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Item 2. Management’s Discussion and Analysis

2023-08-11 compared with 2022-11-14 · 156 added, 196 removed, 121 unchanged (74% of the section changed)

MANAGEMENT’S DISCUSSION

AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATION

The following discussion

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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

risk factors identified in this report and our 2022 Form 10-K that could cause actual results to differ materially from those anticipated

in these forward-looking statements.

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Air Industries Group is a

holding company with three legal subsidiaries, Air Industries Machining Corp.

(“AIM”), Nassau Tool Works, Inc.

and the Sterling Engineering Company (“SEC”).

SEC began manufacturing aircraft components in 1941 – over 80-years ago

– for use in World War II.

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.

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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 are focused on attaining

profitability and maintaining 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.

take advantage of the long-term growth opportunities we see in our markets, we have made significant capital investments in new equipment.

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.

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.

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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

for the product or products covered by the contract for an agreed upon period of time, sometimes five-years or longer, with negotiated

increases to reflect a portion of the impact of inflation.

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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 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.

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.

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 and seeking to qualify new suppliers with our customers.

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 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.

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

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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

of inflation, though over the term of LTAs 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.

Our direct costs of production include costs for material, labor, and significant factory overhead;

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

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Three Months Ended

Nine Months Ended

September 30,

Cost of sales

Operating expenses and interest and financing costs

Operating expenses

Interest and financing costs

Other income, net

Net (loss) income

Provision/(Benefit) from income taxes

Balance Sheet Data:

September 30,

Working capital

Total stockholders’ equity

Results of Operations for the three months

ended September 30, 2022

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 three months ended March 31, 2023 were $12,549,000, an increase of $487,000, or 4.0%, compared with $12,062,000 for the three months

ended March 31, 2022.

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.

below, four customers represented 57.1% and 70.8% of total net sales for the three months ended March 31, 2023 and March 31, 2022, respectively.

Percentage of Sales

Goodrich Landing Gear Systems

Sikorsky Aircraft

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.

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

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.

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.

Percentage of Sales

Goodrich Landing Gear Systems

Sikorsky Aircraft

United States Department of Defense

Customer was less than 10% of sales for the three months March 31, 2023

Customer was less than 10% of sales for the three months March 31, 2022

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.

Consolidated gross profit from operations for the three months ended

March 31, 2023 was $1,880,000, a decrease of $198,000, or 9.5%, as compared to gross profit of $2,078,000 for the three months ended March

Consolidated gross profit as a percentage of sales was 15.0% and 17.2% for the three months ended March 31, 2023 and 2022, respectively.

For the three months ended March 31, 2022, substantially all of the inventory value was 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 the first quarter

of 2022 was estimated using the gross profit percentage in 2021.

Consolidated gross profit

for the March 2023 quarter was negatively impacted by sales of several lower margin products due to increased costs in processing these

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.

for the three months ended March 31, 2023 totaled $2,038,000 and increased by $167,000 or 8.9% compared to $1,871,000 for the three months

ended March 31, 2022.

The increase was caused by increases in professional fees and information technology.

These increased costs were

partially offset by reductions in stock compensation expense and shipping 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.

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.

Interest and financing costs

for the three months ended March 31, 2023 were $476,000 an increase of $153,000 or 47.4% compared to $323,000 for the three months ended

March 31, 2022.

The average interest rate charged was 7.04% and 3.5% for the three month periods ended March 31, 2023 and 2022, respectively.

Net loss for the three months

ended March 31, 2023 was $618,000, compared to net loss of $28,000 for the three months ended March 31, 2022 due to the reasons stated

LIQUIDITY AND CAPITAL RESOURCES

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are for debt service, capital expenditures and funding working capital/operating costs.

As of September 30, 2022,

we have debt service requirements related to:

As of March 31, 2023, we have

debt service requirements related to:

Our Webster Facility of $19,152,000 consisting of a Revolving Loan of $13,220,000 and a term loan in the amount of $5,933,000.

During the remainder of fiscal 2022, we are required to pay $178,000 of principal under the term loan.

Related party debt consisting of convertible subordinated note payables of $4,812,000 and subordinated note payables of $1,350,000.

During the remainder of our fiscal 2023, we are required to pay $709,000 of this amount plus an Excess Cash Flow payment of $195,000 (paid in June 2023) as defined in the Webster Facility for Fiscal year 2022.

Related party debt consisting of convertible subordinated notes payable of $4,812,000 and subordinated notes payable 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.

Under the Webster Facility we are permitted to make principal payments against this debt in the amount of $250,000 per quarter, as long as certain conditions are met.

Various equipment leases and contractual obligations related to our normal business.

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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

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

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

to meet our short-term cash requirements over the next twelve months out of cash flow from operations.

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

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 $195,000

for fiscal year ended December 31, 2022 to Webster prior to the April 15, 2023 deadline and authorized such payment to be made from the

Revolving Loan.

On June 13, 2023, Webster applied this payment to the term loan.

On August 4, 2023, we entered into the Fifth Amendment to the Webster

Facility (“Fifth Amendment”).

The purpose of the amendment was to waive the default caused by the failure to achieve the required

Fixed Coverage Charge Ratio for the Fiscal Quarter ended March 31, 2023 and decrease the required Fixed Coverage Charge Ratio to 0.95

to 1.00 for the Fiscal Quarters ending June 30, 2023 and September 30, 2023.

Additionally, the Fifth Amendment increased the amount of

purchase money secured debt the Company is allowed to have outstanding at any time to $2,000,000.

In connection with these changes, we

paid an amendment fee of $10,000.

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 have increased

and likely would increase further if prevailing interest rates increased or we failed to meet our covenant in the Webster Facility.

a result of recent increases in the federal funds borrowing rate, interest rates and related expense under our Webster Facility increased

in 2023 compared to 2022 and if rates remain stable or increase in 2023, our interest expense will further increase in 2023 due to the

timing of rate increases in 2022.

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 our 2022 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.

that we have sufficient access to credit and/or financing from public and private debt and equity markets.

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 are

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The following table summarizes

our net cash flow from operating, investing and financing activities for the periods indicated below:

Nine Months Ended

September 30,

our net cash flow from operating, investing and financing activities for the periods indicated (in thousands):

Three months ended

Cash provided by (used in)

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Financing activities

Net decrease in cash

$ (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

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

Net increase (decrease) in cash

Cash Provided by Operating Activities

Cash provided by operating

activities primarily consists of our net loss adjusted for certain non-cash items and changes to working capital items.

For the three months ended

March 31, 2023, our net loss of $(618,000) was offset by $873,000 of non-cash items consisting primarily of depreciation of property and

equipment of $617,000, employee and director stock compensation expense of $99,000 and amortization of right-of-use assets of $146,000

which were partially offset by a deferred gain on the sale of real estate in the amount of $10,000.

Operating assets and liabilities

provided cash in the net amount of $1,183,000 consisting primarily of net decreases in accounts receivable and prepaid expense in the

amounts of $2,206,000 and $19,000, respectively, and a net increase in accounts payable and accrued expenses of $146,000, which were partially

offset by increases in inventory, deposits and other assets and prepaid taxes in the amounts of $623,000, $105,000 and $1,000, respectively,

and decreases in operating lease liabilities and deferred revenue in the amounts of $186,000 and $273,000, respectively.

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.

Cash used in investing activities consists of cash

used for capital expenditures for property and equipment.

For the three months ended

March 31, 2023, cash used in investing activities was $973,000 This was primarily for the purchase of state-of-the art machinery.

Cash Provided by Financing Activities

Cash provided by financing activities consists

of the borrowing and repayments under our credit facilities with our senior lender, Webster, increases in and repayments of finance obligations

and other notes payable.

For the three months ended

March 31, 2023, cash provided by financing activities was $379,000.

This was comprised of increased borrowings on our Webster term loan

of $740,000, partially offset by net payments on our Webster revolving loan and Webster term note in the amounts of $132,000 and $208,000,

respectively, and payments of $20,000 and $1,000 on our financing lease obligations and loan payable – financed asset.

OFF-BALANCE SHEET ARRANGEMENTS

We did not have any off-balance

sheet arrangements as of September 30, 2022.

sheet arrangements as of March 31, 2023.

Critical Accounting Policies and Estimates

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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.

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:

Inventory valuation;

Revenue recognition;

Income taxes;

Stock-based compensation;

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.

All applicable U.S.

GAAP accounting standards effective as of March 31, 2023 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:

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;

Income Taxes, which includes the determination of the valuation allowance for deferred tax assets.

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.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis