Air Industries Group (AIRI) - Q2 2016 10-Q Summary
Business Context and Reporting Period
This report covers the quarterly period ended June 30, 2016. Air Industries Group is an aerospace manufacturer operating primarily in the defense sector, with growing exposure to commercial and industrial markets. The company operates through three segments: Complex Machining, Aerostructures & Electronics, and Turbine Engine Components. The company is classified as a smaller reporting company.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2016 | Six Months Ended June 30, 2016 |
|---|---|---|
| Net Sales | $19,363,000 | $34,547,000 |
| Gross Profit | $4,155,000 (21.5% margin) | $6,976,000 (20.2% margin) |
| Operating Income (Loss) | $(27,000) | $(1,618,000) |
| Net Loss | $(252,000) | $(1,682,000) |
| Net Loss Attributable to Common Stockholders | $(334,000) | $(1,764,000) |
| Cash and Cash Equivalents | $759,000 | $759,000 |
| Total Debt (Notes Payable & Capital Leases) | $40,833,000 | $40,833,000 |
| Working Capital | $6,741,000 | $6,741,000 |
Material Changes vs. Prior Period
- Revenue: Net sales increased 1.6% quarter-over-quarter (QoQ) to $19.4M but decreased 3.7% year-over-year (YoY) for the six-month period to $34.5M. The Q2 increase was driven by the Complex Machining segment, offset by declines in Aerostructures & Electronics (due to the absence of a biennial contract) and Turbine Engine Components.
- Profitability: Gross profit margin improved to 21.5% in Q2 from 20.4% in Q2 2015. However, the six-month gross margin declined to 20.2% from 23.0% in the prior year. Operating expenses increased 9.3% QoQ due to hiring for business development.
- Segment Performance:
- Complex Machining: Generated pre-tax income of $507,000 in Q2, up from $363,000 in Q2 2015.
- Aerostructures & Electronics: Reported a pre-tax loss of $167,000 in Q2, compared to a loss of $46,000 in Q2 2015.
- Turbine Engine Components: Reported a pre-tax loss of $738,000 in Q2, similar to the $735,000 loss in Q2 2015, driven by lower revenues at Sterling Engineering.
- Debt: Total debt decreased to $40.8M from $44.8M at year-end 2015, following a $1.5M payment to PNC Bank and the conversion of $1.75M in related-party notes to preferred stock.
Guidance, Outlook, Risks, and Unusual Items
- Capital Structure Changes: In May/June 2016, the company completed a private placement of 700,000 shares of Series A Convertible Preferred Stock, raising gross proceeds of $5.25M. $1.75M of this was netted against related-party promissory notes. The preferred stock carries a cumulative dividend of 12% annually for the first two years (payable in cash or PIK shares).
- Debt Covenants: The company is not in compliance with the minimum EBITDA covenant under its PNC Bank Loan Facility as of June 30, 2016. A waiver has been requested. The Fixed Charge Coverage Ratio covenant was excluded for Q2 2016. Due to a subjective acceleration clause and covenant breaches, all term loans are classified as current liabilities.
- Liquidity: The company is highly leveraged and relies on its PNC credit facility and equity/debt from principal stockholders. Cash collections are swept directly to the bank to reduce revolving debt. There is no assurance that additional equity or debt financing will be available on favorable terms.
- Controls and Procedures: Management concluded that disclosure controls and procedures were not effective as of June 30, 2016, due to material weaknesses in tax/financial reporting of complex transactions and inventory accounting (specifically tracking aging and obsolescence).
- Unusual Items: The company executed a sale-leaseback transaction in April 2016 for a Connecticut property, receiving $1.7M proceeds which were applied to PNC debt. The property is now recorded as a capital lease facility.
Investor Verification Checklist
- Covenant Compliance: Verify the status of the requested waiver for the EBITDA covenant with PNC Bank and the risk of debt acceleration.
- Preferred Stock Dividends: Monitor the company's ability to pay the 12% annual dividend on Series A Preferred Stock in cash versus issuing PIK (Payment-in-Kind) shares, which would increase dilution.
- Inventory Valuation: Review the methodology for inventory valuation (96% estimated via gross profit method) and the adequacy of reserves for obsolescence, given the material weakness in inventory controls.
- Customer Concentration: Note that four customers represented 54.0% of sales for the six months ended June 30, 2016, creating significant concentration risk.
- Segment Turnaround: Assess the outlook for the Turbine Engine Components segment, which continues to generate significant pre-tax losses.