AIR INDUSTRIES GROUP 10-K

ITEM 1. BUSINESS Introduction As used in this report, unless otherwise stated or the context requires otherwise, the “Company” and terms such as “we,” “us” “our,” and “AIRI” refer to Air Industries Group, a Nevada corporation, and its wholly-owned subsidiaries. We are a manufacturer of complex machined parts and assemblies for the Aerospace and Defense (“A&D”) market. Our products are used by Original Equipment Manufacturers (“OEM”) in the manufacture of fixed wing aircraft, helicopters jet turbine engines, and other complex sophisticated A&D products. We also manufacture parts for the ground power turbine industry and are in discussions to manufacture products for submarines. We are a holding company with three legal subsidiaries, Air Industries Machining, (“AIM”) Nassau Tool Works (“NTW”) and Sterling Engineering Company (“SEC”). Our subsidiaries have been manufacturers of A&D product for decades; 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 1951. Collectively, our subsidiaries have over 200 years of manufacturing experience in the A&D market. We operate our business using two main facilities. One is located in Long Island, New York, and the other is in Barkhamsted, Connecticut. We have over 150,000 square feet of manufacturing space, approximately 75,000 square feet in each location, and employ approximately 190 people. Historically, we operated our businesses and reported their results as two separate segments, with AIM and NTW comprising our Complex Machining Segment (“CMS”) and our SEC as the Turbine & Engine Component Segment (“TEC”). Our CMS segment specializes in flight critical components including flight controls and landing gear. Our TEC segment focuses on manufacturing components for jet engines. Historically, each segment had different customers and utilized different production facilities. In recent years the operations of our CMS and TEC segments have become increasingly integrated. In addition, we have made significant capital expenditures to modernize our manufacturing equipment 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 now make decisions regarding the allocation of resources and assess operating performance based on one integrated business rather than two reporting segments. As such, effective with our first quarter ended March 31, 2022, we began to present our operations as one reportable operating segment. The A&D business is comprised of a small number of OEM’s relying on several “tiers” or layers of many more numerous smaller manufacturers supplying product. Each successive tier supplies increasingly larger, more complex product to the next higher tier and OEM companies. Air Industries is generally either a tier one manufacturer supplying product directly to an OEM, or a tier two manufacturer supplying product to a tier one supplier which delivers to an OEM. Our business has evolved over the years, our products becoming increasing complex. Where once we manufactured smaller individual components for others to assemble into complex assemblies, we now manufacture those complex assemblies ourselves. For example, in the past we, along with other suppliers, manufactured individual components to be assembled into a landing gear by an OEM customer. Today we manufacture the entire landing gear, assembling over 200 individual parts, most manufactured internally, others sub-contracted or purchased into a complete landing gear delivered directly to an OEM, ready to be installed on an aircraft. 1 We are predominately a supplier of military aviation product. Defense products were 82.6% and 87.7% of our business in 2022 and 2021 respectively. Our OEM customers in the defense sector include: ● Raytheon Technologies Corporation (f/k/a United Technologies Corporation). We supply products for several units of Raytheon Technologies Corporation, including: o Goodrich Landing Systems – we manufacture landing gear components for the Northrop Grumman E2-D Hawkeye, airborne warning and control aircraft deployed with the US Navy and several foreign governments, the Lockheed F-35 Lightning II Joint Strike multi-role fighter aircraft used by all branches of the US military and multiple foreign militaries and for the F-15 Eagle fighter aircraft. Pratt & Whitney – we manufacture jet turbine engine components for several military and commercial jet engines. ● Lockheed Martin Corporation. We supply products for the Sikorsky Aircraft unit of Lockheed primarily for the UH-60 BlackHawk multi-purpose helicopter used by the US and many foreign militaries. ● General Electric Corporation . We supply products used in General Electric jet turbine aircraft engines used by several military aircraft platforms. ● US Department of Defense . We supply landing gear product for the US Navy F-18 fighter aircraft directly to the Defense Department. ● Northrop Grumman Corporation. We supply product used on the E2-D Hawkeye, airborne warning and control aircraft. The balance of our business, comprising 17.4% and 12.3% of our business in 2022 and 2021 respectively, is in commercial aviation and to a minor degree in ground power electricity generation. Our OEM customers in the commercial sector include: ● Rohr Inc., (a wholly owned subsidiary of Raytheon Technologies) We manufacture a component used in several versions of the Pratt & Whitney new geared turbine fan commercial jet turbine engine. ● General Electric Corporation. We supply products used in General Electric jet turbine aircraft engines used by several commercial aircraft platforms and ground power electricity generation. Our business is concentrated on five aircraft platforms which comprised 76.9% and 76.6% of our business in 2022 and 2021 respectively. ● UH-60 BlackHawk . We have manufactured many components and assemblies for the BlackHawk and its many variants for more than 20 years. BlackHawk helicopters entered service in 1979 and remain in production today. It is the primary helicopter used by the US Army and other branches of the US military. The BlackHawk is also used by many foreign countries and militaries. Over 4,000 aircraft have been produced with many, perhaps as many as 3,000, remaining in use today and generating significant after-market demand. ● F-35 Lightning II. The F-35 Lightning also known as the Joint Strike Fighter is a new aircraft that will in coming years replace the US Air Force F-15 and the US Navy and Marine Corps F-18 fighters. Eight other nations have participated in the development of the aircraft and will be users of the aircraft, as will other international militaries. There are three variants of the aircraft, conventional take-off and landing F-35A, short take-off and vertical landing F-35B and a carrier based variant F-35C. The aircraft entered service with the US Marine Corps in 2015 and approximately 2,300 are expected to be produced. 2 ● F-18 Hornet. The F-18 Hornet currently is the primary fighter aircraft for the US Navy operating primarily from aircraft carriers. The F-18 is also in service internationally, notably Finland and Australia. We manufacture complete landing gear and landing gear components for the many variants of the aircraft. ● Northrop Grumman E2-D Advanced Hawkeye. The ED-D Hawkeye is a US Navy carrier-based aircraft used to provide airborne warning and control for carrier-based air operations. The aircraft’s role is to maintain control of the airspace surrounding an aircraft carrier for protection of the vessel and aircraft in operation. The “D” version, the most current of the E2 remains in production. The aircraft is also used by seven foreign militaries notably Japan. ● Pratt & Whitney Geared Turbo-Fan. The P&W Geared Turbo-Fan (“GTF”) is a next generation jet turbine engine used in commercial aviation. The GTF engine is widely acknowledged to deliver improved fuel economy and a lower noise footprint than existing jet engines. There are several versions of the GTF. Air Industries produces a component for the smaller versions of the engine used on the popular A-220 and Embraer narrow body aircraft. Our Market The A&D industry has become very consolidated, now dominated by just a few very large prime contractors and OEM’s. These include Airbus, Boeing, General Electric, Lockheed Martin, Northrop Grumman, and Raytheon Technologies. Many if not most of the large prime contractors and OEM’s are our direct Tier One customers, and we also supply product as a Tier two supplier to many of their Tier one suppliers. We also sell directly to the US Department of Defense (“DOD”). Our products are incorporated into many aircraft platforms, the majority of which remain in production today. The demand for after-market products for the maintenance, repair and overhaul (“MRO”) of aircraft can continue for many years, even decades, after the production line for new aircraft is shut-down. We target products that are flight critical, whose flawless operation is essential to the safe operation of the aircraft. To qualify to produce these products a manufacturer needs to maintain various accreditations. Obtaining accreditation while not impossible is difficult, time consuming and thus a barrier to entry for competitors. Further, flight critical components are frequently replaced on aircraft on a flight time, or flight cycle basis. Thus, demand for these products arises from both production of new aircraft, and MRO demand based on the flight hours of existing fleets of aircraft. For many of our products we are the sole or single source of product for our customers. Sole source product means that we are the only manufacturer of the product. Single source means that while other manufacturers could supply the product, we are the only producer currently in the market. Single or sole sourcing is more likely to occur with legacy aircraft. OEM’s generally prefer to have multiple sources of product to support a production line of new aircraft and avoid single point of failure issues, particularly in light of the supply chain disruptions caused by the outbreak of Covid-19. Our market is predominately military. As such demand for our products is closely aligned with the budget of the DOD. We monitor two components of the DOD budget; procurement which affects demand resulting from new production and operations & maintenance which affects demand resulting from the maintaining of existing aircraft. For Fiscal Year 2022, procurement and operations and maintenance accounted for more than 50% of the entire defense budget. Sales and Marketing We are generally recognized as a Tier 1 or Tier 2 supplier in the A&D industry. We are also recognized as having extensive experience and accreditation to produce and assemble complex flight safety products. Most of our contracts with our customers are in the form of a Long-Term Agreement (“LTA”). These LTA’s specify the number and price of products that the customer may order from us for a period of time. The quantity and price in any year may vary from other years within the LTA. Once awarded, the customer places orders against the LTA. These orders are called releases. Once released the order is a firm order. While a firm order may be cancelled the customer is subject to termination liability and must pay us for the cost of material, labor and other costs incurred up to the date of termination. 3 Our sales cycle is highly variable, ranging from a few weeks to several years depending upon the complexity of the product and the number of steps necessary to complete manufacturing. Contracts for product can be very short, just a few months to as long as ten-years. We obtain new or follow-on LTA’s through competitive bidding. We respond to a customer’s Request for Quotation (“RFQ”) with proposed prices based on quantities, sometimes varying quantities per year, for shipments over a number of years. There may be several rounds of submissions from us and from competitive suppliers, and a period of negotiation before an LTA is awarded. In addition to products sold pursuant to LTA’s there are also “spot buys” of product by customers. LTA’s, particularly for defense products, may be extended or new orders placed without competitive bidding. In this instance and in some others our price for the product must be supported by an analysis or audit and approval of our costs by the customer or by the Government. In 2021 and to a lesser extent in the first half of 2022 our sales and marketing efforts were negatively affected by Covid travel restrictions limiting our ability to visit customers and the reluctance of the employees of some of our customers to return to the office and attend trade shows, complicating our ability to contact them. As a result of these challenges our “book-to-bill” ratio (new orders booked divided by sales) was 0.75 to 1.00 and 0.9 to 1.00 for the years ended December 31, 2022 and 2021 respectively, below historic levels. Our approach to sales and marketing can be best understood through the concept of customer alignment. The aerospace industry is dominated by a small number of large prime contractors and OEM’s. These customers rely heavily upon subcontractors to supply quality parts meeting specifications on a timely and cost effective basis. These customers and other customers we supply routinely rate their suppliers based on a variety of performance factors. One of our principal goals is to be highly rated and thus deemed reliable by all of our customers and throughout the industry. The large prime contractors are increasingly seeking subcontractors who can supply and are qualified to integrate the fabrication of larger, more complex and more complete subassemblies. We seek to position ourselves within the supply chain of these contractors and manufacturers to be selected for subcontracted projects. Successful positioning requires that we qualify to be a preferred supplier by achieving and maintaining independent third party quality approval certifications, specific customer quality system approvals and top supplier ratings through strong performance on existing contracts. During our sales and marketing efforts we let customers know that we have employees with the talent and experience to manage the manufacture of sections of aircraft structures to be delivered to the final assembly phase of the aircraft manufacturing cycle, and customers have now engaged us for these services. Initial contracts are usually obtained through competitive bidding against other qualified subcontractors, while follow-on contracts are usually retained by successfully performing initial contracts. Our long term business generally benefits from barriers to entry resulting from investments, certifications, familiarization with the needs and systems of customers, and manufacturing techniques developed during the initial manufacturing phase. We endeavor to develop each of our relationships to one of a “partnership” where we participate in the resolution of pre-production design and build issues, and initial contracts are obtained as single source awards and follow-on pricing is determined through negotiations. In response to the impediments to traditional means of marketing our products and services encountered during 2020 and 2021 as a result of the cancellation of industry-wide events and the difficulties in scheduling meetings with our customers, we have adapted our business development efforts to increase our use of social media and online presentations, and will continue to look for new ways to interact with our customers. 4 Our Backlog The backlog we report consists solely of firm orders received from customers. We do not estimate possible or probable future orders pursuant to LTA’s or anticipated contract renewals. Our backlog exists due to the long lead times necessary to produce many of our products. Our production cycle from ordering raw material to delivering finished product can vary from several weeks to more than one year. Customers must place orders in light of these lead-times creating a back-log of future deliveries. The production cycle for jet engine products is much shorter and accordingly the backlog for jet engine products is much lower. Our total 18-Month firm backlog was $60.1 and $75.0 Million at December 31, 2022 and 2021, respectively. Our backlog today is the result of purchase orders for the Sikorsky Black Hawk, the F-25 Joint Strike Fighter, the Northrop Grumman E2-D, the F-18 fighter aircraft and the Pratt & Whitney Geared Turbo-Fan jet engine. Competition Winning a new contract is highly competitive. We manufacture to customer design specifications. We compete against companies that have similar, or better manufacturing capabilities and often greater financial, physical and technical resources in the domestic and, to a lesser degree, in the global marketplace. Our ability to win new contracts requires providing quality products on a timely basis at competitive prices. This requires that we strive for continuous improvement in our capabilities to enhance our competitiveness. To accomplish this, we have made significant investments in new machinery and equipment totaling approximately $3,725,000; $1,364,000 and $2,361,000 in 2021 and 2022, respectively. This new equipment improves the productive capacity of our employees, increases efficiency and speed, while maintaining closer tolerances, and increasing the size of product we can manufacture with a larger working “envelope”. We anticipate spending an additional $1,750,000 to $2,500,000 in 2023 to continue to expand our productive capacity. Our marketing strategy involves developing long-term working relationships with customers. These relationships enable us to develop barriers to entry to competitors by establishing and maintaining advanced quality approvals, certifications and tooling investments that are difficult and expensive to duplicate. Among our competitors are: Monitor Aerospace, a division of Stellex Aerospace; Hydromil, a division of Triumph Aerospace Group; Heroux Aerospace and Ellanef Manufacturing, a division of Magellan Corporation. Raw Materials and Replacement Parts The manufacturing process for certain products, particularly those for which we serve as product integrator, requires significant purchases of raw materials, hardware and subcontracted details. As a result, much of our success in profitably meeting customer demand for these products requires efficient and effective subcontract management. Price and availability of many raw materials utilized in the aerospace industry are subject to volatile global markets and political conditions. Most suppliers of raw materials are unwilling to commit to long-term contracts at fixed prices. This is a substantial risk as our strategy often involves long term fixed price commitments to our customers. Employees As of May 1, 2023, we employed 185 people. Of these, 76 were in administration, 9 were in sales and procurement, and 100 were in manufacturing. AIM is a party to a collective bargaining agreement (the “Agreement”) with the United Service Workers, IUJAT, Local 355 (the “Union”) with which we believe we maintain good relations. The Agreement was renewed as of December 31, 2021 and expires on December 31, 2024 and covers the majority of AIM’s personnel, approximately 130 individuals, which equates to approximately 70% of all of our employees. AIM is required to make a monthly contribution to each of the Union’s United Welfare Fund and the United Services Worker’s Security Fund. This is the only pension benefit required by the Agreement and the Company is not obligated for any future defined benefit to retirees. The Agreement contains a “no-strike” clause, whereby, during the term of the Agreement, the Union will not strike and AIM will not lockout its employees. All of our employees are covered under a co-employment agreement with Insperity Services, LLC, a professional employer organization that provides out-sourced human resource and payroll services. 5 Regulations Environmental Regulation; Employee Safety We are subject to regulations administered by the United States Environmental Protection Agency, the Occupational Safety and Health Administration, various state agencies and county and local authorities acting in cooperation with federal and state authorities. Among other things, these regulatory bodies impose restrictions that require us to control air, soil and water pollution, to protect against occupational exposure to chemicals, including health and safety risks, and to require notification or reporting of the storage, use and release of certain hazardous chemicals and substances. The extensive regulatory framework imposes compliance burdens and financial and operating risks on us. Governmental authorities have the power to enforce compliance with these regulations and to obtain injunctions or impose civil and criminal fines in the case of violations. The Comprehensive Environmental Response, Compensation and Liability Act of 1980 (“CERCLA”) imposes strict, joint and several liabilities on the present and former owners and operators of facilities that release hazardous substances into the environment. The Resource Conservation and Recovery Act of 1976 (“RCRA”) regulates the generation, transportation, treatment, storage and disposal of hazardous waste. New York and Connecticut, the states where our production facilities are located, also have stringent laws and regulations governing the handling, storage and disposal of hazardous substances, counterparts of CERCLA and RCRA. In addition, the Occupational Safety and Health Act, which requires employers to provide a place of employment that is free from recognized and preventable hazards that are likely to cause serious physical harm to employees, obligates employers to provide notice to employees regarding the presence of hazardous chemicals and to train employees in the use of such substances. Federal Aviation Administration We are subject to regulation by the Federal Aviation Administration (“FAA”) under the provisions of the Federal Aviation Act of 1958, as amended. The FAA prescribes standards and licensing requirements for aircraft and aircraft components. We are subject to inspections by the FAA and may be subjected to fines and other penalties (including orders to cease production) for noncompliance with FAA regulations. Our failure to comply with applicable regulations could result in the termination of or our disqualification from some of our contracts, which could have a material adverse effect on our operations. We have never been subject to such fines or disqualifications. Government Contract Compliance Our government contracts and those of many of our customers are subject to the procurement rules and regulations of the United States government, including the Federal Acquisition Regulations. Many of the contract terms are dictated by these rules and regulations. During and after the fulfillment of a government contract, we may be audited in respect of the direct and allocated indirect costs attributed to the project. These audits may result in adjustments to our contract costs. Additionally, we may be subject to U.S. government inquiries and investigations because of our participation in government procurement. Any inquiry or investigation can result in fines or limitations on our ability to continue to bid for government contracts and fulfill existing contracts. We believe that we are in compliance with all federal, state and local laws and regulations governing our operations and have obtained all material licenses and permits required for the operation of our business. 6