our then existing debt, sell assets or borrow more funds, which we may not be able to accomplish on terms acceptable to us, or at all. In addition, the terms of existing or future debt agreements may restrict us from pursuing any of these alternatives.

The indenture governing the notes imposes significant operating and financial restrictions, which may prevent us from pursuing certain business opportunities and taking certain actions that may be potentially profitable or in our best interests.

The indenture governing the notes imposes, and future debt agreements may impose, operating and financial restrictions on us. These restrictions limit or prohibit, among other things, our ability to:

incur or guarantee additional indebtedness or issue certain preferred stock;

make certain investments or acquisitions;

issue stock of subsidiaries;

grant or permit certain liens on our assets;

enter into certain transactions with affiliates;

pay dividends, redeem subordinated debt or make other restricted payments;

merge, consolidate or transfer substantially all of our assets;

transfer, sell or acquire assets, including capital stock of our subsidiaries; and