Air Industries Group — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. The unaudited consolidated statements cover the aerospace and defense manufacturer’s continuing operations; WMI Group is presented as discontinued operations and classified as held for sale.
Financial performance and liquidity
| Metric | Three months ended Sept. 30, 2018 | Nine months ended Sept. 30, 2018 | Prior comparable period |
|---|---|---|---|
| Net sales | $11.043 million | $35.200 million | $13.690 million and $40.235 million |
| Gross profit / margin | $1.360 million / 12.3% | $4.951 million / 14.1% | $1.557 million / 11.4%; $5.531 million / 13.7% |
| Operating loss | $0.615 million | $2.287 million | $0.950 million; $2.888 million |
| Continuing-operations loss | $1.360 million | $4.585 million | $2.942 million; $6.286 million |
| Net loss, including discontinued operations | $3.130 million | $4.413 million | $2.880 million; $6.006 million |
- Revenue and segment trends: Q3 sales fell 19.3% year over year, with declines in Complex Machining (5.0%), Aerostructures & Electronics (83.2%) and Turbine Engine Components (36.7%). Nine-month sales fell 12.5%. Management attributed the declines to production disruption during AIM/NTW consolidation, lower Eur-Pac sales, lack of new turbine bookings/billings, and the prior-year completion of a large Eur-Pac order.
- Margins and expenses: Gross margin improved year over year in both comparison periods, but management cited product mix and said it believed margins could improve further. Operating expenses declined 21.2% in Q3 and 14.0% year to date; interest and financing costs also declined substantially. Lower expenses helped reduce the nine-month continuing-operations loss.
- Cash flow: Nine-month operating cash use was $2.866 million, versus $7.754 million in 2017. Investing used $1.029 million, compared with $2.929 million provided in 2017, which included subsidiary-sale proceeds. Financing provided $4.182 million; cash increased $287,000 to $917,000. Operating cash use included working-capital outflows, notably receivables, inventory, deposits and lower accounts payable.
- Balance sheet at September 30: Current assets were $51.159 million and current liabilities $38.367 million; reported working capital was $12.792 million. Total assets were $63.012 million, total liabilities $45.773 million, and stockholders’ equity $17.239 million. Cash was $917,000.
- Debt: Notes payable and capital lease obligations totaled $30.014 million, of which $24.047 million was current. PNC debt was $22.433 million, including a $20.070 million revolver and $2.363 million term loan; the PNC facility was secured by substantially all assets. The facility and term loan matured December 31, 2018. Related-party notes payable, net of discount, were $2.860 million; third-party convertible notes, net of discount, were $2.606 million.
- Equity and dilution: Weighted-average basic shares were 26.3 million for the first nine months of 2018 versus 13.5 million in 2017. The company reported 27,743,867 shares outstanding as of November 16, 2018.
Material changes, outlook and risks
- Going concern and financing: The company reported recurring operating losses and negative operating cash flow and stated that continued operations depend on reaching profitability and positive cash flow or obtaining further equity or other financing. It described itself as highly leveraged and dependent on PNC borrowing and capital raised from shareholders and other investors. It was in compliance with the amended PNC covenants at September 30, but that facility was due to mature at year-end 2018.
- WMI Group sale: The proposed $9 million sale to CPI Aerostructures had been terminated and was the subject of litigation. A subsequent October stipulation and November court order required delivery of audited WMI Group financial statements, after which CPI would have 21 days to close under the transaction terms. As of the filing, the audit was incomplete and the amendment to the sale agreement had not been executed. The transaction remained subject to conditions, including CPI financing, and required a $2 million escrow. WMI Group assets of $12.341 million and associated liabilities of $3.327 million were classified as held for sale. The filing recorded a $930,000 nine-month impairment/loss on assets held for sale; Q3 discontinued operations included a $1.770 million loss.
- Eur-Pac debarment: On November 8, 2018, the Navy notified Eur-Pac that it was debarred from future federal contracts until October 29, 2020. Management was considering completion of existing awarded work and planned to close Eur-Pac in Q1 or Q2 2019; management considered the expected impact on September 30 financial position immaterial. Eur-Pac recorded sales of $310,000 in Q3 and $1.554 million year to date.
- Other financing: During 2018, the company raised capital through private placements and related-party financing. In September, holders amended the 8% subordinated convertible notes, extending maturity to December 31, 2020 and changing interest and conversion terms; $921,968 of accrued interest was paid in shares. The company also sold $1 million of equity and warrants on October 1, after quarter-end.
- Operating and concentration risks: Three customers represented 67.4% of Q3 sales and 69.1% of nine-month sales. The company also identified sole-source supplier dependencies, competitive fixed-price bidding, volatile materials costs, skilled-labor constraints, and sensitivity of margins to sales volumes and product mix.
- Legal and accounting matters: Litigation included the CPI dispute, a sublease action, and a shareholder class action concerning the 2017 proxy and authorized shares; the company said it could not estimate a possible loss for the class action. Management could not estimate the final impact of the Tax Act accounting and maintained a full valuation allowance against net deferred tax assets. Inventory values were partly estimated at quarter-end without a physical count.
- Controls: Management concluded disclosure controls were not effective, citing material weaknesses involving inventory accounting, subsidiary close and consolidation/reporting processes, stock compensation, accounting staffing, and oversight. Remediation depended on hiring experienced personnel and implementing and testing controls.
- Management outlook: No quantitative revenue or earnings guidance was provided. Management said it was focused on customer needs and timely backlog execution, and expected the WMI sale to close in December 2018, subject to the stated conditions.
Investor verification priorities
- Confirm whether the PNC facility was renewed, refinanced or repaid after its December 31, 2018 maturity, and assess current covenant status and borrowing availability.
- Verify whether the CPI transaction closed, its final proceeds and adjustments, escrow/indemnity obligations, and any consequences of the related litigation.
- Assess the financial and operational impact of Eur-Pac’s debarment and planned closure, including remaining contract obligations.
- Track cash burn, financing needs, debt maturities and further equity issuance or dilution; reconcile the stated share count with subsequent securities issued.
- Monitor remediation of the disclosed material weaknesses and the reliability of inventory valuation and financial reporting.