SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period Commission File Number 1-11398 ended September 30, 2006 CPI AEROSTRUCTURES, INC. (Exact name of registrant as specified in its charter) New York 11-2520310 (State or other jurisdiction (IRS Employer Identification Number) of incorporation or organization) 60 Heartland Blvd., Edgewood, NY 11717 (Address of principal executive offices) (zip code) (631) 586-5200 (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 [_] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer" and "large accelerated filer" in Rule 12b-2 of the Exchange Act (Check one): Large accelerated filer [_] Accelerated filer [_] Non-accelerated filer [X] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [_] No [X] As of November 10, 2006, the number of shares of common stock, par value $.001 per share, outstanding was 5,447,042. INDEX -------------------------------------------------------------------------------- Part I: Financial Information: Item 1 - Condensed Financial Statements: Condensed Balance Sheets as of September 30, 2006 (Unaudited) and December 31, 2005 3 Condensed Statements of Operations for the Three Months and Nine Months ended September 30, 2006 (Unaudited) and 2005 (Unaudited) 4 Condensed Statements of Cash Flows for the Nine Months ended September 30, 2006 (Unaudited) and 2005 (Unaudited) 5 Notes to Condensed Financial Statements (Unaudited) 6 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 12 Item 3 - Quantitative and Qualitative Disclosures About Market Risk 18 Item 4 - Controls and Procedures 18 Part II. Other Information Item 1A. - Risk Factors 19 Item 2 - Unregistered Sales of Equity Securities 19 Item 6 - Exhibits 19 Signatures and Certifications 20 2 PART I: FINANCIAL INFORMATION: ITEM 1 - FINANCIAL STATEMENTS: CONDENSED BALANCE SHEETS -------------------------------------------------------------------------------- SEPTEMBER 30, DECEMBER 31, 2006 2005 (UNAUDITED) (NOTE 1) ------------- ------------ ASSETS Current Assets: Cash $ 85,412 $ 877,182 Accounts receivable 2,016,089 1,849,796 Costs and estimated earnings in excess of billings on uncompleted contracts 26,272,509 28,389,202 Prepaid expenses and other current assets 136,008 342,165 Refundable income taxes 878,987 -- ----------- ----------- TOTAL CURRENT ASSETS 29,389,005 31,458,345 Plant and equipment, net 894,110 962,209 Other assets 249,775 267,230 ----------- ----------- TOTAL ASSETS $30,532,890 $32,687,784 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 3,347,959 $ 4,559,181 Accrued expenses and other current liabilities 541,899 648,521 Current portion of long-term debt 57,568 87,617 Line of credit 350,000 -- Income taxes payable -- 133,110 ----------- ----------- TOTAL CURRENT LIABILITIES 4,297,426 5,428,429 Long-term debt, net of current portion 2,474 42,188 Other liabilities 87,630 54,895 ----------- ----------- TOTAL LIABILITIES 4,387,530 5,525,512 =========== =========== Commitments Shareholders' Equity: Common stock - $.001 par value; authorized 50,000,000 shares, issued 5,478,057 and 5,475,057 shares, respectively, and outstanding 5,447,042 and 5,444,042 shares, respectively 5,478 5,475 Additional paid-in capital 23,028,237 22,768,135 Retained earnings 3,432,501 4,709,518 Treasury stock, 31,015 shares of common stock (at cost) (320,856) (320,856) ----------- ----------- TOTAL SHAREHOLDERS' EQUITY 26,145,360 27,162,272 ----------- ----------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $30,532,890 $32,687,784 =========== =========== See Notes to Condensed Financial Statements 3 CONDENSED STATEMENTS OF OPERATIONS -------------------------------------------------------------------------------- FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, 2006 2005 2006 2005 (UNAUDITED) (UNAUDITED) -------------------------- --------------------------- Revenue $4,412,931 $6,452,246 $11,900,141 $19,010,780 Cost of sales 3,651,385 4,769,256 11,077,893 13,763,040 ---------- ---------- ----------- ----------- Gross profit 761,546 1,682,990 822,248 5,247,740 Selling, general and administrative expenses 774,123 803,492 2,756,265 2,570,393 ---------- ---------- ----------- ----------- Income (loss) before provision for (benefit from) income taxes (12,577) 879,498 (1,934,017) 2,677,347 ---------- ---------- ----------- ----------- Provision for (benefit from) income taxes -- 331,000 (657,000) 1,041,000 ---------- ---------- ----------- ----------- Net income (loss) $ (12,577) $ 548,498 $(1,277,017) $ 1,636,347 Income (loss) per common share - basic $ 0.00 $ 0.10 $ (0.23) $ 0.30 Income (loss) per common share - diluted $ 0.00 $ 0.09 $ (0.23) $ 0.27 ========== ========== =========== =========== Shares used in computing earnings (loss) per common share: Basic 5,447,042 5,421,650 5,446,526 5,419,411 Diluted 5,447,042 6,115,014 5,446,526 6,120,977 ---------- ---------- ----------- ----------- See Notes to Condensed Financial Statements 4 CONDENSED STATEMENTS OF CASH FLOWS -------------------------------------------------------------------------------- FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006 2005 ------------------------------------------------------------------------- ----------- ----------- (UNAUDITED) Cash flows from operating activities: Net income (loss) $(1,277,017) $ 1,636,347 Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization 158,633 143,685 Deferred rent 21,822 41,172 Stock-based compensation expense 241,054 -- Tax benefit from stock option exercise (4,600) -- Deferred portion of provision for income taxes (48,000) 36,000 Changes in operating assets and liabilities: Increase in accounts receivable (166,293) (116,745) (Increase) decrease in costs and estimated earnings in excess of billings on uncompleted contracts 2,116,692 (1,841,575) Decrease in prepaid expenses and other assets 223,612 48,484 Increase in refundable income taxes (878,987) -- Decrease in accounts payable, accrued expenses and other current liabilities (1,258,931) (1,000,878) Increase (decrease) in income taxes payable (133,110) 330,000 ----------- ----------- Net cash used in operating activities (1,005,125) (723,510) ----------- ----------- Cash used in investing activities - purchase of plant and equipment (90,532) (255,581) ----------- ----------- Cash flows from financing activities: Net repayment of long-term debt (69,763) (51,570) Proceeds from line of credit 350,000 -- Proceeds from exercise of stock options 19,050 47,591 Tax benefit from stock option exercise 4,600 -- ----------- ----------- Net cash provided by (used in) financing activities 303,887 (3,979) ----------- ----------- Net decrease in cash (791,770) (983,070) Cash at beginning of period 877,182 1,756,350 ----------- ----------- Cash at end of period $ 85,412 $ 773,280 =========== =========== Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 8,891 $ 10,739 =========== =========== Income taxes $ 403,093 $ 675,000 =========== =========== See Notes to Condensed Financial Statements 5 NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) -------------------------------------------------------------------------------- 1. INTERIM FINANCIAL The financial statements of CPI Aerostructures, STATEMENTS: Inc. ("the Company") as of September 30, 2006 and for the three and nine months ended September 30, 2006 and 2005 are unaudited, however, in the opinion of the management of the Company, these financial statements reflect all adjustments (consisting solely of normal recurring adjustments) necessary to present fairly the financial position of the Company and its results of operations and cash flows. The results of operations for such interim periods are not necessarily indicative of the results to be obtained for a full year. The balance sheet at December 31, 2005 has been derived from the audited financial statements at that date but does not include all of the information and notes required by accounting principles generally accepted in the United States for complete financial statements. For further information, refer to the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2005. Certain reclassifications have been made in the prior period financial statements to conform to the current period presentation. 2. STOCK-BASED COMPENSATION Effective January 1, 2006, the Company began recording compensation expense associated with stock options in accordance with Statement of Financial Accounting Standard ("SFAS") No. 123R, "Share-Based Payment." Prior to January 1, 2006 the Company accounted for stock-based compensation related to stock options under the recognition and measurement principles of Accounting Principles Board Opinion No. 25; therefore, the Company measured compensation expense for its stock option plans using the intrinsic value method, that is, as the excess, if any, of the fair market value of the Company's stock at the grant date over the amount required to be paid to acquire the stock, and provided the disclosures required by SFAS No. 123 and 148. The Company has adopted the modified prospective transition method provided under SFAS 123R, and as a result, has not retroactively adjusted results from prior periods. Under this transition method, compensation expense associated with stock options in the three and nine month periods ended September 30, 2006 includes: (1) period expense related to the remaining unvested portion of all stock option awards granted prior to January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123; and (2) expense related to all stock option awards granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. As a result of the adoption of SFAS 123R, the Company's net loss for the nine months ended September 30, 2006 includes approximately $252,000 of non-cash compensation expense related to the Company's stock options. The Company recorded no compensation expense related to stock options for the three month period ended September 30, 2006. The non-cash compensation expense related to all of the Company's stock-based compensation arrangements is recorded as a component of selling, general and administrative expense. Prior to the Company's adoption of SFAS 123R, the Company presented tax benefits resulting from the exercise of stock options as cash flows from operating activities on the Company's consolidated statements of cash flows. SFAS 123R requires cash flows resulting from tax deductions in excess of the cumulative compensation cost recognized for options exercised (excess tax benefits) be classified as cash inflows from financing activities and cash outflows from operating activities. 6 NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) -------------------------------------------------------------------------------- In November 2005, the FASB issued FASB Staff Position No. FAS 123R-3, "Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards." The Company has elected to adopt the alternative transition method provided in the FASB Staff Position for calculating the tax effects of share-based compensation pursuant to SFAS 123R. The alternative transition method includes a simplified method to establish the beginning balance of the additional paid-in capital pool related to the tax effects of employee share-based compensation, which is available to absorb tax deficiencies recognized subsequent to the adoption of SFAS 123R. In April 1992, the Company adopted the 1992 Stock Option Plan (the "1992 Plan"). The 1992 Plan, for which 83,334 common shares are reserved for issuance, provides for the issuance of either incentive stock options or nonqualified stock options to employees, consultants, directors or others who provide services to the Company. The options may not be exercised more than five years from the date of issuance. No more options may be granted under the 1992 Plan. In 1995, the Company adopted the 1995 Stock Option Plan (the "1995 Plan"), as amended, for which 200,000 common shares are reserved for issuance. The 1995 Plan provides for the issuance of either incentive stock options or nonqualified stock options to employees, consultants, directors or others who provide services to the Company. The options' exercise price is equal to the closing price of the Company's shares on the day of issuance, except for incentive stock options granted to the Company's former president, which are exercisable at 110% of the closing price of the Company's shares on the date of issuance. In 1998, the Company adopted the 1998 Performance Equity Plan (the "1998 Plan"). The 1998 Plan, as amended, reserved 463,334 common shares for issuance. The 1998 Plan provides for the issuance of either incentive stock options or nonqualified stock options to employees, consultants, directors or others who provide services to the Company. The options' exercise price is equal to the closing price of the Company's shares on the day prior to the date of issuance, except for incentive stock options granted to the Company's former president, which are exercisable at 110% of the closing price of the Company's shares on the date of issuance. In 2000, the Company adopted the Performance Equity Plan 2000 (the "2000 Plan"). The 2000 Plan, as amended, reserved 1,230,000 common shares for issuance. The 2000 Plan provides for the issuance of either incentive stock options or nonqualified stock options to employees, consultants, directors or others who provide services to the Company. The options' exercise price is equal to the closing price of the Company's shares on the day prior to the date of issuance, except for incentive stock options granted to the Company's former president, which are exercisable at 110% of the closing price of the Company's shares on the date of issuance. At September 30, 2006, the Company had 285 options available for grant under the 1995 Plan, 666 options available for grant under the 1998 Plan, and 313,025 options available for grant under the 2000 Plan. The estimated fair value of each option award granted was determined on the date of grant using the Black-Scholes option valuation model. The following weighted- 7 NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) -------------------------------------------------------------------------------- average assumptions were used for option grants during the nine month period ended September 30, 2006 and 2005: September 30, 2006 2005 ------- ------ Risk-free interest rate 4.2% 3.9% Expected volatility 22% 32% Dividend yield 0% 0% Expected option term 5 years 5years The risk free interest rate for the nine months ended September 30, 2006 and 2005 is based on the 5 year U.S. Treasury note rate on the day of grant. The expected volatility computation is based on the average of the volatility over the most recent two year period. The Company has never paid a dividend, and is not expected to pay a dividend in the foreseeable future, therefore the dividend yield is assumed to be zero. A summary of the status of the Company's stock option plans as of September 30, 2006 and changes during the period is as follows: Weighted Weighted average average remaining Aggregate Exercise contractual Intrinsic Fixed Options Options Price term (in years) Value ------------------------- --------- -------- ----------------- ---------- Outstanding at beginning of period 1,130,085 $4.89 Granted during period 85,000 8.57 Exercised (3,000) 6.35 Forfeited/Expired -- --------- ----- ---- ---------- Outstanding and vested at end of period 1,212,085 $5.14 4.55 $1,542,050 ========= ===== ==== ========== The weighted-average fair value of each option granted during the nine months ended September 30, 2006 and 2005, estimated as of the grant date using the Black-Scholes option valuation model was $2.45 and $3.49, respectively. As of September 30, 2006 there was no unrecognized compensation cost related to non-vested stock option awards. The net income for the three months and nine months ended September 30, 2005 does not include any compensation charges related to options granted to employees. The following table illustrates the pro forma effect on net loss and loss per share assuming the Company had applied the fair value recognition provisions of SFAS 123 instead of the intrinsic value method under APB No. 25 to stock-based employee compensation for the three month and nine month periods ended September 30, 2005: 8 NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) -------------------------------------------------------------------------------- Three Months Nine Months ------------ ----------- Net income, as reported $548,498 $1,636,347 Stock compensation expense, net of tax 76,287 406,918 -------- ---------- Net income, pro forma $472,211 $1,229,429 ======== ========== Basic net income per common share, as reported $0.10 $0.30 Diluted net income per common share, as reported $0.09 $0.27 Basic net income per common share, pro forma $0.09 $0.23 Diluted net income per common share, pro forma $0.08 $0.20 Cash received from stock option exercises for the nine months ended September 30, 2006 and 2005 was $19,050 and $47,591, respectively. The income tax benefit from stock option exercises totaled $4,600 and $73,000 for the nine months ended September 30, 2006 and 2005, respectively. 9 NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) -------------------------------------------------------------------------------- 3. COSTS AND ESTIMATED Costs and estimated earnings in excess of EARNINGS IN EXCESS OF billings on uncompleted contracts consist of: BILLINGS ON UNCOMPLETED CONTRACTS: September 30, 2006 --------------------------------------- U.S. Government Commercial Total ----------- ----------- ----------- Costs incurred on uncompleted contracts $44,486,743 $15,251,819 $59,738,562 Estimated earnings 26,665,989 6,639,980 33,305,969 ----------- ----------- ----------- 71,152,732 21,891,799 93,044,531 Less billings to date 47,132,716 19,639,306 66,772,022 ----------- ----------- ----------- COSTS AND ESTIMATED EARNINGS IN EXCESS OF BILLINGS ON UNCOMPLETED CONTRACTS $24,020,016 $ 2,252,493 $26,272,509 =========== =========== =========== December 31, 2005 --------------------------------------- U.S. Government Commercial Total ----------- ----------- ----------- Costs incurred on uncompleted contracts $41,075,851 $14,400,603 $55,476,454 Estimated earnings 25,430,030 6,273,397 31,703,427 ----------- ----------- ----------- 66,505,881 20,674,000 87,179,881 Less billings to date 39,878,934 18,911,745 58,790,679 ----------- ----------- ----------- COSTS AND ESTIMATED EARNINGS IN EXCESS OF BILLINGS ON UNCOMPLETED CONTRACTS $26,626,947 $ 1,762,255 $28,389,202 =========== =========== =========== 10 NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) -------------------------------------------------------------------------------- 4. INCOME PER COMMON SHARE: Basic income per common share is computed using the weighted average number of shares outstanding. Diluted income per common share for the three month and nine month periods ended September 30, 2005 is computed using the weighted-average number of shares outstanding adjusted for the incremental shares attributed to outstanding options and warrants to purchase common stock. Incremental shares of 693,364 and 701,566 were used in the calculation of diluted income per common share in the three month and nine month periods ended September 30, 2005, respectively. Incremental shares of 648,388 and 640,186 were not included in the diluted earnings per share calculations for the three month and nine month periods ended September 30, 2005, respectively, as their exercise price was in excess of the Company's average stock price for the respective period and, accordingly, these shares are not assumed to be exercised for the diluted earnings per share calculation, as they would be anti-dilutive. Incremental shares of 1,407,085 were not included in the diluted earnings per share calculation at September 30, 2006 because of the reported net loss, and accordingly their effect would be anti-dilutive. 5. CREDIT FACILITY: In September 2003, the Company entered into a three year, $5.0 million revolving credit facility with JP Morgan Chase Bank ("Chase Facility"), secured by the assets of the Company. The facility specified interest rates ranging between the Prime Rate and 225 basis points over LIBOR, depending on certain terms and conditions. In October 2006, the Chase Facility was amended and restated to provide for a $1.0 million revolving credit facility, secured by the assets of the Company. The facility specifies an interest rate equal to the greater of (a) the prime rate and (b) the federal funds rate , plus 0.5%. The facility expires on December 31, 2006. As of September 30, 2006, the Company had borrowed $350,000 under the Chase Facility. 11 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- The following discussion should be read in conjunction with the Company's Condensed Financial Statements and footnotes thereto contained in this report. FORWARD LOOKING STATEMENTS The statements discussed in this report include forward looking statements that involve risks and uncertainties, including the timely delivery and acceptance of the Company's products and the other risks detailed from time to time in the Company's reports filed with the Securities and Exchange Commission. BUSINESS OPERATIONS The operations of CPI Aerostructures, Inc. consist of the design and production of structural aircraft parts principally for the United States Air Force and other branches of the U.S. armed forces. We also provide aircraft parts to the commercial sector of the aircraft industry, but we are not currently pursuing business in this sector. Our strategy for growth includes de-emphasizing our commercial operations and concentrating on sales to the government and to prime contractors. We compete with other prime contractors to win contracts through a process of competitive bidding. Notwithstanding defense budget increases and the Department of Defense's commitment to maintaining support for aging aircraft, as affirmed in the DoD's 2006 Quadrennial Defense Review, there has been a significant slowdown in government contract awards as well as releases under previously awarded contracts. Faced with the uncertainties of appropriations and time of contract awards and releases under previously awarded contracts, a key element of our strategy has been to expand our activities to include operating as a subcontractor to leading aerospace prime contractors. While the slowdown in government contract awards also has affected these prime contractors, because they are able to bid on and receive contract awards for different programs than we are, we believe that pursuing such opportunities will enable us to access programs that we would not otherwise be able to given our smaller size and resources. By increasing our customer base, we are positioned to take advantage of additional market opportunities and reduce the impact of the slowdown in government contract awards and releases. These subcontracting opportunities have begun to materialize, and we have been awarded some subcontracts. We currently have proposals submitted to multiple prime contractors, and while we cannot predict the timing of awards, our outstanding proposals are significant. After winning a contract, the length of the contract varies but is typically between one and two years for U.S. government contracts (although our T-38 contract and our C-5 TOP contract are for periods of 10 years and 7 years, respectively), and up to 10 years for commercial contracts. Our one commercial contract has an indefinite life. Except in cases where contract terms permit us to bill on a progress basis, we must incur upfront costs in producing assemblies and bill our customers upon delivery. Because of the upfront costs incurred, the timing of our billings and the nature of the percentage-of-completion method of accounting described below, there can be a significant disparity between the periods in which (a) costs are expended, (b) revenue and earnings are recorded and (c) cash is received. 12 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- CRITICAL ACCOUNTING POLICIES REVENUE RECOGNITION We recognize revenue from our contracts over the contractual period under the percentage-of-completion (POC) method of accounting. Under the POC method of accounting, sales and gross profit are recognized as work is performed based on the relationship between actual costs incurred and total estimated costs at the completion of the contract. Recognized revenues that will not be billed under the terms of the contract until a later date are recorded as an asset captioned "Costs and estimated earnings in excess of billings on uncompleted contracts." Contracts where billings to date have exceeded recognized revenues are recorded as a liability captioned "Billings in excess of costs and estimated earnings on uncompleted contracts." Changes to the original estimates may be required during the life of the contract. Estimates are reviewed monthly and the effect of any change in the estimated gross margin percentage for a contract is reflected in cost of sales in the period the change becomes known. When the current estimates of total contract revenue and contract costs indicate a loss, a provision for the entire estimated loss on the contract is recorded. The use of the POC method of accounting involves considerable use of estimates in determining revenues, costs and profits and in assigning the amounts to accounting periods. As a result, there can be a significant disparity between earnings as reported and actual cash received by us during any reporting period. We continually evaluate all of the issues related to the assumptions, risks and uncertainties inherent with the application of the POC method of accounting; however, we cannot assure you that our estimates will be accurate. If our estimates are not accurate or a contract is terminated, we will be forced to adjust revenue in later periods. Furthermore, even if our estimates are accurate, we may have a shortfall in our cash flow and we may need to borrow money to pay taxes until the reported earnings materialize to actual cash receipts. SHARE-BASED PAYMENT Effective January 1, 2006, the Company adopted SFAS No. 123 R, "Share-Based Payment" for employee options, using the modified prospective transition method. SFAS 123 R revised SFAS 123 to eliminate the option to use the intrinsic value method and required the Company to expense the fair value of all employee stock-based compensation over the vesting period. Under the modified prospective transition method, the Company recognized compensation cost for the nine months ended September 30, 2006, which includes (1) period compensation cost related to share-based payments granted prior to, but not yet vested as of, January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123 and (2) compensation cost related to share-based payments granted within the period, which vested fully upon grant. In accordance with the modified prospective method, the Company has not restated prior period results. 13 ITEM2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- RESULTS OF OPERATIONS REVENUE Revenue for the three months ended September 30, 2006 was $4,412,931 compared to $6,452,246 for the same period last year, representing a decrease of $2,039,315 or 32%. For the nine months ended September 30, 2006, revenue decreased $7,110,639, or 37% to $11,900,141, compared to $19,010,780 for the same period last year. The decrease was due to fewer contract awards and releases in 2006 as compared to 2005, which resulted from the overall slowdown in the government contract award process and smaller than anticipated releases on our multiyear contracts during the 18 month period from February 2005 through August 2006. We generate revenue primarily from government contracts and to a lesser extent from one commercial contract. Revenue from government contracts for the nine months ended September 30, 2006 was $10,682,342 compared to $18,526,114 for the nine months ended September 30, 2005, a decrease of $7,843,772 or 42%. During the nine months ended September 30, 2006, we received new contract awards of $21,270,306. Included in this amount is approximately $6.7 million related to the C-5 TOP contract. Although the contract is valued at up to $215 million over the seven-year life of the program, orders under this program, including the $6.7 million award, have totaled only $13.5 million as of September 30, 2006. As of September 30, 2006, we had over $290 million in bids outstanding, representing approximately 25% of the 2005 solicitations and approximately 70% of the 2006 solicitations. We continue to make bids on contracts on a weekly basis. Although we are not actively pursuing commercial contract work, our one remaining commercial contract accounted for revenue of $1,217,799 for the nine months ended September 30, 2006 compared to $484,666 for the nine months ended September 30, 2005. 14 ITEM2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- GROSS PROFIT Gross profit for the three months ended September 30, 2006 was $761,546 compared to $1,682,990 for the three months ended September 30, 2005, a decrease of $921,444. As a percentage of revenue, gross profit for the three months ended September 30, 2006 was 17% compared to gross profit of 26% for the same period last year. For the nine months ended September 30, 2006, gross profit was $822,248, or 7% of revenue, compared with $5,247,740, or 28% of revenue for the first nine months of last year. The decrease in gross profit percentage was due to overtime and rework costs incurred to correct poor supplier workmanship and delays in deliveries by some of our suppliers. Additionally, as previously reported, we had maintained our overhead levels through June 2006 in anticipation of new awards and releases on contracts we had already been awarded. Since these awards and releases have not materialized to increase profitability, at the end of the second quarter, we reduced our staff by approximately 12%. These staff reductions, along with tighter control over other overhead costs, reduced factory overhead by approximately $60,000 in the three month period ended September 30, 2006 as compared to the three month period ended June 30, 2006. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses for the three months ended September 30, 2006 were $774,123 compared to $803,492 for the three months ended September 30, 2005, a decrease of $29,369, or 4%. This decrease was the result of tighter control over expenses during the three month period ended September 30, 2006. For the nine months ended September 30, 2006, selling, general and administrative expenses were $2,756,265 compared to $2,570,393 for the same period last year, an increase of $185,872, or 7%. This increase was primarily due to recording non-cash compensation of approximately $252,000 related to stock options as required pursuant to SFAS 123R as described in Note 2 of the Condensed Financial Statements, offset by decreases in officers' bonuses of approximately $44,000 and travel and entertainment of approximately $20,000. INCOME (LOSS) BEFORE PROVISION FOR (BENEFIT FROM) INCOME TAXES Loss before benefit from income taxes for the three months ended September 30, 2006 was $12,577 compared to income before provision for income taxes of $879,498 for the same period last year For the nine months ended September 30, 2006, loss before benefit from income taxes was $1,934,017 compared to income before provision for income taxes of $2,677,347 for the same period last year. The decrease was primarily due to the decrease in gross profit described above. PROVISION FOR (BENEFIT FROM) INCOME TAXES There was a benefit from income taxes of $657,000 for the nine months ended September 30, 2006, which was the result of a recovery of federal taxes paid in 2005 which are refundable through the filing of a net operating loss carryback claim. This compares to a provision for income taxes of $331,000 and $1,041,000 for the three and nine months ended September 30, 2005, respectively. 15 ITEM2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- NET INCOME (LOSS) As a result, basic net loss for the three months ended September 30, 2006 was $12,577, or $0 per basic share, compared to net income of $548,498, or $0.10 per basic share, for the same period last year. For the nine months ended September 30, 2006, basic net loss was $1,277,017, or $0.23 per basic share, compared with net income of $1,636,347, or $0.30 per basic share for the same period last year. Diluted earnings per share for the three months ended September 30, 2005 was $0.09, calculated utilizing 6,115,014 diluted average shares outstanding. Diluted income per share for the nine months ended September 30, 2005 was $0.27, calculated utilizing 6,120,977 diluted average shares outstanding. Incremental shares of 850,678 were not included in the diluted earnings per share calculation at September 30, 2006 because of the reported net loss, and accordingly their effect would be anti-dilutive LIQUIDITY AND CAPITAL RESOURCES General At September 30, 2006, we had working capital of $25,091,579 compared to $26,029,916 at December 31, 2005, a decrease of $938,337, or 4%. CASH FLOW A large portion of our cash is used in paying for materials and processing costs associated with contracts that are in process and which do not provide for progress payments. Additionally, contracts that permit us to bill on a progress basis must be classified as "on time" for us to apply for progress payments. Due to delays in deliveries from some of our suppliers, we are presently late on two of our contracts for which progress payments are available. Accordingly, we are precluded from applying for progress payments on these contracts. During the year ended December 31, 2005, we incurred approximately $2,358,000 of costs related to contracts in excess of the amounts that we were permitted to bill on such contracts. These costs are components of "Costs and estimated earnings in excess of billings on uncompleted contracts" on our balance sheet and represent the aggregate costs and related earnings for uncompleted contracts for which the customer has not yet been billed. These costs and earnings are recovered upon shipment of products and presentation of billings in accordance with contract terms. Because the POC method of accounting requires us to use estimates in determining revenues, costs and profits and in assigning the amounts to accounting periods, there can be a significant disparity between earnings (both for accounting and taxes) as reported and actual cash received by us during any reporting period. Accordingly, it is possible that we may have a shortfall in our cash flow and may need to borrow money until the reported earnings materialize into actual cash receipts. 16 ITEM2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- JP MORGAN CHASE CREDIT FACILITY In September 2003, we entered into a three year, $5.0 million revolving credit facility with JP Morgan Chase Bank ("Chase Facility"), secured by our assets. The facility specified interest rates ranging between the Prime Rate and 225 basis points over LIBOR, depending on certain terms and conditions. In October 2006, the Chase Facility was amended and restated to provide for a $1.0 million revolving credit facility, secured by our assets. The facility specifies an interest rate equal to the greater of (a) the prime rate and (b) the federal funds rate , plus 0.5%. The facility expires on December 31, 2006. As of September 30, 2006, we had borrowed $350,000 under the Chase Facility. We anticipate either extending the line or securing a new line of credit prior to its expiration. Although we are currently in the process of negotiating an extension to the line of credit, there is no assurance that an extension, or a new line of credit, can be secured on terms acceptable to us. We believe that our existing resources, together with the availability under our credit facility, will be sufficient to meet our current working capital needs for at least the next 12 months. CONTRACTUAL OBLIGATIONS The table below summarizes information about our contractual obligations as of September 30, 2006 and the effects these obligations are expected to have on our liquidity and cash flow in the future years. PAYMENTS DUE BY PERIOD ($) ------------------------------------------------------------- LESS THAN CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR 1-3 YEARS 4-5 YEARS AFTER 5 YEARS ----------------------------------- --------- --------- --------- --------- ------------- Short-Term Debt 350,000 350,000 -0- -0- -0- Long-Term Obligations 60,042 57,568 2,474 -0- -0- Operating Leases 3,634,267 394,941 825,781 876,071 1,537,474 Employment Agreement Compensation * 657,118 548,830 108,288 -0- -0- Total Contractual Cash Obligations 4,701,427 1,351,339 936,543 876,071 1,537,474 * The employment agreements provide for bonus payments that are excluded from these amounts. 17 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK None ITEM 4 - CONTROLS AND PROCEDURES An evaluation of the effectiveness of our disclosure controls and procedures was made as of September 30, 2006 under the supervision and with the participation of our management, including our chief executive officer and chief financial officer. During the first quarter of 2006, we remediated the material weakness identified by our independent registered public accounting firm and discussed in detail in our Annual Report on Form 10-K for the year ended December 31, 2005. This material weakness related to our internal failure to detect that (i) costs incurred, revenue recognized and billing to the customer on certain contracts during the year ended December 31, 2005 were not recognized properly due to an error made during our conversion from a manual accounting system to MAPICS, an enterprise-wide electronic processing system, and that (ii) there had been a misapplication of percentage of completion accounting with respect to our commercial contract. To remediate the material weakness, our senior management implemented a new procedure and began monitoring all costs and control total amounts generated through the MAPICS system and related to billings and expenses and cross checked such amounts to the general ledger and the applicable master job cost sheet. Senior management is continually monitoring the effectiveness of the remedial measures to ensure the effectiveness of our disclosure controls and procedures for future periods. With these remedial actions in place, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures were effective as of September 30, 2006 in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934. During the most recently completed fiscal quarter, except as described above, there has been no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 18 PART II: OTHER INFORMATION ITEM 1A: RISK FACTORS There are no material changes from the risk factors set forth in Item 1A, "Risk Factors," of our Annual Report on Form 10-K for the year ended December 31, 2005. Please refer to that section for disclosures regarding the risks and uncertainties to our business. ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES None ITEM 6 - EXHIBITS Exhibit 10.23 Amended and Restated Revolving Credit Agreement between the Company and JPMorgan Chase Bank N.A. Exhibit 10.24 Amended and Restated Revolving Credit Note made by the Company and payable to JPMorgan Chase Bank, N.A. Exhibit 10.25 Amended and Restated Security Agreement between the Company and JPMorgan Chase Bank, N.A. Exhibit 31.1 Section 302 Certification by Chief Executive Officer Exhibit 31.2 Section 302 Certification by Chief Financial Officer Exhibit 32 Section 906 Certification by Chief Executive Officer and Chief Financial Officer 19 SIGNATURES In accordance with the requirements of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CPI AEROSTRUCTURES, INC. Dated: November 14, 2006 By /S/ Edward J. Fred ------------------------------------- Edward J. Fred Chief Executive Officer, President, and Secretary Dated: November 14, 2006 By: /S/ Vincent Palazzolo ------------------------------------ Vincent Palazzolo Chief Financial Officer 20 EXHIBIT 31.1 SECTION 302 CERTIFICATION PURSUANT TO RULE 13a-14 AND 15d-14 UNDER THE SECURITIES ACT OF 1934, AS AMENDED I, Edward J. Fred, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of CPI Aerostructures, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the issuer as of, and for, the periods presented in this report; 4. The issuer's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the issuer and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the issuer, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) [intentionally omitted]; (c) Evaluated the effectiveness of the issuer's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the issuer's internal control over financial reporting that occurred during the issuer's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the issuer's internal control over financial reporting; and 5. The issuer's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the issuer's auditors and to the audit committee of the issuer's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the issuer's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the issuer's internal control over financial reporting. Date: November 14, 2006 By: /S/ Edward J. Fred ------------------------------------ Name: Edward J. Fred Title: Chief Executive Officer, President and Secretary 21 EXHIBIT 31.2 SECTION 302 CERTIFICATION PURSUANT TO RULE 13a-14 AND 15d-14 UNDER THE SECURITIES ACT OF 1934, AS AMENDED I, Vincent Palazzolo, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of CPI Aerostructures, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the issuer as of, and for, the periods presented in this report; 4. The issuer's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the issuer and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the issuer, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) [intentionally omitted]; (c) Evaluated the effectiveness of the issuer's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the issuer's internal control over financial reporting that occurred during the issuer's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the issuer's internal control over financial reporting; and 5. The issuer's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the issuer's auditors and to the audit committee of the issuer's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the issuer's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the issuer's internal control over financial reporting. Date: November 14, 2006 By: /S/ Vincent Palazzolo ------------------------------------ Name: Vincent Palazzolo Title: Chief Financial Officer 22 EXHIBIT 32 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of CPI Aerostructures, Inc. (the "Company") on Form 10-Q for the period ended September 30, 2006 as filed with the Securities and Exchange Commission (the "Report"), the undersigned, in the capacities and on the date indicated below, hereby certifies pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1. the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. the information contained in the Report fairly presents, in all material respects, the financial condition and results of operation of the Company. Dated: November 14, 2006 /S/ Edward J. Fred ---------------------------------------- Edward J. Fred Chief Executive Officer, President and Secretary Dated: November 14, 2006 /S/ Vincent Palazzolo ---------------------------------------- Vincent Palazzolo Chief Financial Officer 23