Air Industries Group Q2 FY2020 Earnings Call

Good day, and welcome to the Air Industries Conference Call. Today’s conference is being recorded. Air Industries Group’s Safe Harbor statement. Except for the historical information contained herein, the matters discussed in this presentation contain forward-looking statements. The accuracy of these statements is subject to significant risks and uncertainties. Actual results could differ materially from those contained in the forward-looking statements. See the company’s SEC filings on Forms 10-K and 10-Q for important information about the company and related risks. EBITDA is used as a supplemental liquidity measure, because management finds it useful to understand and evaluate results, excluding the impact of non-cash depreciation and amortization charges, stock-based compensation expenses, and non-recurring expenses and outlays prior to consideration of the impact of other potential sources and uses of cash, such as working capital items. This calculation may differ in method of calculation from similarly titled measures used by other companies. At this time, I would like to turn the conference over to CEO, Mr. Lou Melluzzo. Please go ahead.

Thank you, James. Good afternoon, and thank you for joining us as we summarize Air Industries’ results for the second quarter and the first half of the year. In addition to discussing our results, we will also discuss the impacts of COVID-19 on our operations. As we continue to navigate through a new normal work environment, we are thankful that our workforce is staying healthy and safe. Air Industries results for the quarter were significantly impacted by COVID-19. As we have discussed before, we were affected by employee absenteeism particularly in April and May, which reduced production in our factories. In addition, our subcontractors and supply base were adversely affected as well, including plating, heat treating, painting, to name a few. During the quarter, many of the companies that provide us services completely shut down for extended periods. The combination of these factors impacted both production and shipping of product. Net sales for the quarter were just $8.5 million. During the quarter, and particularly in April and May, we chose to maintain employment and continue to produce even though it could not be immediately processed and shipped and would need to stay in inventory for a time. This caused our work in process inventory to increase by about $2.5 million. The sum of net sales and the increase in semi-finished inventory is roughly $11 million, which is much closer to our normal sales level of $13 million plus in the first quarter. As you know, Air Industries business is heavily concentrated on components for military aircraft. Unlike commercial aerospace, there has been little change in demand for military products. We have had some cancellations and reductions in our commercial business and we are filling these gaps by accelerating the production of military products. Our backlog, which consists of firm orders only, has only marginally reduced and remains at about $100 million. I would like to turn the call over to our CFO, Mike Recca for a financial recap, then I'll return to close the call. Mike?

Now as Lou said, our results for the first quarter are understandable. This is a disruption due to the virus affecting us and every other business in the country. Our sales for the quarter approximately $8.5 million, which is a 36% decline from the prior year. The effect on gross profit was more significant. Gross profit declined by $1.6 million or 76%. The decline of gross profit was greater than the decline of sales. Lou spoke about employee absenteeism and quantified this during the quarter. Total manufacturing hours were 8,000 hours less than in Q2 of 2019. With these fewer labor hours, we had under absorption of our manufacturing overheads. Nearly all, that would be 98% of the lost labor hours, occurred in April and May. For the quarter, our operating costs were essentially unchanged, a couple of hundred thousand dollars one way or another. The low interest rate on our bank debt, which we mentioned before, dramatically reduced our interest expense by more than 50%, which went from 992 in 2019 to 428 in 2020. Now for the six months, sales of $21.9 million is a decline of 21% and again, more than 90% of the decline for the six months occurred in the last three months of the second quarter. We had an operating loss for six months of $1.4 million and 95% of that loss is attributable to the second quarter. We had negative EBITDA for Q2 and our EBITDA for the six months was $894,000. We are in compliance with all the covenants of our loan agreement and expect to remain in compliance for the balance of the year and beyond. Lou, I'll turn the call back to you.

Thank you, Mike. Let me close the call with a few thoughts on the remainder of the year. We recently made an announcement of a major investment in equipment totaling about $2.5 million. These acquisitions, made at very attractive prices, will accelerate production and also greatly enhance the work envelope of the product that we can manufacture. It may seem counterintuitive to make these investments during the disruption caused by COVID-19, but we are in the enviable position of having orders in backlog that exceed our ability to fulfill them. These new machines will be installed and operating in the fourth quarter. They reflect our confidence in the future. This concludes the formal remarks this afternoon and I would like to open up the call to questions from participants. James, can you open up the lines please?

Thank you, and we'll take our first question.

Hi, good afternoon Lou and Mike. First I wanted to get into the second quarter which was adversely impacted by employee absenteeism and there were temporary closures which is understood with the virus. You mentioned the supply facilities. I was hoping if you could update us on how these conditions currently look?

Hi John, how are you today?

Good thanks.

It seems like everyone is starting to stabilize. Everybody is open for business right now. Some places have had an attrition in workforce. We've been lucky enough to maintain the workforce for the most part the way we were. We temporarily furloughed a few staff during the crisis, during the height of this virus, but we have since either hired back or brought those folks back and it was only a handful of people. But it seems like all our sub-tier suppliers, our supply base, our subcontractors, however you want to call them, are getting back to the cadence that we were accustomed to and helping with our products. So that's been stabilized to some degree. It might be with fewer folks but they are there and they are working.

Okay, not fully back as far as your suppliers are concerned, but obviously marked improvement since the second quarter, I can take it at that?

Active suppliers, yes. In terms of absenteeism, it has returned to normal; 2% or 3% on any given day, we are now around. Our absenteeism in the factories is at historical levels; it is back to normal.

All right. And I have a question regarding your $2.5 million machinery purchase orders which you said you anticipate will be operational in the fourth quarter. I was hoping that you could quantify how much of your bottleneck with suppliers you believe that this new machinery will alleviate or, if I could put it another way, what percentage of your bottleneck with suppliers will the new equipment be able to handle?

To put it in perspective, it is hard to give you a percentage, but I'm going to explain how this thing works. The equipment that we purchased includes a new five-axis machine that greatly enhances the size capability of our product. For instance, our largest product was 48 inches or 50 inches; this machine allows us an envelope that's another foot beyond that. So it gives us access to other products that we were either not doing effectively or puts us in a position where we can quote larger work. It also eliminates bottlenecks in existing equipment. We have had the smaller 800 mm pallet machine in our facility for a while; this is the 1000 mm machine that is the next step up in five-axis machining. So that opens up some new doors. It takes out bottlenecks from the existing equipment that we had and it has all the newest technologies in it; all the 1000 whistles in process inspection that help us really inspect the product without having to take it off the table. So it does a lot in that respect. The other two pieces of equipment we bought are additional five-axis machines, which are smaller in size. The envelope there is about 39 and 40 inches, let's call it for all intents and purposes. The beauty of these machines is what we call a lights-out cell. The machines are integrated into a pallet system with 28 different pallets that can be loaded and unloaded while the machines are working. You really can load 28 pallets with different work, push a button, and walk away for the weekend. The machine will inspect the parts and tell you when it is done. If there is a problem, it glows a red light and stops the process; it's called a lights-out cell because it could work around the clock. With the right work, it can work around the clock, which is another feature that Air Industries has not had in the past, and it breaks new ground for the type of work we can do that we would not have been competitive in the past. The last piece of equipment that we purchased was a vertical mill. Now we have a 48-inch capacity vertical mill now, which goes up to eight inches in diameter and 48 inches in stroke. This new mill goes 60 inches in length and stroke and up to 16 inches in diameter, which again is for products we would have passed on in the past and now we could effectively manage. So it not only eliminates bottlenecks with one mill being replaced by another mill but it gives us access to bigger products.

And this here obviously won’t take care of the entire bottleneck; it sounds like you are going to have to outsource, but would you say that it would alleviate at least a significant portion of your current bottleneck right now?

It would definitely. Well, yes and yes. So it would eliminate a bottleneck and would eliminate the risk of having one machine that does that breakdown and fails while opening up capabilities. So it provides, it solves a couple of different problems, John.

Okay, I just wanted to get an idea, because obviously with the backlog I think you mentioned over in your comments it is still floating around the $100 million mark, that’s the firm backlog for about 18 months, correct?

That is correct, yes.

I just want to get a handle on this because significant investment in the machinery, which is a good thing, I mean if you can alleviate that bottleneck to some percentage that is great because I realize without that bottleneck, you could probably be doing over $17 million quarters on the top line if you dispersed the backlog over six quarters evenly. So that's why I was just trying to get a handle on how much of this bottleneck would be alleviated by these purchases. Forgive me for being the analyst trying to get percentages, but I just think, bottom line is this is only going to help to get product out the door faster and to help bring that backlog down much quicker.

Faster and more efficiently.

Yes, okay, and this should be fully operational by the fourth quarter, is what you said? All the equipment?

The machines were available, and these machines, the five-axis typically have a 12 to 14 month lead time, but an OEM cancelled an order due to a commercial business going away. So that machine is available right now in a warehouse. We just poured the foundation in the last week and it has to dry for four weeks. By the first week in September, that machine could be in our facility.

Beautiful, good for you. And I just have one final question. If I can get into the commercial business, I know that's significantly depressed currently, but is there anything to report regarding the long-term agreement for the thrust struts? I know Mike, you love to hear me say that word thrust struts. That was announced back in January; it was significant. I'm just hoping that there is some life still to this. Is there anything to report on this going forward at least in the next six months or so?

Yes, we have been told to expect a push out on the thrust strut order; not a cancellation but a reduction in requirements for the balance of this year and next. We are still trying to finalize what that would be. We have had that event and further we have some products for the A380 that they had outright cancelled and that we were repaying that termination. The good news is we were nearly done; I don't know what the percentage is, so we will repay the balance for what we would have been paid for as we finished the product. Then these holes that have been created we have been able to fill by accelerating military products, military components that the governments want to receive as soon as we can get them done.

Looking out, I'll conclude, looking through the Q, you did have some sales in the second quarter of commercial sales. Did the thrust struts order contribute to any of that revenue in the second quarter in the commercial segment?

Yes, we did make shipments of thrust struts in the second quarter.

Okay.

I don’t have the specifics...

Could you quantify that?

I can't.

Okay, all right, that's all I had. Thanks for taking my questions.

Always a pleasure, John.

Thank you, John.

And that will conclude today's question-and-answer session. I will now turn the conference over to Mr. Lou Melluzzo for any additional closing remarks.

Thank you, James. So with that, this concludes our formal remarks this afternoon and thank you for calling and for your attention and questions. The conference is now concluded, and I would like to thank James for his assistance.