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, 2022 and 2021 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. 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 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, 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. 18 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 variable 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 the 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 and market price of certain minerals, such as titanium, for which Russia was a source of supply. To obtain necessary raw materials at prices deemed acceptable, we are working with those of our larger customers 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. 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 and life-style changes in response to 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 b 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 Years ended December 31, 2022 and 2021: Selected Financial Information: 2022 2021 Net sales $ 53,238,000 $ 58,939,000 Cost of sales 45,786,000 48,686,000 Gross profit 7,452,000 10,253,000 Operating expenses 7,646,000 7,766,000 Interest and financing costs 1,338,000 1,265,000 Other income, net 139,000 405,000 Gain on write-off of accounts payable 317,000 - Provision/(Benefit) from income taxes - - Net (loss) income $ (1,076,000 ) $ 1,627,000 19 Balance Sheet Data: December 31, December 31, 2022 2021 Cash $ 281,000 $ 627,000 Working capital $ 18,600,000 $ 17,478,000 Total assets $ 53,814,000 $ 53,425,000 Total stockholders’ equity $ 16,839,000 $ 17,389,000 Net Sales: Consolidated net sales for the year ended December 31, 2022 were $53,238,000, a decrease of $5,701,000, or 9.7%, compared with $58,939,000 for the year ended December 31, 2021. The decrease in sales resulted principally from the sale of products with lower selling prices and from contracts that expired in 2021 that were not renewed in 2022. As indicated in the table below, four customers represented 76.5% and three customers represented 75.4% of total sales for the years ended December 31, 2022 and 2021, respectively. Customer Percentage of Sales 2022 2021 Goodrich Landing Gear Systems 29.3 % 37.2 % Sikorsky Aircraft 21.4 % 25.7 % United States Department of Defense 14.3 % 12.5 % Rohr 11.5 % * * Customer was less than 10% of sales for the year-ended December 31, 2021 As indicated in the table below, three customers represented 70.3% and three customers represented 74.7% of gross accounts receivable at December 31, 2022 and 2021, respectively. Customer Percentage of Receivables 2022 2021 Goodrich Landing Gear Systems 33.1 % 50.3 % Rohr 23.6 % 12.7 % Sikorsky 13.6 % ** United States Department of Defense * 11.7 % * Customer was less than 10% of accounts receivable at December 31, 2022 ** Customer was less than 10% of accounts receivable at December 31, 2021 Gross Profit: Consolidated gross profit from operations for the year ended December 31, 2022 was $7,452,000, a decrease of $2,801,000, or 27.3%, as compared to gross profit of $10,253,000 for the year ended December 31, 2021. Consolidated gross profit as a percentage of sales was 14.0% and 17.4% for the years ended December 31, 2022 and 2021, respectively. These decreases were attributable to lower sales and the mix of products sold during 2022 as compared to 2021. The Company also corrected its policy for determining the reserve for slow-moving and excess inventory which led to an increase in the reserve, further decreasing the gross profit and gross profit percentage. 20 Operating Expenses Consolidated operating expenses were $7,646,000 and $7,766,000 for fiscal 2022 and 2021, respectively, representing a decrease of $120,000 or 1.5%. As a percentage of consolidated net sales, operating expenses were 14.4% and 13.2% for fiscal 2022 and 2021, respectively. There were increase in cost related to employment costs, including employee health benefits which were not passed on to the employees, increases in investor relations and increased travel costs resulting from the resumption of travel to customers as Covid-19 restrictions eased. The increased costs were primarily offset by reductions in expenses related to information technology and the recovery of bad debt. Gain on write-off of Accounts Payable During the year ending December 31, 2022, the Company, reviewed all old outstanding payables that were not paid and based on the statute of limitations, a claim would no longer be enforceable. The Company determined that approximately $317,000 of old payables fell into this category. This adjustment is recorded as Write-off of accounts payable on the accompanying Statement of Operations. Interest and Financing Costs Our interest and financing costs for the year ended December 31, 2022 totaled $1,338,000, an increase of $73,000 or 5.8% from $1,265,000 in 2021, as a result of higher interest rates on our Loan Facility during 2022. The average interest rate charged was 4.50% and 3.50% for the years ended December 31, 2022 and 2021, respectively. Net (Loss) Income Net loss for the year ended December 31, 2022 was $1,076,000, compared to net income of $1,627,000 for the year ended December 31, 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 December 31, 2022, we have debt service requirements related to: 1) Our Webster Facility of $18,748,000 consisting of a Revolving Loan of $13,352,000 and a term loan in the amount of $5,396,000. 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, 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 over the next twelve months. On May 17, 2022, we entered into the Fourth Amendment to the Loan and Security Agreement with Webster. 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. During December 2022 we borrowed $878,000 for a capital expenditure and again in January 2023 we borrowed $739,500 for an additional capital expenditure. For so long as the Webster term loan remains outstanding, if Excess Cash Flow (as defined) is a positive amount for any Fiscal Year, we are obligated to pay Webster an amount equal to the lesser of (i) twenty-five percent (25%) of the Excess Cash Flow 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. As required, we provided the calculation for the Excess Cash Flow payment of $208,000 for fiscal year ended December 31, 2022 to Webster prior to the April 15, 2023 deadline for such payment. Additionally, we authorized such payment to be made from the Revolving Loan. As of the date of this filing, such payment has not been processed by Webster. 21 Because we believe that our sales in 2023 will be comparable to those of 2022, we believe our liquidity will remain stable, though our borrowing costs would increase if prevailing interest rates increased or we failed to meet our covenant in the Webster Facility. 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, which could be significant. However, such increases are not expected to materially impact our liquidity. 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 a widespread health crisis, the continuation of the war in the Ukraine, the outbreak of another conflict and the ongoing tensions between the United States and China, increases in inflation, disruptions in the labor market and other risks detailed in Part 1, Item 1A of this Annual Report. 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 Changes in our cash flow during fiscal 2022 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, 2022 2021 Cash provided by (used in) Operating activities $ 448 $ 4,064 Investing activities (2,361 ) (1,364 ) Financing activities 1,567 (4,578 ) Net (decrease) increase in cash and cash equivalents $ (346 ) $ (1,878 ) 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, 2022, net loss of $(1,076,000) and $3,094,000 of non-cash items, consisting primarily of employee and director stock-based compensation of $526,000, amortization of right-of-use assets of $545,000, depreciation of property and equipment of $2,522,000 and Impairment of Goodwill of $163,000 were partially offset by non-cash other income recognized in the amount of $94,000, a reduction in bad debt expense in the amount of $313,000 and accounts payable write-offs in the amount of $317,000. Operating assets and liabilities used cash in the net amount of $1,570,000, consisting primarily of the net increases in inventory, deposits and other assets and prepaid expenses, taxes and other current assets of $2,289,000, $194,000 and $87,000, respectively, and net decreases in operating lease liabilities, customer deposits and deferred payroll tax expense-CARES ACT in the amounts of $686,000, $439,000 and $314,000, which were partially offset by a decrease in accounts receivable of $1,303,000 and an increase in accounts payable in the amount of $1,136,000. 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, 2022, cash used in investing activities was $2,361,000. This was primarily for the purchase of state-of-the-art machinery. 22 Cash Provided by Financing Activities Cash provided by 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, 2022, cash provided by financing activities was $1,567,000. This was comprised of net borrowings of $916,000 on our Webster revolving loan, increased borrowings of $2,823,000 under the Webster term loan, offset by repayments of $1,609,000 on our Webster term loan, and payments on our financed lease obligations, related party notes and our financed asset note payables in the amounts of $284,000, $250,000 and $9,000, respectively. CONTRACTUAL OBLIGATIONS For a discussion of our contractual obligations see “Item 8. Financial Statements and Supplementary Data” – “Note 8. Debt” and “Note 9. Operating Lease Liabilities”. 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, 2022 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: ● Inventory Valuation, which includes the estimates and methodology used in accounting for the transition of production costs to inventory costs. In our financial statements, inventory is reflected at the lower of cost or net realizable value including write-downs for obsolescence, slow moving and excess inventory; and ● Income Taxes, which includes the determination of the valuation allowance for deferred tax assets. See Note 2 of the notes to our consolidated financial statements included in this Annual Report on Form 10-K for a more complete description of our significant accounting policies. 23 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.