AIR INDUSTRIES GROUP quarterly report, Q3 FY2020

Air Industries Group — Q3 2020 Form 10-Q

Reporting period: Three and nine months ended September 30, 2020. The company manufactures aerospace components and assemblies, principally for defense contractors, through Complex Machining and Turbine Engine Components segments. Figures below are unaudited.

Financial performance

Metric	Q3 2020	Q3 2019	Nine months 2020	Nine months 2019
Net sales	$13.662 million	$13.997 million	$35.603 million	$41.243 million
Gross profit	$1.656 million	$2.963 million	$4.451 million	$7.428 million
Gross margin	12.1%	21.2%	12.5%	18.0%
Operating income (loss)	$(0.240) million	$1.155 million	$(1.613) million	$1.311 million
Net income (loss)	$(0.477) million	$0.187 million	$(1.003) million	$(1.471) million

• Q3 diluted loss per share was $0.02, versus earnings per share of $0.01 a year earlier. Nine-month loss per share was $0.03, versus $0.05.
• Q3 sales declined 2.4%; nine-month sales fell 13.7%. Nine-month sales decreased in both Complex Machining (12.7%) and Turbine Engine Components (21.3%).
• Gross profit fell 44.1% in Q3 and 40.1% for the first nine months. Management attributed lower margins to COVID-related inefficiencies and added safety costs. Q3 operating expenses rose 4.9%; nine-month operating expenses rose 3.8%.
• Interest and financing costs declined 57.0% in Q3 and 58.2% year to date, primarily following the replacement of the PNC facility with the lower-cost Sterling National Bank (SNB) facility.

Cash flow, balance sheet and debt

• At September 30, cash was $1.460 million, working capital was $9.085 million, total assets were $58.764 million and stockholders’ equity was $11.352 million. Cash was $1.294 million and working capital $5.623 million at December 31, 2019.
• Nine-month operating cash flow was negative $3.184 million, compared with positive $0.270 million in 2019. Inventory growth used $4.194 million and receivables growth used $2.257 million. Capital spending used $1.471 million.
• Financing provided $4.821 million, including $3.340 million of net revolving-credit borrowings, $2.414 million in SBA loans and $0.984 million from stock issuance, partly offset by debt repayments and issuance costs. Cash increased by $0.166 million over the period.
• Notes payable and finance lease obligations totaled $29.373 million, including $15.883 million drawn on the SNB revolver, a $3.386 million SNB term loan, $6.018 million in related-party notes, $1.440 million in third-party convertible notes and $2.414 million in SBA loans. The SNB facility is secured by substantially all company assets.
• The company was not in compliance with all SNB loan covenants at September 30; the full SNB term-loan balance was classified as current. On November 6, 2020, SNB amended the facility, waived identified defaults through September 30, increased the term loan to $5.685 million and revised monthly principal payments to $67,679 beginning December 1, 2020.
• On November 3, third-party holders converted $1.225 million of notes and $210,282 of accrued interest into 1,063,272 shares at $1.35 per share. The company reported 31,729,755 shares outstanding as of November 4.

Management outlook, risks and unusual items

• COVID-19 reduced revenue and operating margins, especially in the second quarter, through absenteeism, supplier disruption, productivity impacts and program delays. Management said conditions were close to normal by September and suppliers had substantially returned to normal, but operating and macroeconomic conditions remained uncertain.
• Management cited a substantial backlog and stated that confirmed orders, operating cash generation, government loan programs and credit availability were expected to provide sufficient cash to support activities through November 1, 2021. This is a management estimate, not a guarantee.
• The company invested approximately $2.5 million in four machines and expanded its Connecticut operations. One machine was operational by September; the others were expected to be operational by December 31, 2020.
• The company received a $1.416 million tax refund from a CARES Act net operating loss carryback. It deferred $429,000 of employer Social Security taxes, repayable half in December 2021 and half in December 2022.
• The $2.414 million SBA loans remained outstanding. The lender approved the company’s forgiveness application and submitted it to the SBA for final review; forgiveness was not assured, and the company expected an audit because it received more than $2 million.
• Three customers represented 70.6% of Q3 sales and 74.2% of nine-month sales. The filing also identifies sole-source supplier exposure, fixed-price contract cost risk, and sensitivity to commercial aerospace conditions and defense demand.
• Material legal matters include CPI Aerostructures’ disputed claim of approximately $4.2 million relating to a subsidiary sale; a court denied CPI’s motion on procedural grounds, without resolving the merits. Contract Pharmacal seeks more than $1 million; the company disputed the claim and recorded no accrual because loss could not be estimated.
• The company recorded a $367,000 bad-debt expense for the first nine months. It reported no off-balance-sheet arrangements and stated that disclosure controls were effective.

Key facts for investors to verify

• Current borrowing-base availability under the SNB revolver, compliance with amended covenants, and the impact of the increased term loan on liquidity and debt service.
• Final SBA forgiveness and audit outcomes, and the timing and repayment terms if any loan amount is not forgiven.
• Whether sales, factory productivity and gross margins recover, particularly in Turbine Engine Components and commercial aerospace programs.
• Backlog conversion, capital-equipment commissioning and the cash requirements associated with inventory and receivables.
• Developments and potential financial exposure in the CPI and Contract Pharmacal disputes.
• Customer concentration, sole-source supply continuity, and dilution following note conversion and other share issuances.