Air Industries Group: Q3 2017 10-Q Summary
Business Context and Reporting Period
This report covers the quarterly period ended September 30, 2017. Air Industries Group (AIRI) is an aerospace manufacturer operating primarily in the defense sector, producing structural parts, assemblies, and components for military and commercial aircraft. The company is classified as a smaller reporting company and an emerging growth company. As of November 13, 2017, there were 23,282,831 shares of common stock outstanding.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2017 | Nine Months Ended Sep 30, 2017 | Dec 31, 2016 (Balance Sheet) |
|---|---|---|---|
| Net Sales | $17,278,000 | $50,515,000 | N/A |
| Gross Profit | $2,157,000 (12.5% margin) | $7,778,000 (15.4% margin) | N/A |
| Net Loss | $(2,880,000) | $(6,006,000) | N/A |
| Cash and Equivalents | N/A | N/A | $408,000 (Sep 30, 2017) |
| Working Capital | N/A | N/A | $8,050,000 (Sep 30, 2017) |
| Total Debt (Current + Long Term) | N/A | N/A | ~$30.7M (Notes & Leases) |
| Operating Cash Flow (9mo) | N/A | $(7,754,000) | N/A |
Material Changes vs. Prior Period
- Revenue: Net sales increased 10.0% ($1.6M) for the three months ended September 30, 2017, compared to the same period in 2016. For the nine months, sales were relatively flat, up 0.5% ($258,000). Excluding the sold AMK subsidiary, organic revenue growth was stronger.
- Profitability: Gross profit margin declined to 15.4% for the nine months ended September 30, 2017, compared to 17.9% in the prior year period. Net loss widened significantly to $6.0M for the nine months (vs. $3.7M in 2016), driven by higher interest costs and losses in the Turbine Engine Components segment.
- Interest Costs: Interest and financing costs surged 105.8% to $3.6M for the nine months ended September 30, 2017, compared to $1.8M in the prior year, due to increased debt levels and amortization of debt discounts.
- Liquidity: Cash and cash equivalents decreased from $1.3M at year-end 2016 to $408,000 at September 30, 2017. However, working capital improved to $8.05M from $2.9M at year-end 2016, largely due to a public offering and debt restructuring.
Guidance, Outlook, Risks, and Unusual Items
- Going Concern: The company explicitly states that the continuation of its business is dependent on achieving profitability and positive cash flow, or securing future equity/debt financing. The financial statements do not include adjustments that might be necessary if the company cannot continue as a going concern.
- Covenant Compliance: As of September 30, 2017, the company was not in compliance with its Fixed Charge Coverage Ratio covenant under its PNC Loan Facility. While waivers were obtained for prior periods, the failure to satisfy covenants constitutes a default, potentially allowing the lender to demand immediate repayment of all amounts.
- Capital Restructuring: In July 2017, the company completed a public offering of 5.175M shares at $1.50/share, raising ~$7.76M gross. Proceeds were used to pay trade payables, redeem convertible notes, and fund working capital. Subsequently, in October 2017, stockholders approved the conversion of all Series A Preferred Stock and remaining convertible notes into common stock.
- Asset Sale: The company sold its AMK subsidiary in January 2017 for $4.5M, recording a gain of $338,000. Proceeds were applied to debt reduction.
- Internal Controls: Management concluded that disclosure controls and procedures were not effective due to deficiencies in inventory control systems, automated time tracking, and the quarterly closing process.
- Goodwill Impairment Risk: While no impairment was recorded as of September 30, 2017, management noted that goodwill is at risk of impairment based on year-to-date performance.
Investor Verification Checklist
- Covenant Status: Verify the current status of the Fixed Charge Coverage Ratio covenant with PNC and whether a formal waiver or restructuring agreement is in place to prevent immediate acceleration of debt.
- Cash Burn Rate: Assess the sustainability of operations given the negative operating cash flow of $7.75M for the nine-month period and the low cash balance of $408,000.
- Inventory Valuation: Review the methodology for inventory valuation, noting that ~50% of the $39.2M inventory balance was estimated using gross profit percentages rather than physical counts for the interim period.
- Customer Concentration: Confirm the stability of the top four customers, who represented 67.9% of net sales in Q3 2017.
- Debt Structure: Analyze the remaining $21.9M debt to PNC and the $5.5M in 8% Subordinated Convertible Notes, including their maturity dates and interest rates.