Air Industries Group — Q2 2018 Form 10-Q
Business context and reporting period. The aerospace and defense manufacturer reported for the quarter and six months ended June 30, 2018. Its operations span Complex Machining, Aerostructures & Electronics, and Turbine Engine Components. Results include WMI Group as continuing operations after the company ended its planned sale of the group.
Financial performance and liquidity
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Net sales | $15.817 million, down 7.4% year over year | $30.602 million, down 7.9% |
| Gross profit / margin | $2.311 million / 14.6%; prior year 17.1% | $4.702 million / 15.4%; prior year 16.9% |
| Operating income (loss) | $973,000; prior year loss of $1.198 million | $267,000; prior year loss of $1.717 million |
| Net income (loss) | $185,000; prior year loss of $1.972 million | Loss of $1.283 million; prior year loss of $3.126 million |
| Net income (loss) per share | $0.01; prior year $(0.36) | $(0.05); prior year $(0.51) |
| Operating cash flow | Six-month use of $3.074 million; prior-year use of $3.396 million |
Second-quarter earnings included a $1.563 million noncash gain from reversing the prior impairment reserve on WMI Group assets held for sale. Excluding the gain, reported operating and pretax performance was weaker than the headline operating income and near break-even pretax result suggest.
At June 30, cash was $405,000, working capital was $9.257 million, total assets were $63.402 million, and stockholders’ equity was $18.262 million. Current liabilities were $40.519 million. Inventory was $39.045 million; the company estimated about half of interim inventory using gross-profit percentages rather than a physical inventory count.
Total notes payable and capital lease obligations were $29.694 million, including $21.986 million owed to PNC. PNC debt comprised a $19.253 million revolving loan and a $2.733 million term loan. The PNC facility, secured by substantially all assets, matures December 31, 2018. The company also reported $4.775 million of 8% subordinated convertible notes, with $2.575 million due November 2018 and $2.200 million due February 2019. Cash declined $225,000 during the first half, as financing cash inflows of $3.678 million did not fully offset operating and investing cash use.
Material changes versus prior periods
- Sales and gross profit declined in both the quarter and first half; gross margins contracted. Management attributed margin pressure primarily to product mix.
- Complex Machining quarterly sales fell 7.3%, with production disruption during the AIM/NTW consolidation. Aerostructures & Electronics first-half sales fell 14.7%, mainly due to a prior-year large EPC order. Turbine Engine Components first-half sales fell 33.2%, reflecting AMK’s 2017 sale and weak Sterling billings.
- Operating expenses decreased 29.5% in Q2 and 18.3% for the first half, primarily due to lower salary and amortization expense. Interest and financing costs also declined modestly.
- Shares issued and outstanding increased to 26.43 million from 25.21 million at year-end 2017. The company raised equity and related-party debt during the period and issued an additional 322,000 shares for $460,460 in July.
Outlook, risks, contingencies, and unusual items
- Going concern and funding: Management says continued operations depend on achieving profitability and positive cash flow and, until then, obtaining additional equity or other financing. The company has a history of operating cash outflows and substantial reliance on external financing. It reported compliance with the amended PNC covenants at March 31 and June 30, 2018, but the facility’s December 31, 2018 maturity creates a near-term refinancing risk.
- PNC terms: The May 2018 amendment waived specified prior covenant violations and introduced minimum EBITDA tests, including $1.2 million for the nine months ending September 30, 2018. It also restricts dividends and limits capital expenditures.
- WMI sale litigation: The company terminated its agreement to sell WMI Group to CPI Aerostructures; CPI sued seeking specific performance, damages, and fees, and sought a preliminary injunction. Air Industries denies the claims and is pursuing counterclaims. The filing does not provide a clear estimate of potential loss.
- Federal contracting: Eur-Pac received a Notice of Proposed Debarment after contract performance failures. The company appealed and was awaiting the government’s response; a debarment could prevent Eur-Pac from bidding on federal contracts.
- Concentration and operations: Two customers represented 49.2% of first-half sales, and two customers represented 49.8% of gross receivables at June 30. The company also depends on certain sole-source suppliers and faces volatile materials costs, skilled-labor constraints, and variable factory utilization.
- Controls and estimates: Management concluded disclosure controls were not effective, citing material weaknesses in inventory accounting, subsidiary close and consolidation processes, period-end reporting, stock compensation, staffing, and supervision. Remediation was incomplete. Interim inventory estimates and the WMI reserve reversal warrant attention.
- Management commentary: Management believes it can improve gross margins and says it is aligning production to customer needs and executing backlog; no quantitative sales or earnings guidance was provided. The company also noted that it is assessing the effects of new revenue and lease accounting standards.
Important facts for investors to verify
- Whether the company refinanced or extended the PNC facility before its December 31, 2018 maturity, and whether it continued meeting lender covenants.
- Whether operating cash use, working-capital needs, and low cash balances improved without further costly financing or dilution.
- The outcome and financial exposure of the CPI litigation, and the government’s decision on Eur-Pac’s proposed debarment.
- Whether gross margins recovered and whether production disruptions and weak Turbine Engine Components bookings were resolved.
- Whether the disclosed material weaknesses were remediated, and whether inventory estimates or WMI-related accounting required further adjustments.