AIR INDUSTRIES GROUP 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION The following discussion of our financial condition and results of operations should be read in conjunction with our audited consolidated financial statements for the years ended December 31, 2021 and 2020 and the notes to those statements included elsewhere in this report. This discussion contains forward-looking statements that involve risks and uncertainties. You should specifically consider the various risk factors identified in this report that could cause actual results to differ materially from those anticipated in these forward-looking statements. Business Overview Air Industries Group is a holding company with three legal subsidiaries, AIM, NTW and SEC. SEC began manufacturing aircraft components in 1941 – over 80-years ago – for use in World War II. NTW was formed in the early 1960’s and AIM has been in business since 1971. We became a public company in 2005. We manufacture aerospace components primarily for the defense industry. Our Complex Machining Segment (“CMS”), which consists of AIM and NTW, manufactures structural parts and assemblies focusing on flight safety, including aircraft landing gear, arresting gear, engine mounts, flight controls, throttle quadrants, and other components. Our Turbine and Engine Component segment (“TEC”) segment consists of SEC which makes components and provides services for aircraft jet engines and ground-power turbines. Products of CMS are currently deployed on a wide range of high-profile military and commercial aircraft including the Sikorsky UH-60 Blackhawk, Lockheed Martin F-35 Joint Strike Fighter, Northrop Grumman E2D Hawkeye, the US Navy F-18 and USAF F-16 and F-15 fighter aircraft, CMS also makes a critical component for the Pratt & Whitney Geared TurboFan (“GTF”) aircraft engine used on commercial airliners. TEC makes products used in jet engines that are used on military and commercial aircraft including the USAF F-15 and F-16, the Airbus A-330 and the Boeing 777, and others, and in addition, a number of ground-power turbine applications. The aerospace market is highly competitive in both the defense and commercial sectors and we face intense competition in all areas of our business. Nearly all of our revenues are derived by producing products to customer specifications after being awarded a contract through a competitive bidding process. As the commercial aerospace and defense industries continue to consolidate and major contractors seek to streamline supply chains by buying more complete sub-assemblies from fewer suppliers, we have sought to remain competitive not only by providing cost-effective world class products and service but also by increasing our ability to produce more complex and complete assemblies for our customers. We are focused on maintaining profitability and positive cash flows from operating activities. We remain resolute on meeting customers’ needs. To take advantage of the long-term growth opportunities we see in our markets, we have made significant capital investments in new equipment in recent years. We believe these investments will increase the velocity and efficiency of production, increase the size of product we can make and allow us to offer additional services to our customers. Some of our investment expands our capabilities allowing us to internally process product that was previously outsourced to third party suppliers. We are pleased with the positive responses from our customers about these initiatives. Our ability to operate profitably and generate positive cash flows from operating activities is determined by our ability to win new or renewal contracts and fulfilling these contracts on a timely and cost effective basis. Winning a contract generally requires that we submit a bid containing fixed prices for the product or products covered by the contract for an agreed upon period of time, sometimes for five-years or longer. Thus, when submitting bids, we are required to estimate our future costs of production and, since we often rely upon subcontractors, the prices we can obtain from our subcontractors. While our revenues are largely determined by the number of contracts we are awarded, the volume of product delivered and price of product under each contract, our costs are determined by a number of factors. The principal factors impacting our costs are the cost of materials and supplies, labor, financing and the efficiency at which we can produce our products. The cost of materials used in the aerospace industry is highly volatile. In addition, the market for the skilled labor we require to operate our plants is highly competitive. The profit margin of the various products we sell varies based upon a number of factors, including the complexity of the product, the intensity of the competition for such product and, in some cases, the ability to deliver replacement parts on short notice. Thus, in assessing our performance from one period to another, a reader must understand that changes in profit margin can be the result of shifts in the mix of products sold. Our operations have a large percentage of fixed factory overhead. As a result, our profit margins are also highly variable with sales volumes as under-absorption of factory overhead decreases profits. 18 Our revenues are determined by orders from our customers, generally orders – which we call releases – against LTA’s with those customers. These long-term agreements generally have fixed prices for product, though over the term of a LTA prices often increase. Our direct costs of production include costs for material, labor, and factory overhead; all of these costs may vary based on the efficiency of our factory operations. Our gross profit is highly variable due to the mix of products sold, and by sales volume, which can lead to the over absorption or under absorption of factory overhead costs. Beyond these direct costs of production, we incur general and administrative costs termed Operating Expenses and financing costs for borrowed money, income taxes and miscellaneous income and expense. A very large percentage of the products we produce are used on military as opposed to civilian aircraft. These products can be replacements for aircraft already in the fleet of the armed services or for the production of new aircraft. Reductions to the Defense Department budget and decreased usage of aircraft reduces the demand for both new production and replacement spares and could adversely impact our business and our revenue. Segment Data In this report, we follow Financial Accounting Standards Board (“FASB”) ASC 280, “Segment Reporting” (“ASC 280”), which establishes standards for reporting information about operating segments in annual and interim financial statements, ASC 280 requires that companies report financial and descriptive information about their reportable segments based on a management approach. ASC 280 also establishes standards for related disclosures about products and services, geographic areas and major customers. Historically we have operated our businesses and reported their results as two separate segments with AIM and NTW comprising our CMS segment and SEC as the TEC segment. Our CMS segment specializes in flight critical components including flight controls and landing gear. Our TEC segment focuses on manufacturing components for jet engines. Each segment having different customers. The accounting policies of our segments are the same as those described in the Summary of Significant Accounting Policies. We evaluate performance based on revenue, gross profit contribution and assets employed. In recent years we integrated and consolidated the business of AIM and NTW into one facility on Long Island and the operations of our CMS and TEC segments have become increasingly integrated. We also made significant capital expenditures and all of our operations now share the same manufacturing facilities and use most, if not all, of the same sales and marketing functions. We made these changes to take advantage of the long-term growth opportunities we see in the A&D market. In early fiscal 2022, we further changed our management approach and will now make decisions about resources to be allocated and assessing performance based on one integrated business rather than two reporting segments. As such, effective with our first quarter ending March 31, 2022, we will present our operations as one reportable operating segment. 19 RESULTS OF OPERATIONS-CONTINUING OPERATIONS Years ended December 31, 2021 and 2020: For purposes of the following discussion of our selected financial information and operating results, we have presented our financial information based on our continuing operations unless otherwise noted. Selected Financial Information: 2021 2020 Net sales $ 58,939,000 $ 50,097,000 Cost of sales 48,686,000 43,585,000 Gross profit 10,253,000 6,512,000 Operating expenses and interest and financing costs 9,031,000 9,442,000 Other income, net 405,000 430,000 Forgiveness of notes payable - SBA Loan - 2,414,000 Benefit from income taxes - (1,412,000 ) Income from continuing operations $ 1,627,000 $ 1,326,000 Balance Sheet Data: December 31, December 31, 2021 2020 Cash and cash equivalents $ 627,000 $ 2,505,000 Working capital $ 17,478,000 $ 16,284,000 Total assets $ 53,425,000 $ 57,777,000 Total stockholders’ equity $ 17,389,000 $ 15,109,000 20 The following sets forth the results of operations for each of our segments individually and on a consolidated basis for the periods indicated: Year Ended December 31, 2021 2020 COMPLEX MACHINING Net Sales $ 52,921,000 $ 44,659,000 Gross Profit 9,780,000 6,493,000 Income before benefit from income taxes 7,146,000 4,965,000 Assets 49,691,000 51,368,000 TURBINE ENGINE COMPONENTS Net Sales 6,018,000 5,438,000 Gross Profit 473,000 19,000 Loss before benefit from income taxes (229,000 ) (31,000 ) Assets 3,275,000 3,899,000 CORPORATE Net Sales - - Gross Profit - - Loss before benefit from income taxes (5,290,000 ) (5,020,000 ) Assets 459,000 2,510,000 CONSOLIDATED Net Sales 58,939,000 50,097,000 Gross Profit 10,253,000 6,512,000 Income (Loss) before benefit from income taxes 1,627,000 (86,000 ) Benefit from Income Taxes - (1,412,000 ) Loss from Discontinued Operations, net of taxes - (230,000 ) Net Income 1,627,000 1,096,000 Assets $ 53,425,000 $ 57,777,000 Net Sales: Consolidated net sales for the year ended December 31, 2021 were $58,939,000, an increase of $8,842,000, or 17.6%, compared with $50,097,000 for the year ended December 31, 2020. Net sales of CMS were $52,921,000, an increase of $8,262,000, or 18.5%, from $44,659,000 in the prior year. Net sales in our TEC segment were $6,018,000, an increase of $580,000 or 10.7%, compared with $5,438,000 for the year ended December 31, 2020. The increase was directly attributable to shipping product that had remained in Work In Process at the end of 2020 due certain subcontractors who were severely impacted by COVID-19 and our ability to increase production and return to pre-COVID-19 business environment. 21 As indicated in the table below, three customers represented 75.4% and 73.9% of total sales for the years ended December 31, 2021 and 2020, respectively. Customer Percentage of Sales 2021 2020 Goodrich Landing Gear Systems 37.2 % 30.4 % Sikorsky Aircraft 25.7 % 30.3 % United States Department of Defense 12.5 % 13.2 % As indicated in the table below, three customers represented 74.7% and 80.3% of gross accounts receivable at December 31, 2021 and 2020, respectively. Customer Percentage of Receivables 2021 2020 Goodrich Landing Gear Systems 50.3 % 57.1 % Rohr 12.7 % 11.2 % United States Department of Defense 11.7 % 12.0 % Gross Profit: Consolidated gross profit from operations for the year ended December 31, 2021 was $10,253,000, an increase of $3,741,000, or 57.4%, as compared to gross profit of $6,512,000 for the year ended December 31, 2020. Consolidated gross profit as a percentage of sales was 17.4% and 13.0% for the years ended December 31, 2021 and 2020, respectively. These increases were directly attributable to a better mix of products that were shipped during 2021, and the end of an LTA, where our costs were equal to the sales price of the item. Operating Expenses Consolidated operating expenses were $7,766,000 and $7,951,000 for fiscal 2021 and 2020, respectively, representing a decrease of $185,000 or 2.3%. Operating expenses declined due to a bad debt expense in 2020 that was partially recovered in 2021. Absent this, operating expenses increased by $345,000 or 4.6%. As a percentage of consolidated net sales, operating expenses were 13.2% and 15.8% for fiscal 2021 and 2020, respectively. Interest and Financing Costs Our interest and financing costs for the year ended December 31, 2021 totaled $1,265,000, a decrease of $226,000 or 15.2% from $1,491,000 in 2020, as a result of lower balances on our Loan Facility at the end of 2021. Income from Continuing Operations, Net of Taxes Income from continuing operations, net of tax for the year ended December 31, 2021 was $1,627,000, an improvement of $301,000 compared to $1,326,000 for the year ended December 31, 2020. Included in income from continuing operations for 2020 was the forgiveness of the Paycheck Protection Program (“PPP”) loans in the amount of $2,414,000 and $1,416,000 resulting from a tax refund from tax law changes enacted in the CARES Act. Net Income Net income for the year ended December 31, 2021 was $1,627,000, an improvement of $531,000, compared to $1,096,000 for the year ended December 31, 2020, for the reasons discussed above. 22 LIQUIDITY AND CAPITAL RESOURCES During fiscal 2020, we took advantage of a number of U.S. government programs to improve our liquidity to offset the negative impact to our business from COVID-19. These steps include: 1) Received PPP Loans from the SBA – In May 2020, our three operating subsidiaries entered into government subsidized loans with Webster Bank (F/K/A Sterling National Bank) (“Webster”) in an aggregate principal amount of approximately $2,414,000 (“SBA Loans”). In accordance with U.S. government regulations we applied for forgiveness of each Loan in full. In December 2020, we received final approval from the SBA that our SBA Loans which approximated $2,414,000 plus accrued interest had been forgiven. 2) Deferred Certain Tax Payments – In accordance with Section 2302 of the CARES Act, we elected to defer the deposit and payment of the employer’s portion of Social Security taxes. These deferred amounts must be repaid 50% on December 31, 2021 with the remaining 50% on December 31, 2022. In December 2021 we made the first required deposit and payment of the employer’s portion of our deferred Social Security taxes. The second of these required payments will be made during December 2022. As of December 31, 2021, we continue to defer $314,000, which is classified as Deferred payroll tax liability – CARES Act in the accompanying Consolidated Balance Sheets. 3) Received a Net Operating Loss Refund – Pursuant to the CARES Act, we filed a net operating loss carryback claim for $1,416,000, which was received during the second quarter of 2020. Also, the U.S. Department of Defense has, to date, taken steps to increase the rate for certain progress payments from 80 percent to 90 percent for costs incurred and worked performed on certain contracts. In addition to taking advantage of the aforementioned U.S. government programs, we took additional significant steps to improve our liquidity, including: 1) Entered into a Lower Cost Financing Facility – On December 31, 2019, we entered into a new loan facility (“Webster Facility”) with Webster which originally was set to expire on December 30, 2022. The Webster Facility initially provided for a $16,000,000 revolving loan (“Webster revolving line of credit”) and a term loan (“Webster term loan”). The formula to determine the amounts of revolving advances permitted to be borrowed under the Webster Facility is based on a percentage of eligible receivables and inventory (as defined). On June 14, 2021, we entered into the Second Amendment to the Loan and Security Agreement (“Second Amendment”). The purpose of the Second Amendment was to clarify the definition and calculation of Excess Cash Flow, and to confirm the extension of the due date for the payment of the Excess Cash Flow. On December 7, 2021, we entered in the Third Amendment to the Loan and Security Agreement (“Third Amendment”). The purpose of the amendment was to extend the maturity date of both the Webster revolving line of credit and the Webster term loan by three years, from December 30, 2022 to December 30, 2025. Additionally, the Webster revolving line of credit was increased to $20,000,000 from $16,000,000 and the inventory sublimit for the Webster revolving line of credit was increased to $14,000,000 from $11,000,000. Under the terms of the Third Amendment, we are now allowed, subject to certain limitations, to begin amortizing a portion of our subordinated debt. The terms of the Webster Facility require that, among other things, we maintain a specified Fixed Charge Coverage Ratio of 1.25 to 1.00 at the end of each Fiscal Quarter. In addition, we are limited in the amount of Capital Expenditures we can make. As of December 31, 2021, we were in compliance with all loan covenants. The Webster Facility also restricts the amount of dividends we may pay to our stockholders. Substantially all of our assets are pledged as collateral under the Webster Facility. 23 In addition, for so long as the Webster term loan remains outstanding, if Excess Cash Flow (as defined) is a positive number for any fiscal year, beginning with the year ending December 31, 2020, we shall pay to Webster an amount equal to the lesser of (i) twenty-five percent (25%) of the Excess Cash Flow for such Fiscal Year and (ii) the outstanding principal balance of the term loan. Such payment shall be made to Webster and applied to the outstanding principal balance of the term loan, on or prior to the April 15 immediately following such Fiscal Year. The amount of the Excess Cash Flow for the year ended December 31, 2021 was calculated to be $787,000. This is scheduled to be paid on or about April 15, 2022 per the terms of the Webster Facility. As of December 31, 2021, our debt to Webster in the amount of $16,648,000 consisted of the Webster revolving line of credit note in the amount of $12,456,000 and the Webster term loan in the amount of $4,192,000. 2) Increased Term Loan to modernize equipment - On November 6, 2020, we entered into the First Amendment to Loan and Security Agreement, increasing the Term Loan to $5,685,000. This allowed us to finance the acquisition of the new equipment at what we believe to be a reasonable interest rate. The repayment terms of the term loan were amended to provide monthly principal installments in the amount of $67,679 beginning on December 1, 2020, with a final payment of any unpaid balance of principal and interest payable on December 30, 2022. We paid an amendment fee of $20,000. We are currently in early discussions with Webster Bank to further expand our Term Loan to support the acquisition of additional equipment. We anticipate that this additional financing will occur in the second quarter of 2022. We anticipate spending an additional $1,750,000 to $2,500,000 during 2022 to continue to acquire new equipment. 3) Conversion and Extension of Subordinated Notes – During 2020, third party holders of convertible subordinated notes of the remaining principal balance plus accrued interest, converted these notes into common stock. In addition, the maturity date of related party convertible subordinated notes and subordinated notes payable in the aggregate amount of $6,012,000 plus $400,000 of accrued interest was extended until July 1, 2023, and we were relieved of the obligation to make any principal payments on these notes prior to maturity. During December 2021, in accordance with the extension of the due date of the Webster Facility, these notes were further extended to July 1, 2026. In addition to our loan with Webster and Subordinated Notes, we have various equipment leases and contractual obligations of an ongoing nature which we service in the ordinary course out of our cash flow from operations. Substantially all of these obligations are described in the notes to our financial statements included in this report. Because we believe our fiscal 2022 sales will be in line with the amount achieved in fiscal 2021, we believe our liquidity in 2022 will continue to improve. Nevertheless, our liquidity may be adversely impacted by various risks and uncertainties, including, but not limited to future and current impacts of global events such as COVID-19 and the war in the Ukraine, increases in inflation, disruptions in the labor market and other risks detailed in Part1, Item 1A of this Annual Report. Changes in our cash flow during fiscal 2021 are discussed further below. Cash Flow The following table summarizes our net cash flow from operating, investing and financing activities for the periods indicated (in thousands): Year Ended December 31, 2021 2020 Cash provided by (used in) Operating activities $ 4,064 $ (1,525 ) Investing activities (1,364 ) (3,797 ) Financing activities (4,578 ) 6,533 Net (decrease) increase in cash and cash equivalents $ (1,878 ) $ 1,211 The above cash flows include the cash flows from our continuing and discontinued operations. 24 Cash Provided By Operating Activities Cash provided by or used in operating activities reflects our net income adjusted for certain non-cash items and changes to working capital items. For the year ended December 31, 2021, net income of $1,627,000 and $3,746,000 of non-cash items, consisting primarily of employee and directors stock based compensation of $653,000, amortization of right-of-use assets of $492,000, depreciation of property and equipment of $2,803,000 were partially offset by non-cash other income recognized in the amount of $326,000. Operating assets and liabilities used cash in the net amount of $1,309,000, consisting primarily of the net increases in accounts receivable and deposits and other assets of $1,589,000 and $193,000, respectively, and net decreases in accounts payable, operating lease liabilities and deferred payroll tax expense-CARES ACT in the amounts of $1,594,000, $701,000 and $313,000, which were partially offset primarily by a decrease in inventory and an increase in deferred revenue in the amounts of $2,588,000 and $553,000, respectively. Cash Used In Investing Activities Cash used in investing activities consists of cash used for capital expenditures for property and equipment. For the year ended December 31, 2021, cash used in investing activities was $1,364,000. Primarily this was for the purchase of state of the art machinery installed at our Bay Shore facility. The purchase of state of the art machinery installed at our Bay Shore facility allowed us to relocate machinery from our Bay Shore to our Connecticut facility. Cash Used In Financing Activities Cash used in financing activities consists of the borrowings and repayments under our credit facilities with our senior lender, Webster, increases in and repayments of finance lease obligations and other notes payable. For the year ended December 31, 2021, cash used in financing activities was $4,578,000. This was comprised of repayments of $3,193,000 on our Webster revolving loan, $1,371,000 on our Webster term loan, $9,000 on our financed lease obligations and $5,000 on our financed asset note payable. 25 CONTRACTUAL OBLIGATIONS The following table sets forth our future contractual obligations as of December 31, 2021 (in thousands): Payment due by period Less than More than Total 1 year 1-3 years 3-5 years 5 years Debt and Finance Leases $ 23,390 $ 14,122 $ 1,758 $ 7,510 $ - Operating Leases $ 4,837 $ 1,007 $ 2,108 $ 1,722 $ - Total $ 28,227 $ 15,129 $ 3,866 $ 9,232 $ - Critical Accounting Policies and Estimates A critical accounting policy is one that is both important to the portrayal of a company’s financial condition and results of operations and requires management’s most difficult, subjective or complex judgements, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our consolidated financial statements are presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). All applicable U.S. GAAP accounting standards effective as of December 31, 2021 have been taken into consideration in preparing the consolidated financial statements. The preparation of consolidated financial statements requires estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. Some of those estimates are subjective and complex, and consequently, actual results could differ from those estimates. The following accounting policies and estimates have been highlighted as significant because changes to certain judgements and assumptions inherent in these policies could affect our consolidated financial statements: ● Going Concern ● Inventory Valuation ● Revenue Recognition ● Income Taxes ● Stock-Based Compensation ● Goodwill See Note 3 of the notes to our consolidated financial statements included in this Annual Report on Form 10-K for a description of our significant accounting policies. 26 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK . No disclosure is required in response to this Item. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Financial Statements The financial statements required by this item begin on page F-1 hereof. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.