ACCOUNTING POLICIES

Principles of Consolidation

The Consolidated Financial Statements included in this report have been prepared by management of LMI Aerospace, Inc. All significant intercompany balances and transactions have been eliminated in consolidation.

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.

Revenue and Profit Recognition

Except as described below, the Company recognizes revenue for sales of products and related services in accordance with Financial Accounting Standards Board, (“FASB”) Accounting Standards Codification (“ASC”) Topic 605-15 Products and Topic 605-20 Services. The Company sells products under long term supply contracts and purchase orders where the product is built to the customer specifications based on firm purchase orders from the customer. The purchase orders tend to be of a relatively short duration and customers place orders on a periodic basis. The pricing is generally fixed for some length of time and the quantities are based on individual purchase orders. Revenue is recognized when title passes and services are rendered, the price is fixed or determinable, and collection is reasonably assured. Approximately 80.0% to 90.0% of the total revenue the Company recognized in any given quarter is accounted for in accordance with Topics 15 and 20. The remainder of the revenue is accounted for using methods consistent with ASC Topic 605-35 Construction-Type and Production-Type Contracts.

The percentage of completion method used to account for contracts depends on the nature of the products provided under the contract. For example, for contracts that require us to perform a significant level of development effort, in comparison to the total value of the contract, sales are recorded using the cost to cost method to measure progress toward completion. Under the cost to cost method of accounting, we recognize sales and estimated profit as costs are incurred based on the proportion that the incurred costs bare compared to total estimated costs. For contracts that require us to provide a substantial number of similar items without a significant level of development, we record sales and estimated profit on a percentage of completion basis using units of delivery as the basis to measure progress toward completing the contract. Under both methods, profit recognized is based on the total expected profit margin percentage multiplied by revenue recognized to date.

The Company periodically reviews all estimates to complete as required by the authoritative guidance and the estimated total cost and expected gross profit are revised as required over the life of the contract. Any revisions to the estimated total cost are accounted for as a change of an estimate. A cumulative catch-up adjustment is recorded in the period of the change of the estimated costs to complete the contract.

In addition, should total estimated costs at completion exceed the estimated total revenue, the anticipated full loss is recognized in the period in which the anticipated loss is determined. The loss is reported as a component of cost of sales. The Company does not have any cost to cost contracts with an anticipated loss. The Company does have a contract being accounted for using the units of delivery method which was acquired during the Valent acquisition and where estimated costs exceed the total contract revenue. The provision for anticipated loss was established in 2013 for $5,267 and was treated as a measurement period change and as such increased the goodwill related to the Valent acquisition.

Cumulative catch-up adjustments had the following impact to operating income in the years presented:




	2013		2012		2011

Favorable adjustments	106		587		492
Unfavorable adjustments	(1,609	)	(519	)	(779	)
Net operating income adjustments	(1,503	)	68		(287	)

The negative cumulative catch-up adjustments in 2013 relate primarily to two contracts. The first contract relates to a design program on the 787 platform on which the Company was unable to pass through as much of the engineering changes incurred to the customer as originally estimated. The Company recorded a reduction of contact revenue of $811 for this program in 2013. The Company continues to pursue claims related to this contract but has not estimated a recovery in the estimate at completion. The total revenue recognized on this program at December 31, 2013 was $13,397. The second contract relates to part production for the Embraer KC-390 program. In 2013, an adjustment of $706 was recorded to reflect a revision in the expected labor hours necessary to complete the program. Total revenue recognized on the program at December 31, 2013 was $17,131.

For contracts accounted for using the percentage of completion method, management’s estimates of total units to be produced, and material, labor and overhead costs on long-term contracts are critical to the Company. Due to the size, length of time and nature of many of our contracts, the estimation of revenue and costs through completion is complicated and subject to many variables. Claims and unpriced change orders will impact the estimate of total revenues and profits. In the ordinary course of business, the Company may receive requests from its customers to perform tasks not specified in its contracts. When this occurs on a long-term contract using the cost-to-cost method of percentage of completion accounting, the Company may record revenue for claims or unpriced change orders to be negotiated with customers. Approximately 0.5% of the Company's revenue recognized in 2013 represented amounts associated with claims and unpriced change orders. Total contract cost estimates are largely based our current cost of production, purchase order terms negotiated or estimated by our supply chain.

The development of a contract revenue and gross margin percentage involves utilization of detailed procedures by a team of operational and financial personnel that provides information on the status of the contracts. Estimates of revenue and costs associated with each significant contract are reviewed and approved by the team on a quarterly basis.

Due to the significance of the judgment in the estimation process described above, it is possible that materially different margins could be recorded if we used different assumptions or if the underlying circumstances were to change.

Pre-Contract and Pre-Production Costs under Long-Term Supply Contracts

In certain circumstances, the Company capitalizes costs incurred prior to the execution of a contract with the customer. These circumstances are limited to instances in which the Company has substantially negotiated the terms and conditions of the anticipated contract with its customers and concluded that their recoverability from the anticipated contract is probable. As these costs are directly associated with a specific anticipated contract and they are concluded to be recoverable under that anticipated contract, the Company has capitalized these amounts.

The Company may incur design and development costs prior to the production phase of contracts that are outside the scope of the contract accounting method. These pre-production costs are generally related to costs the Company incurs to design and build tooling that is owned by the customer and design and engineering services. The Company receives the non-cancellable right to use these tools to build the parts as specified in a contractual agreement and therefore has capitalized these costs. In certain instances, the Company enters into agreements with its customers that provide it a contractual guarantee for reimbursement of design and engineering services incurred prior to the production phase of a contract. Due to the contractual guarantee, the Company capitalizes the costs of these services. The pre-production costs are amortized to cost of sales over the shorter of the life of the contractual agreement or the related tooling.

Cash and Cash Equivalents

Cash and cash equivalents include cash on hand, deposits in transit and all highly liquid investment instruments with an initial maturity of three months or less.

Inventories

The Company’s inventories are stated at the lower of cost or market and utilize actual costs for raw materials and an average cost for work in process, manufactured and purchased components and finished goods. The Company evaluates the inventory carrying value and reduces the carrying costs based on customer activity, estimated future demand, price deterioration, and other relevant information. The Company’s customer demand is unpredictable and may fluctuate due to factors beyond the Company’s control. In addition, inventoried costs include capitalized contract costs relating to programs and contracts with long-term production cycles, a portion of which is not expected to be realized within one year. See further discussion regarding deferred long-term contract costs under “Revenue and Profit Recognition” and “Pre-Contract and Pre-Production Costs under Long-Term Supply Contracts.”

Allowance for Doubtful Accounts

The allowance for doubtful accounts receivable reflects the Company’s best estimate of probable losses inherent in its accounts receivable. The basis used to determine this value is derived from historical experience, specific allowances for known troubled customers and other known information.

Property, Plant and Equipment

Property, plant and equipment are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives of the related assets. Leasehold improvements are amortized using the straight-line method over the shorter of the lease term or the estimated useful lives of the assets. Estimated useful lives for buildings, machinery and equipment, and purchased software are 20 to 35 years, 4 to 10 years and 3 to 4 years, respectively. Amortization incurred under capital leases is reported with depreciation expense.

Long Lived Assets

Long lived assets held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable.

Goodwill and Intangible Assets

The Company’s acquisitions involve the purchase of tangible and intangible assets and the assumption of certain liabilities. As part of the purchase price allocation, the Company allocates the purchase price to the tangible assets acquired and liabilities assumed based on estimated fair market values, and the remainder of the purchase price is allocated to intangibles and goodwill. Goodwill and intangible assets with indefinite lives are not amortized but are subject to an impairment assessment at least annually in relation to their fair value. Under guidelines established by FASB ASC Topic 280, the Company operates in two operating segments. However, the Company has recorded its goodwill and conducts testing for potential goodwill impairment at a reporting unit level. The reporting units represent a business for which discrete financial information is available, and segment management regularly reviews the operating results. As part of this process, the Company first assesses qualitatively whether it is necessary to perform the quantitative test. The qualitative assessment involves evaluating relevant events or circumstances to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If it is, the Company can bypass the quantitative assessment of goodwill. If it is not, or if the Company has elected to bypass the qualitative assessment process, the quantitative assessment of goodwill utilizes a two-step process, where the carrying value of the reporting unit is compared to its fair value. If the carrying value is less than the fair value, no impairment exists, and the second step is not performed. However, if the carrying value is greater than the fair value, the second step is performed. An impairment charge would be recognized for the amount that the carrying value of the goodwill exceeds its fair value. The fair values for goodwill testing are estimated using a combination of the income and market approach unless circumstances indicate that a better estimate of fair value is available. The income approach utilizes the discounted cash flow model (“DCF model”) and the market approach is based on the market data for a group of guideline companies.

Deferred Gain on Sale of Real Estate

On December 28, 2006, the Company entered into an agreement with a third party to sell and lease back certain of its real estate properties for $10,250. The amount of the sale price in excess of book value for these properties of $4,242 was deferred and is being amortized over the 18 year term of the leases on a straight-line basis.

Share-Based Compensation

The Company recognizes compensation expense for share-based payment transactions in the financial statements at their fair value. The expense is measured at the grant date, based on the calculated fair value of the share-based award, and is recognized over the requisite service period (generally the vesting period of the equity award).

Income Taxes

Provisions for federal and state income taxes are calculated on reported net income before income taxes based on current tax law and also include, in the current period, the cumulative effect of any changes in tax rates from those used previously in determining deferred tax assets and liabilities. Such provisions differ from the amounts currently receivable or payable because certain items of income and expense are recognized in different time periods for financial reporting purposes than for income tax purposes. Significant judgment is required in determining income tax provisions and evaluating tax positions.

A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. When determining the amount of net deferred tax assets that are more likely than not to be realized, Management assesses all available positive and negative evidence. This evidence includes, but is not limited to, prior earnings history, expected future earnings, carry-back and carry-forward periods and the feasibility of ongoing tax strategies that could potentially enhance the likelihood of the realization of a deferred tax asset. The weight given to the positive and negative evidence is commensurate with the extent the evidence may be objectively verified. As such, it is generally difficult for positive evidence regarding projected future taxable income exclusive of reversing taxable temporary differences to outweigh objective negative evidence of recent financial reporting losses.

Based on these criteria and the relative weighting of both the positive and negative evidence available, and in particular the activity surrounding the Company's significant loss in 2013, management determined that it was necessary to establish a valuation allowance against all of its net U.S. deferred tax assets at December 31, 2013. This determination was made as the Company entered into a cumulative loss position over the three year period ended December 31, 2013 primarily due to the recording a goodwill impairment of $73,528 related to Valent. Once the Company entered into a cumulative loss position it has passed the threshold after which there is a presumption that a company should no longer rely solely on projected future income in determining whether the deferred tax asset is more likely than not to be realized. The Company will continue to monitor its deferred tax position and may adjust the valuation allowance, if necessary, for utilization of the underlying deferred tax assets through current taxable income or as available evidence changes.

The accounting for uncertainty in income taxes requires a more-likely-than-not threshold for financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. The Company records a liability for the difference between the benefit recognized and measured for financial statement purposes and the tax position taken or expected to be taken on our tax return. To the extent that management’s assessment of such tax positions changes, the change in estimate is recorded in the period in which the determination is made.

The Company’s unrecognized tax benefits as of December 31, 2013 and 2012 are immaterial. The Company expects no significant increases or decreases in unrecognized tax benefits due to changes in tax positions within one year of December 31, 2013. The Company has no material interest or penalties relating to income taxes recognized on the Consolidated Balance Sheet as of December 31, 2013 and 2012. As of December 31, 2013, returns for calendar years 2010 through 2012 remain subject to examination by the Internal Revenue Service and/or various state tax jurisdictions.

Financial Instruments

Fair values of the Company’s long-term obligations approximate their carrying values as the applicable interest rates approximate the current market rates or have variable rate characteristics. The Company’s other financial instruments have fair values that approximate their respective carrying values due to their short maturities.

Reclassifications

Certain reclassifications have been made to prior period financial statements in order to conform to current period presentation.

Recent Accounting Pronouncements

In March 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2013-5, "Foreign Currency Matters". The amendments in ASU 2013-5 resolve the diversity in practice about whether current literature applies to the release of the cumulative translation adjustment into net income when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business within a foreign entity. In addition, the amendments in ASU 2013-5 resolve the diversity in practice for the treatment of business combinations achieved in stages (sometimes also referred to as step acquisitions) involving a foreign entity. ASU 2013-5 is effective prospectively for fiscal years, and interim reporting periods within those years, beginning after December 15, 2013. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial statements.

In July 2013, FASB issued ASU 2013-10, “Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes”, which amends the current accounting requirements in Topic 815 “Derivatives and Hedging”. Before the amendments in this update, only interest rates on direct Treasury obligations of the U.S. government (“UST”) and, for practical reasons, the London Interbank Offered Rate (“LIBOR”) swap rate were considered benchmark interest rates in the United States. Due the increased importance of OIS (“Overnight Index Swap Rate” or also referred to as the “Fed Funds Effective Swap Rate”), the objective of this update is to provide for the inclusion of OIS as a U.S. benchmark interest rate for hedge accounting purposes, in addition to UST and LIBOR. This amendment became effective for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.

In July 2013, FASB issued ASU 2013-11, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists”. ASU 2013-11 requires entities to net its liability for unrecognized tax positions against a net operating loss carryforward, a similar tax loss or a tax credit carryforward when settlement in this manner is available under the tax law. The provisions of this new guidance are effective as of the beginning of the Company’s first quarter of 2014. The adoption of this standard is not expected to have a material impact on the Company's consolidated financial statements.