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, 2022 (the “2022 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 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 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 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. 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 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 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 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. 18 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 LTAs 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 significant 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, 2023 2022 2023 2022 Net sales $ 12,293,000 $ 13,278,000 $ 38,047,000 $ 39,348,000 Cost of sales 11,065,000 11,036,000 32,769,000 32,606,000 Gross profit 1,228,000 2,242,000 5,278,000 6,742,000 Operating expenses 2,024,000 2,073,000 6,160,000 6,116,000 Interest and financing costs 516,000 323,000 1,472,000 935,000 Other income, net 13,000 12,000 42,000 132,000 Provision for income taxes - - - - Net loss $ (1,299,000 ) $ (142,000 ) $ (2,312,000 ) $ (177,000 ) 19 Balance Sheet Data: September 30, December 31, 2023 2022 Cash $ 740,000 $ 281,000 Working capital $ 12,307,000 $ 18,600,000 Total assets $ 49,719,000 $ 53,814,000 Total stockholders’ equity $ 14,949,000 $ 16,839,000 Results of Operations for the three months ended September 30, 2023 Net Sales: Consolidated net sales for the three months ended September 30, 2023 were $12,293,000, a decrease of $985,000, or 7.4%, compared with $13,278,000 for the three months ended September 30, 2022. The decrease in net sales was primarily due to the timing of certain shipments of large high dollar components and a supply chain issue related to securing raw material for a specific product. As indicated in the table below, three customers represented 60.8% and two customers represented 63.9% of total sales for the three months ended September 30, 2023 and September 30, 2022, respectively. Percentage of Sales Customer 2023 2022 Sikorsky Aircraft 31.9 % ** Boeing 18.0 % ** Collins Aerostructures 10.9 % ** Goodrich Landing Gear Systems * 40.7 % United States Department of Defense * 23.2 % * Customer was less than 10% of sales for the three months September 30, 2023 ** Customer was less than 10% of sales for the three months September 30, 2022 Gross Profit: Consolidated gross profit for the three months ended September 30, 2023 was $1,228,000, a decrease of $1,014,000, or 45.2%, as compared to gross profit of $2,242,000 for the three months ended September 30, 2022. Consolidated gross profit as a percentage of sales was 10.0% and 16.9% for the three months ended September 30, 2023 and 2022, respectively. The decrease in gross profit percentage was attributable to lower sales which led to the under absorption of manufacturing overhead. The decrease in sales for the quarter was primarily the result of a delay in the receipt of raw materials from one of our suppliers related to a specific product which delayed production. Additionally, during 2023 the mix of product that was sold had lower margins than what was sold during 2022. Operating Expense Consolidated operating expenses for the three months ended September 30, 2023 totaled $2,024,000 and decreased by $49,000 or 2.4% compared to $2,073,000 for the three months ended September 30, 2022. The decrease was caused by reductions in compensation and shipping expense. These decreased costs were partially offset by an increase in amounts spent on information technology. 20 Interest and Financing Costs Interest and financing costs for the three months ended September 30, 2023 were $516,000, an increase of $193,000 or 59.8% compared to $323,000 for the three months ended September 30, 2022. This increase was related to increase in debt related to new equipment and higher interest rates charged during the period. The average interest rate charged was 7.78% and 4.70% for the three months ended September 30 2023 and 2022, respectively. Net Loss Net loss for the three months ended September 30, 2023 was $1,299,000, compared to a net loss of $142,000 for the three months ended September 30, 2022 due to the reasons stated above. Results of Operations for the nine months ended September 30, 2023 Net Sales: Consolidated net sales for the nine months ended September 30, 2023 were $38,047,000, a decrease of $1,301,000, or 3.3%, compared with $39,348,000 for the nine months ended September 30, 2022. The decrease in net sales was primarily due to the timing of certain shipments of large high dollar components and a supply chain issue related to securing raw material for a specific product. As indicated in the table below, four customers represented 62.6% and three customers represented 68.9% of total sales for the nine months ended September 30, 2023 and September 30, 2022, respectively. Percentage of Sales Customer 2023 2022 Sikorsky Aircraft 24.4 % 19.5 % Goodrich Landing Gear Systems 17.3 % 32.5 % RUAG 10.9 % ** Boeing 10.0 % ** United States Department of Defense * 16.9 % * Customer was less than 10% of sales for the nine months September 30, 2023 ** Customer was less than 10% of sales for the nine months September 30, 2022 Gross Profit: Consolidated gross profit from operations for the nine months ended September 30, 2023 was $5,278,000, a decrease of $1,464,000, or 21.7%, as compared to gross profit of $6,742,000 for the nine months ended September 30, 2022. Consolidated gross profit as a percentage of sales was 13.9% and 17.1% for the nine months ended September 30, 2023 and 2022, respectively. The decrease in gross profit percentage was attributable to lower sales which led to the under absorption of manufacturing overhead. The decrease in sales in 2023 was partially the result of a delay in the receipt of raw materials from one of our suppliers related to a specific product which delayed production. Additionally, during 2023 the mix of product that was sold had lower margins than what was sold during 2022. 21 Operating Expenses Consolidated operating expenses for the nine months ended September 30, 2023 totaled $6,160,000 and increased by $44,000 or 0.7% compared to $6,116,000 for the nine months ended September 30, 2022. The increase was caused by increases in stock compensation expense and an increase in amounts spent on information technology. These increased costs were partially offset by decreases in compensation and shipping expense. Interest and Financing Costs Interest and financing costs for the nine months ended September 30, 2023 were $1,472,000 an increase of $537,000 or 57.4% compared to $935,000 for the nine months ended September 30, 2022. This increase was related to increase in debt related to new equipment and higher interest rates charged during the period. The average interest rate was 7.44% and 3.94% for the nine month periods ending September 30, 2023 and 2022, respectively Net Loss Net Loss for the nine months ended September 30, 2023 was $2,312,000, compared to net loss of $177,000 for the nine months ended September 30, 2022, 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, 2023, we have debt service requirements related to: 1) Our Webster Facility of $13,719,000 consisting of a Revolving Loan of $8,444,000 and a term loan in the amount of $5,275,000. During the remainder of fiscal 2023, we are required to pay $236,000 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. 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. 3) Various equipment leases and contractual obligations related to our normal business, including advances under the facility with Connecticut Green Bank for the installation of solar energy systems including the replacement of the existing roof at our Sterling Facility. We meet our cash requirements with funds provided by a combination of cash generated from operating activities and from our Webster credit facility. 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 Bank (“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 $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 (finance leases) 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. 22 On November 20, 2023, we entered into the Sixth Amendment to the Webster Facility (“Sixth Amendment”). The amendment waived the default caused by the failure to achieve the required Fixed Charge Coverage Ratio for the Fiscal Quarter ended September 30, 2023 and the fact that our Capital Expenditures were in excess of the amount permitted in the Webster Facility. The Sixth Amendment allows for the Fixed Charge Coverage Ratio to be calculated on a rolling basis ( w) for the Fiscal Quarter Ending December 31, 2023, three month basis, (x) for the Fiscal Quarter Ending March 31, 2024, six month basis, (y) for the Fiscal Quarter Ending June 30, 2024, nine month basis, and (z) for all other Fiscal Quarters, twelve month basis. Additionally, the Fixed Charge Coverage Ratio shall not be less than (i) 0.95 to 1.00 for the Fiscal Quarters ending June 30, 2023, September 30, 2023, and December 31, 2023, (ii) 1.10 to 1.00 for the Fiscal Quarter ending March 31, 2024, (iii) 1.20 to 1.00 for the Fiscal Quarter ending June 30, 2024, and (iv) 1.25 to 1.00 for all other Fiscal Quarters. The Sixth Amendment has increased the Capital Expenditure limit to $2,500,000 in any Fiscal Year. In connection with these changes, the Company paid an amendment for of $20,000. As a result of recent increases in the federal funds and prime borrowing rates, 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, or the conflict in Israel, the outbreak of another conflict or the expansion of the conflict in Israel to other countries, the ongoing tensions between the United States and China, the Russian Federation and certain countries in the Middle East, 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. Navigating the current business landscape poses significant challenges. Accurately projecting future financial periods and ensuring covenant compliance has become extremely difficult. We are grappling with supply chain issues, particularly in securing critical inventory essential for fulfilling specific orders. Additionally, the recent Middle East war has heightened geopolitical instability that we expect will cause fluctuations in our future business results., Our future liquidity may be adversely impacted by various risks and uncertainties, including but not limited to the ongoing wars in Ukraine and Israel, other geopolitical volatility, deterioration in the financial markets or defense industries and other macroeconomic events. While we are presently in full compliance with our Webster Facility, we have failed to meet our covenants, as amended, during two out of three of the last fiscal quarters. Additionally, it is possible, that we may not meet our financial covenants in one of the upcoming fiscal quarters over the next twelve months due to either future losses and /or raising interest rates. Therefore, due to the aforementioned issues, we have classified the term loan that expires on December 30, 2025 as current as of September 30, 2023, in accordance with the guidance in ASC 470-10-45 related to the classification of callable debt. Failure to meet the revised covenants in future periods and secure any necessary waivers raises substantial doubt about the Company’s ability to continue as a going concern within one year after the issuance date of this report. The Company is required to maintain a collection account with Webster Bank into which substantially all of the Company’s cash receipts are remitted. If Webster were to cease lending and keep the funds remitted to the collection account, the Company would lack the funds to continue its operations. The accompanying consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded assets or the classification of liabilities that might be necessary should the Company be unable to continue as a going concern. 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 discussed further below. Cash Flow The following table summarizes our net cash flow from operating, investing and financing activities for the periods indicated below (in thousands): Nine months ended September 30, 2023 2022 Cash provided by (used in) Operating activities $ 7,093 $ (73 ) Investing activities (1,867 ) (1,980 ) Financing activities (4,767 ) 1,618 Net increase (decrease) in cash $ 459 $ (435 ) 23 Cash Provided by (Used in) Operating Activities Cash provided by (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, 2023, our net loss of $2,312,000 was offset by $2,784,000 of non-cash items consisting primarily of depreciation of property and equipment of $1,853,000, employee and director stock compensation expense of $422,000 and amortization of right-of-use assets of $449,000 which were partially offset by a deferred gain on the sale of real estate in the amount of $29,000. Operating assets and liabilities provided cash during the nine months ended September 30 in the net amount of $6,621,000 consisting primarily of net decreases in accounts receivable, inventory and prepaid expense in the amounts of $4,224,000, $473,000 and $72,000, respectively, and a net increase in customer deposits in the amount of $2,695,000, which were partially offset by an increase in deposits in the amount of $20,000, and decreases in operating lease liabilities and accounts payable and accrued expenses in the amounts of $572,000 and $251,000, respectively. The increase in customer deposits is related to an advance payment by a customer to be used for the procurement of long lead time raw materials this amount will be disbursed during the remainder of 2023 and early 2024. 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, 2023, cash used in investing activities was $1,867,000. This was primarily for the purchase of state-of-the-art machinery. Cash Used in Financing Activities Cash used in 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 nine months ended September 30, 2023, cash used in financing activities was $4,767,000. This was comprised of net payments on our Webster revolving loan in the amounts of $4,908,000 and payments of $876,000 on our Webster term loan, $84,000 on our financing lease obligations and $7,000 on our loan payable – financed asset, partially offset by borrowings of $740,000 on our Webster term loan and advances totaling $393,000 on our financing agreement from CT Green Bank. OFF-BALANCE SHEET ARRANGEMENTS We did not have any off-balance sheet arrangements as of September 30, 2023. 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, 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; and ● 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. Recently Issued Accounting Pronouncements See Note 2 of the Condensed Consolidated Financial Statements for a discussion of recently issued accounting pronouncements. 24