AIR INDUSTRIES GROUP 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of our financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and notes to those statements included elsewhere in this Form 10-Q and with the audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K, for the year ended December 31, 2021 (the “2021 Form 10-K”). This discussion contains forward-looking statements that involve risks and uncertainties. You should specifically consider the various risk factors identified in this report and in our 2021 Form 10-K 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, Air Industries Machining Corp. (“AIM”), Nassau Tool Works, Inc. (“NTW”) and the Sterling Engineering Company (“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. AIM and NTW, manufacture structural parts and assemblies focusing on flight safety, including aircraft landing gear, arresting gear, engine mounts, flight controls, throttle quadrants, and other components. SEC makes components and provides services for aircraft jet engines and ground-power turbines. Products of AIM and NTW 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. They also make a critical component for the Pratt & Whitney Geared TurboFan (“GTF”) aircraft engine used on commercial airliners. SEC 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 investments expand our capabilities allowing us to internally process product that was previously outsourced to third party processors. 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, with negotiated increases to reflect a portion of the impact of inflation. 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. The invasion of Ukraine by the Russian Federation and retaliatory measures imposed by the United States, United Kingdom, the European Union and other countries, and the responses of Russia to such measures, have negatively impacted the availability of certain minerals, such as titanium, for which Russia was a source of supply. We are working with our larger customers, some of which have access to sources of metals necessary to manufacture their products not readily available to us or other companies of our size. Nevertheless, there can be no assurance that disruptions in the markets for metals will not adversely impact our ability to timely meet the needs of our customers. 20 In addition, the market for the skilled labor we require to operate our plants is highly competitive. Changes in the available pool of labor caused by Covid-19 have not materially adversely impacted our ability to meet our production schedules. Nevertheless, as we seek to grow our business, there can be no assurance that the skilled labor we need to operate our machinery will be available to us or that the costs incurred to maintain our current labor force and those we seek to bring on will not increase. 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. Our revenues are principally determined by orders from our customers for the delivery of product – which we call releases – against LTA’s with those customers. These long-term agreements generally have fixed prices for product with negotiated increases to reflect a portion of the impact of inflation, though over the term of a LTA prices often increase and not all of the increase is covered by agreed upon price protection clauses in our agreements. 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. RESULTS OF OPERATIONS Selected Financial Information: Three Months Ended Nine Months Ended September 30, September 30, September 30, September 30, 2022 2021 2022 2021 Net sales $ 13,278,000 $ 14,354,000 $ 39,348,000 $ 43,519,000 Cost of sales 11,036,000 12,340,000 32,606,000 37,105,000 Gross profit 2,242,000 2,014,000 6,742,000 6,414,000 Operating expenses and interest and financing costs 2,396,000 2,168,000 7,051,000 6,731,000 Other income, net 12,000 88,000 132,000 338,000 Net (loss) income $ (142,000 ) $ (66,000 ) $ (177,000 ) $ 21,000 21 Balance Sheet Data: September 30, December 31, 2022 2021 Cash $ 192,000 $ 627,000 Working capital $ 18,337,000 $ 17,478,000 Total assets $ 54,778,000 $ 53,425,000 Total stockholders’ equity $ 17,636,000 $ 17,389,000 Results of Operations for the three months ended September 30, 2022 Net Sales: Consolidated net sales for the three months ended September 30, 2022 were $13,278,000, a decrease of $1,076,000, or 7.5%, compared with $14,354,000 for the three months ended September 30, 2021. The decrease in sales resulted principally from the sale of products with lower selling prices during the quarter. As indicated in the table below, two customers represented 63.9% and 67.7% of total sales for the three months ended September 30, 2022 and September 30, 2021, respectively. Customer Percentage of Sales 2022 2021 Goodrich Landing Gear Systems 40.7 % 41.6 % Sikorsky Aircraft 23.2 % 26.1 % Gross Profit: Consolidated gross profit from operations for the three months ended September 30, 2022 was $2,242,000, an increase of $228,000, or 11.3%, as compared to gross profit of $2,014,000 for the three months ended September 30, 2021. Consolidated gross profit as a percentage of sales was 16.9% and 14.0% for the three months ended September 30, 2022 and 2021, respectively. For interim periods, substantially all of the inventory value has been estimated using a gross profit percentage based on the annual gross profit percentage of the immediately preceding year. Inventory value and gross profit margin for 2021 was estimated using the gross profit margin percentage in 2020. Gross profit margins in 2020 were negatively impacted by Covid-19 and therefore impacted the estimated gross profit margins applied to the 2021 interim periods. Actual gross profit margins returned to historical levels in 2021 and this higher gross profit margin have been used to calculate the gross profit margins for the interim periods for 2022. Operating Expense Consolidated operating expenses for the three months ended September 30, 2022 totaled $2,073,000 and increased by $239,000 or 13.0% compared to $1,837,000 for the three months ended September 30, 2021. The increase was caused by increases in employment costs, including employee health benefits increases which were not passed on to employees, increases in investor relations and increased travel costs resulting from the resumption of travel to customers as Covid restrictions eased. These increased costs were partially offset by reductions in expenses related to information technology and the recovery of bad debt. Interest and Financing Costs Interest and financing costs for the three months ended September 30, 2022 were $323,000 a decrease of $8,000 or 2.4% compared to $331,000 for the three months ended September 30, 2021. The primary reason for this was lower balances on our debt with Webster Bank. The average interest rate charged was 4.70% and 3.50% for the three months ended September 30 2022 and 2021, respectively. 22 Net Loss Net loss for the three months ended September 30, 2022 was $142,000, compared to a net loss of $66,000 for the three months ended September 30, 2021 due to the reasons stated above. Results of Operations for the nine months ended September 30, 2022 Net Sales: Consolidated net sales for the nine months ended September 30, 2022 were $39,348,000, a decrease of $4,171,000, or 9.6%, compared with $43,519,000 for the nine months ended September 30, 2021. The decrease in sales resulted principally from the sale of products with lower selling prices and from contracts that expired in 2021 and were not renewed in 2022. As indicated in the table below, three customers represented 68.9% and 75.5% of total sales for the nine months ended September 30, 2022 and September 30, 2021, respectively. Customer Percentage of Sales 2022 2021 Goodrich Landing Gear Systems 32.5 % 36.8 % Sikorsky Aircraft 19.5 % 26.2 % United States Department of Defense 16.9 % 12.5 % Gross Profit: Consolidated gross profit from operations for the nine months ended September 30, 2022 was $6,742,000, an increase of $328,000, or 5.1%, as compared to gross profit of $6,414,000 for the nine months ended September 30, 2021. Consolidated gross profit as a percentage of sales was 17.1% and 14.7% for the nine months ended September 30, 2022 and 2021, respectively. For interim periods, substantially all of the inventory value has been estimated using a gross profit percentage based on the annual gross profit percentage of the immediately preceding year. Inventory value and gross profit margin for 2021 was estimated using the gross profit margin percentage in 2020. Gross profit margins in 2020 were negatively impacted by Covid-19 and therefore impacted the estimated gross profit margins applied to the 2021 interim periods. Actual gross profit margins returned to historical levels in 2021 and this higher gross profit margin have been used to calculate the gross profit margins for the interim periods for 2022. Operating Expense Consolidated operating expenses for the nine months ended September 30, 2022 totaled $6,116,000 and increased by $346,000 or 6.0% compared to $5,770,000 for the nine months ended September 30, 2021. The increase was caused by increases in employment costs, including employee health benefits increases which were not passed on to employees, increases in investor relations and increased travel costs resulting from the resumption of travel to customers as Covid restrictions eased. These increased costs were partially offset by reductions in information technology and bad debt expense. Interest and Financing Costs Interest and financing costs for the nine months ended September 30, 2022 were $935,000 a decrease of $26,000 or 2.7% compared to $961,000 for the nine months ended September 30, 2021. The primary reason for this was lower balances on our debt with Webster Bank. The average interest rate charged was 3.94% and 3.50% for the nine months ended September 30 2022 and 2021, respectively. 23 Net (Loss) Income Net Loss for the nine months ended September 30, 2022 was $177,000, compared to net income of $21,000 for the nine months ended September 30, 2021, for the reasons discussed above. LIQUIDITY AND CAPITAL RESOURCES Our material cash requirements are for debt service, capital expenditures and funding working capital/operating costs. As of September 30, 2022, we have debt service requirements related to: 1) Our Webster Facility of $18,788,000 consisting of a Revolving Loan of $14,097,000 and a term loan in the amount of $4,691,000. During the remainder of fiscal 2022, we are required to pay $178,000 of principal under the term loan. 2) Related party debt consisting of convertible subordinated note payables of $4,812,000 and subordinated note payables of $1,350,000. This debt is not due until July 1, 2026. We are permitted to make principal payments against this debt in the amount of $250,000 per quarter pursuant to the Third Amendment to the Loan and Security Agreement with Webster Bank, as long as certain conditions are met. On July 14, 2022, a principal payment in the amount of $250,000 was made as the conditions for such payment were met for the first quarter of 2022. 3) Various equipment leases and contractual obligations related to our normal business. We have historically met our cash requirements with funds provided by a combination of cash generated from operating activities and cash generated from equity and debt financing transactions. Based on our current revenue visibility and strength of our backlog, we believe that we have sufficient liquidity to meet our short-term cash requirements. On May 17, 2022, we entered into the Fourth Amendment to the Loan and Security Agreement with Webster Bank. The purpose of the amendment was to increase the Term Loan to $5,000,000, reduce the monthly principal installments to be made in respect to the term loan and establish a capital expenditure line of credit in the amount of $2,000,000 which we can draw upon from time to time to finance purchases of machinery and equipment, thereby increasing the amount of capital expenditures we may make each year. Because we believe our fourth quarter fiscal 2022 sales will be in line with the amount achieved in the comparable period of 2021, we believe our liquidity will continue to improve. As a result of recent increases in the federal funds borrowing rate, interest rates and related expense under our Webster Facility are expected to increase from current levels. Such increases are not expected to materially impact our liquidity. Our future 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 our 2021 Annual Report on Form 10-K. Should our cash requirements change beyond our current expectations due to general economic conditions or a strategic decision, we may choose to raise additional funds through equity and debt financing transactions. We believe that we have sufficient access to credit and/or financing from public and private debt and equity markets. Changes in our cash flow are discussed further below. 24 Cash Flow The following table summarizes our net cash flow from operating, investing and financing activities for the periods indicated below: Nine Months Ended September 30, 2022 2021 Cash provided by (used in) Operating activities $ (73,000 ) $ 2,514,000 Investing activities (1,980,000 ) (983,000 ) Financing activities 1,618,000 (3,344,000 ) Net decrease in cash $ (435,000 ) $ (1,813,000 ) Cash Provided by (Used in) Operating Activities Cash used in operating activities primarily consists of our net loss adjusted for certain non-cash items and changes to working capital items. For the nine months ended September 30, 2022, our net loss as adjusted for non-cash items provided cash of $2,414,000. This was a result of our net loss of $177,000, offset by $2,591,000 of non-cash items consisting primarily of depreciation of property and equipment of $1,906,000, non-cash employee stock compensation expense of $262,000, amortization of right-of-use assets of $403,000 and non-cash directors’ compensation expense of $162,000. The remaining non-cash items totaled absorbed $142,000. Changes in operating assets and liabilities used cash in the net amount of $2,487,000 consisting primarily of increases in inventory, deposits and prepaid expenses and other current assets in the amounts of $3,876,000, $74,000 and $24,000, respectively, and decreases in operating lease liabilities and customer deposits of $504,000 and $179,000, respectively, partially offset by a decrease in accounts receivable in the amount of $1,917,000, an increase in accounts payable and accrued expenses in the amount of $117,000 and an increase in other current liabilities of $139,000. Cash Used in Investing Activities Cash used in investing activities consists of capital expenditures for property and equipment. For the nine months ended September 30, 2022, cash used in investing activities was $1,980,000. Cash Provided by (Used in) Financing Activities For the nine months ended September 30, 2022, cash provided by financing activities consisted of net proceeds from the Webster re-financing of $1,945,000 and net advances on our Webster revolving loan in the amount of $1,641,000, partially offset by repayments of $1,430,000 on our Webster term note, $263,000 on our financed lease obligations, $250,000 on our subordinated notes payable – related party and $5,000 on our financed asset note payable. OFF-BALANCE SHEET ARRANGEMENTS We did not have any off-balance sheet arrangements as of September 30, 2022. 25 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 judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our condensed consolidated financial statements are presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”), and all applicable U.S. GAAP accounting standards effective as of September 30, 2022 have been taken into consideration in preparing the condensed consolidated financial statements. The preparation of condensed 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 judgments and assumptions inherent in these policies could affect our condensed consolidated financial statements: ● Liquidity; ● Inventory valuation; ● Revenue recognition; ● Income taxes; ● Stock-based compensation; and ● Goodwill. We base our estimates, to the extent possible, on historical experience. Historical information is modified as appropriate based on current business factors and various assumptions that we believe are necessary to form a basis for making judgments about the carrying value of assets and liabilities. We evaluate our estimates on an on-going basis and make changes when necessary. Actual results could differ from our estimates. Recently Issued Accounting Pronouncements See Note 2 of the Condensed Consolidated Financial Statements for a discussion of recently issued accounting pronouncements. 26