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, 2023 and 2022 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 We believe we are one of the leading manufacturers of precision components and assemblies for large aerospace and defense contractors. Our rich history dates to 1941, producing parts for World War II fighter aircraft. Since then, we have maintained an impeccable record with no known incidents of part failure leading to a fatal mission. We became a public company in 2005. Our products include landing gear, flight controls, engine mounts and components for aircraft jet engines and ground turbines and other complex machines. The ultimate end-user for most of our products is the U.S. government, international governments, and commercial global airlines. Whether it is a small individual component for assembly by others or complete assemblies we manufacture ourselves, our high quality and extremely reliable products are used in mission critical operations that are essential for safety of military personnel and civilians. Although our net sales are concentrated amongst a number of defense and aerospace prime contractors, we have cultivated long-standing relationships with a number of their subsidiaries and/or business units. Additionally, our net sales are generated across several high-profile platforms and programs including: the F-18 Hornet, the E-2 Hawkeye, the UH-60 Black Hawk Helicopters, Geared Turbo Engines (used on smaller aircraft such as the Airbus A220 and Embraer E2), the CH-53 Helicopter, the F-35 Lighting II and the F-15 Eagle Tactical Fighter. In many cases, we are the sole or single supplier of certain parts and components and receive LTAs from our customers, both demonstrating their commitment to us. Winning a new contract award is highly competitive. Our ability to win new contract awards generally requires us to deliver superior quality products, more quickly and with lower pricing than our competitors. Accordingly, we must continually invest in process improvements and capital equipment. Recent investments in new equipment have improved the productive capacity of our employees, increased our efficiency and speed, and expanded the size of products we can manufacture. We strategically operate two state-of-the-art manufacturing centers in the U.S. This allows for rigorous oversight of production and the adherence to stringent quality standards. Although there is currently a shortage of skilled workers, we maintain a highly trained and close- knit team of over 180 professionals committed to driving excellence and precision in every aspect of our operations. Our period-to-period net sales and operating results are significantly impacted by timing. In addition, our gross profit is affected by a variety of factors, including the mix and complexity of products, production efficiencies, price competition and general business operating environments. In some cases, our gross profit is impacted by our ability to deliver replacement parts on short notice. Our operations have a large percentage of fixed factory overhead. As a result, our profit margins are highly variable with sales volumes. For the past several years, despite facing significant financial and operational challenges, we have strategically invested substantial amounts in new capital equipment, tooling, and processes to bolster our competitive position. Additionally, we expanded our sales and marketing efforts, with a sharp focus on expanding relationships with existing customers and cultivating new ones. Fiscal 2023 marked a year of overall progress and positioning for growth. Looking forward to fiscal 2024, our business strategy is geared towards achieving sustainable and profitable business growth. We are firmly focused on securing new contract awards, improving operations and successful execution. With total unfilled contract values amounting to $191.9 million (including our $98.3 million in backlog and all potential orders against LTA agreements previously awarded to us), as of December 31, 2023, we are confident in our ability to boost sales in 2024, attain profitability and improve our financial position. 21 RESULTS OF OPERATIONS Years ended December 31, 2023 and 2022: Selected Financial Information: 2023 2023 Percentage of Net Sales 2022 2022 Percentage of Net Sales Change 2023 vs 2022 Percent Change 2023 vs 2022 Net sales $ 51,516,000 100.0 % $ 53,238,000 100.0 % $ (1,722,000 ) -3.23 % Cost of sales 44,088,000 85.6 % 45,786,000 86.0 % (1,698,000 ) -3.71 % Gross profit 7,428,000 14.4 % 7,452,000 14.0 % (24,000 ) -0.32 % Operating expenses 7,723,000 15.0 % 7,646,000 14.4 % 77,000 1.01 % Interest expense 1,920,000 3.7 % 1,338,000 2.5 % 582,000 43.50 % Other income, net 84,000 0.2 % 139,000 0.3 % (55,000 ) -39.57 % Gain on write-off of accounts payable - 0.0 % 317,000 0.6 % (317,000 ) -100.00 % Provision for income taxes - 0.0 % - 0.0 % - - Net loss $ (2,131,000 ) -4.1 % $ (1,076,000 ) -2.0 % $ (1,055,000 ) 98.05 % Balance Sheet Data: December 31, December 31, Percent 2023 2022 Change Change Cash $ 346,000 $ 281,000 65,000 23.13 % Working capital $ 12,117,000 $ 18,600,000 (6,483,000 ) -12.81 % Total assets $ 50,715,000 $ 53,814,000 (3,098,000 ) -5.76 % Total stockholders’ equity $ 15,190,000 $ 16,839,000 (1,649,000 ) -9.79 % Comparison of Fiscal 2023 to 2022 Net Sales: Net sales in 2023 were $51,516,000, a decrease of $1,722,000, or 3.2%, compared with $53,238,000 that we achieved in 2022. The year-over-year decrease in net sales was primarily due to delays in production associated with supply chain issues caused by one supplier failing to deliver raw materials for a key program as well as overall changes in customer mix and production requirements for other key platforms and programs. The composition of customers that exceeded 10% of our net sales in either 2023 or 2022 are shown below: Percentage of Net Sales Customer 2023 2022 RTX (a) 27.3 % 40.6 % Lockheed Martin 24.7 % 21.4 % Boeing 12.2 % 0.0 % United States Government 3.6 % 14.3 % (A) RTX includes Collins Landing Systems and Collins Aerostructures 22 The composition of our net sales by platform or program profiles for the years ended December 31, 2023 and 2022 are shown below: Percentage of Net Sales Platform or Program 2023 2022 F-18 Hornet 24.3 % 13.3 % E2-D Hawkeye 18.9 % 15.6 % UH-60 Blank Hawk Helicopter 18.1 % 16.5 % GTF 10.5 % 9.5 % CH-53 Helicopter 7.4 % 6.3 % F-35 Lightning II 4.0 % 18.6 % F-15 Eagle Tactical Fighter 2.1 % 3.8 % All other platforms 14.7 % 16.4 % Total 100.0 % 100.0 % Based on the significant easing of the 2023 supply chain issue discussed above and expected delivery dates for products used in all our other platforms and programs, we expect fiscal 2024 sales to increase as compared to the level we achieved in 2023. Gross Profit: Gross profit for the year ended December 31, 2023, amounted to $7,428,000, comparable to the $7,452,000 achieved in 2022. Our gross profit percentage in fiscal 2023 increased to 14.4% from the 14.0% we achieved in 2022. This improvement can be attributable to changes in the sales across our major platforms, shifts in product mix, and overall operating efficiencies. Operating Expenses : In fiscal 2023, operating expenses totaled $7,723,000, slightly higher than the $7,646,000 recorded in 2022. As a percentage of consolidated net sales, operating expenses rose to 15.0%, compared to the 14.4% achieved in fiscal 2022. The increase in both dollars and percentage was primarily driven by higher professional fees and costs associated with the improvement of our information technology system and hardening our cyber-security protection. We continue to look for ways to reduce our costs and improve our operating performance and financial results. Interest Expense: Interest expense (which includes amortization of deferred financing costs) was $1,920,000 in fiscal 2023, an increase of $582,000 or 43.5% from $1,338,000 in 2022. The increase is primarily attributable to an increase in the average interest rate on outstanding debt pursuant to our Current Credit Facility which increased to 7.55% in 2023 as compared to 4.50% in 2022. Net Loss: Net loss for the year ended December 31, 2023 was $2,131,000, compared to a net loss of $1,076,000 for the year ended December 31, 2022, for the reasons discussed above. LIQUIDITY AND CAPITAL RESOURCES As of December 31, 2023, we have debt service requirements related to: 1) Outstanding indebtedness under our Current Credit Facility of $15,849,000 (consisting of a Revolving Loan of $10,804,000 and a Term Loan in the amount of $5,045,000). This debt matures on December 30, 2025, and requires us to make monthly payments of approximately $79,000 in 2024. 2) Related Party Notes of approximately $6,162,000. This debt matures on July 1, 2026. Pursuant to the Current Credit 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 our Solar Facility for the installation of solar energy systems including the replacement of the existing roof at our Sterling Facility Under the terms of the Current Credit Facility, we are required to meet a Fixed Charge Coverage Ratio (as defined) that is determined at the end of each fiscal quarter. This ratio is a financial metric that we use to measure our ability to cover fixed charges such as interest and leases expenses as divided by EBITDA (as defined in the Current Credit Facility) which represents net income (loss) before interest, taxes, depreciation and amortization. As of December 31, 2023, we achieved a Fixed Charge Coverage Ratio of 1.31x as compared to the required ratio of 0.95x and were in full compliance with all other covenants. However, as of March 31, 2024, we were not in compliance with the required ratio of 1.10x. Although we have started discussions with our lender to receive a waiver with respect to our failure to meet the Fixed Charge Coverage Ratio at March 31, 2024, it is reasonably possible such waiver will not be granted. Even if such waiver is granted, we may fail to achieve the Fixed Charge Coverage Ratio in the future or otherwise fail to meet covenants in the Current Credit Facility. Therefore, we have classified the term loan that expires on December 30, 2025 as current as of December 31, 2023, in accordance with the guidance in ASC 470-10-45, “Debt – Other Presentation Matters”, related to the classification of callable debt. We are required to maintain a collection account with our lender into which substantially all of our cash receipts are remitted. If we were to default under our Current Credit Facility, our lender could choose to increase the rate of interest we pay or refuse to make loans under the revolving portion of the Facility and keep the funds remitted to the collection account. If the lender were to raise the rate of interest we pay, it would adversely impact our operating results. If the lender were to cease making new loans under our revolving facility, we would lack the funds to continue our operations. The rights granted to our lender under the Current Credit Facility combined with the possibility that we might fail to meet covenants in the future raise substantial doubt about our ability to continue as a going concern for the one year commencing as of the issuance of the opinion of our auditors contained in this report. 23 The following is a brief discussion of recent amendments to the Current Credit Facility (all of which have been filed with the SEC): ● On May 17, 2022, we entered into a Fourth Amendment that increased the Term Loan to $5,000,000 and reduced our monthly principal repayments requirements. It also provided for the establishment of a Capital Expenditure Line in the amount of $2,000,000 on which we can draw upon to purchase machinery and equipment. In 2022, we borrowed $878,000, and in 2023, we borrowed $739,500 against this Capital Expenditure Line. In connection with this amendment, we paid a fee of $20,000. ● On August 4, 2023, we entered into a Fifth Amendment that waived a default caused by our failure to meet the required Fixed Coverage Charge Ratio for the fiscal quarter ended March 31, 2023. Additionally, the amendment provided for a revised Fixed Coverage Charge Ratio for the fiscal quarters ending June 30, 2023 and September 30, 2023 and increased the amount of purchase money secured debt (or finance leases) we are allowed to have outstanding at any time to $2,000,000. In connection with this amendment, we paid a fee of $10,000. ● On November 20, 2023, we entered into a Sixth Amendment that waived defaults caused by the failure by us to achieve the Fixed Charge Coverage Ratio of the Fifth Amendment and because we purchased capital expenditures (as defined) in excess of permitted amounts. This amendment further revised the Fixed Charge Coverage Ratio by requiring it to be calculated on a rolling period basis and not be less than, (a) 1.10x (as calculated on a six-months basis) for the fiscal quarter ending March 31, 2024, (b) 1.20x (as calculated on a nine-months basis) for the fiscal quarter ending June 30, 2024, and (c) 1.25 (as calculated on a twelve-months basis) for all fiscal quarters beginning with September 30, 2024, until the Current Credit Facility expires. This amendment also increased our ability to make additional capital expenditures up to a limit of $2,500,000 in any fiscal year. In connection with this amendment, we paid a fee of $20,000. Although navigating the current business landscape remains challenging and it is difficult to predict period-to-period financial performance, we believe we will be able to meet our financial obligations for the foreseeable future. However, if we are unable to obtain a waiver from our lender and they were to cease lending, we would not be able meet our financial obligations. As of December 31, 2023, we have borrowing capacity of approximately $9,830,000 under the Revolving Loan (including $383,000 pursuant to the Capital Expenditure Line). In addition to required Term Loan payments of approximately $948,000 in fiscal 2024, we may have to make additional payments. For so long as the Term Loan under the Current Credit Facility remains outstanding, if Excess Cash Flow (as defined) is a positive amount for any fiscal year, we are obligated to pay 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 applied to the outstanding principal balance of the Term loan, on or prior to the April 15 immediately following such fiscal year. For the fiscal year ended December 31, 2023, based on the calculation there was no Excess Cash Flow payment required. In addition to the outstanding indebtedness under the Current Credit Facility and Related Party 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. Our material cash requirements are for debt service, capital expenditures and funding working capital. We have historically met these 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 cash requirements. However, if we are unable to obtain a waiver from our lender and they were to cease lending we may not have sufficient liquidity to meet our cash requirements for the next twelve months from the date of issuance of our consolidated financial statements included in this Report. 24 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, 2023 2022 Cash provided by (used in) Operating activities $ 4,862 $ 448 Investing activities (2,112 ) (2,361 ) Financing activities (2,685 ) 1,567 Net increase (decrease) in cash $ 65 $ (346 ) Cash Provided By Operating Activities For the year ended December 31, 2023, we generated cash flows from operations of $4,862,000 as compared to only $448,000 for fiscal 2022. The substantial increase in cash flows was driven by a significant reduction in working capital required during fiscal 2023, primarily the reduction of both accounts receivable and inventory levels. We also benefited from increased customer deposits primarily due to an advance payment by a customer to be used for the procurement of long lead time raw materials expected to be utilized during 2024. Cash Used In Investing Activities We continue to make significant investments to enhance our competitiveness and market position. Cash used in investing activities of $2,112,000 and $2,361,000, in 2023 and 2022, respectively, was for new property and equipment. We continue to make strategic investments in capital equipment to enhance our competitiveness. The investments in 2023 and 2022 increased production efficiency and speed, while maintaining closer tolerances. They also expanded the size of products we can manufacture. We expect to invest approximately $2,000,000 in 2024 for new or upgraded equipment. Cash Provided by Financing Activities For the year ended December 31, 2023, cash used in financing activities was $2,685,000. During fiscal 2023, we reduced borrowings under our Current Credit Facility by $2,921,000 (consisting of net reduction in Revolving Loan borrowings of $2,548,000 and a net decrease of $373,000 against the Term Loan). We also made payments of $123,000 pursuant to financing lease obligations and $9,000 on a loan payable. During fiscal 2023, we also took advances of $393,000 against the Solar Facility including originations fees of $25,000. For the year ended December 31, 2022, cash provided by financing activities was $1,567,000. During fiscal 2022, we increased borrowings under our Current Credit Facility by $2,130,000 (consisting of a net increase in Revolving Loan borrowings of $916,000 and a net increase of $1,214,000 against the Term loan). We also made payments of $284,000 pursuant to financing lease obligations. $250,000 of Related Loan principal repayments, and $9,000 on a loan payable. During fiscal 2022, we paid $20,000 of amendment fees. 25 Critical Accounting Estimates A critical accounting estimate 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. Use of Estimates. The preparation of financial statements in accordance with generally accepted accounting principles in the U.S. requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The financial statements include estimates based on currently available information and our judgment as to the outcome of future conditions and circumstances. Significant estimates in these financial statements include, inventory valuation, useful lives and impairment of long-lived assets, income tax provision, and allowance for credit losses. Changes in the status of certain facts or circumstances could result in material changes to the estimates used in the preparation of the financial statements and actual results could differ from the estimates and assumptions. Below is a description of our critical accounting estimates: ● Inventory Valuation, which includes the estimates and methodology used in accounting for the transition of production costs to inventory costs. In our consolidated financial statements, inventory is reflected at the lower of cost or net realizable value. The Company periodically evaluates inventory items not secured by backlog and establishes write-downs to estimated net realizable value for excess quantities, slow-moving goods (defined as goods which do not have an open order and have not had movement for two years), obsolescence and for other impairments of value. ● Impairment of Long-Lived Assets. We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of the corresponding asset group may not be realizable. If an evaluation is required, the estimated future undiscounted cash flows associated with the asset group are compared to the asset group’s carrying amount to determine if an impairment of such asset is necessary. This requires us to make long-term forecasts of the future revenues and costs related to the asset groups subject to review. Forecasts require assumptions about demand for our products and future market conditions. Estimating future cash flows requires significant judgment, and our projections may vary from cash flows eventually realized. Future events and unanticipated changes to assumptions could require a provision for impairment in a future period. The effect of any impairment would be reflected in operating income in the Consolidated Statements of Operations. In addition, we estimate the useful lives of our long-lived assets periodically review these estimates to determine whether these lives are appropriate. ● Income Taxes. We account for income taxes under the asset and liability method, based on the income tax laws in the United States. This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities using expected rates in effect for the tax year in which the differences are expected to reverse. Developing the provision for income taxes requires significant judgment and expertise in federal, international and state income tax laws, regulations and strategies, including the determination of deferred tax assets and liabilities and, if necessary, any valuation allowances that may be required for deferred tax assets. The Company has recorded a valuation allowance in the current and prior years to reduce deferred tax assets to zero. If we were to subsequently determine that we would be able to realize deferred tax assets in the future in excess of its net recorded amount, an adjustment to deferred tax assets would increase net income for the period in which such determination was made. We will continue to assess the adequacy of the valuation allowance on a quarterly basis. Our judgments and tax strategies are subject to audit by various taxing authorities. ● Allowance for Credit Loss on Accounts Receivable. We account for Credit Losses on Accounts Receivable using ASU No 2016-13, “Financial Instruments – Credit Losses (Topic326): Measurement of Credit Loss on Financial Instruments.” Under this ASU, accounts receivable must be evaluated on a forward-looking “expected loss” model, which will generally result in the earlier recognition of allowances for credit losses. 26 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.