Air Industries Group Q3 FY2021 Earnings Call

Good day, and welcome to the Air Industries conference call. Today's conference is being recorded. Air Industries Group 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 noncash depreciation and amortization charges, stock-based compensation expenses and nonrecurring 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 Mr. Lou Melluzzo, President and CEO. Sir, please begin.

Thank you, Chelsea. Good afternoon, everyone, and thank you for joining us as we summarize Air Industries' results for the third quarter and the first 9 months of 2021. Net sales in the third quarter were about $14.5 million, an increase of more than 5% compared to 2020. For the 9 months, sales were up about 22%. Our gross profit continues to improve, increasing by nearly 22% for the quarter and 44% for the 9 months. These increases are significantly greater than the increase in sales, illustrating our earnings leverage. Despite the local and global supply chain disruptions, we have made significant progress in improving our on-time delivery of product to customers. Since 2020, we have continually improved the composition of our 18-month backlog, which is comprised only of firm, fully funded orders from our customers. Our overdue product to customers has declined considerably, and more current orders have taken their place. Overdue product now accounts for less than 12.5% of the funded backlog and will continue to decrease in the fourth quarter. We are continuing a robust capital investment program and are budgeting an investment of $2 million to $2.5 million in 2021. We have already spent roughly $1 million and are expecting a delivery of additional machines by year-end. The pandemic served as an important reminder about being self-sufficient. And because of that, we are ramping up aggressive in-house processing initiatives. Over the next 2 years, we plan on bringing in-house several outside processes that have slowed down our production in the past. Granted, these outside processes are heavily regulated and require special permitting, so patience and a constant push are required. In the end, we will gain more control over the products we manufacture. I would like to turn the call over to our CFO, Mike Recca, for the financial recap. Then I'll return to open up the call for questions. Mike?

Thank you, Lou. We've already discussed sales and gross profit. So I'd like to focus on some other operating and balance sheet metrics. Our operating costs remain well controlled. Compared to 2020, for the quarter, our operating costs were flat with the prior year. For the 9 months, they were down close to 5%. So the inflation that seems to be emerging in the economy at large has not yet had an impact on our operations. As a result, operating income in the third quarter was positive. It grew by over $400,000. In 2021, we had a profit of $178,000 compared to a loss of nearly $0.25 million in 2020. For the 9 months, operating income improved by $2.2 million. In '21, we had a profit of more than $600,000. Last year, we had an operating loss of $1.6 million. I would like to point to some changes in the balance sheet, which I think are very positive that occurred during the quarter and the 9 months. First and foremost, inventory. Due to all the disruptions in 2020, inventory has been a problem since early in the year. Our inventory grew by some $5 million from about $28 million before the pandemic to a high of $33 million. Inventory has now declined to below $30 million and is down close to $2.8 million or 9% since year-end, and we think this is a major improvement. Our accounts payable and accrued expenses since year-end have declined by nearly $1.6 million or about 15%. Accounts payable and accruals now are about 45 days of sales outstanding, which we think is a pretty good level and metric. So between cash generated from operations, reducing inventory, and the balance sheet changes, we've been able to reduce our debt, which is principally bank debt, by about $3 million. So in summary, for the third quarter and the 9 months, sales, gross profit, operating income all improved; inventories declined; accounts payable declined; and debt declined. With that, I'll turn to Lou and to your questions.

Thank you, Mike. Let me close the call with a few thoughts. Despite the disruptions with transportation, rising fuel costs, the shortage of qualified workers, the new vaccine mandate for federal contractors, and general world uncertainty, Air Industries delivered a solid quarter and is profitable for the 9 months of 2021. The new equipment we purchased earlier in the year is proving its worth in reducing both cycle time and improving bottom line results. We look forward to continuing on this journey of improvement for the balance of the year. With that, Chelsea, I would like to open up the call to questions from participants, if you may?

Our first question.

Lou and Mike, it's John Nobile from Taglich Brothers. I just have a couple of questions. I just wanted to start with what is the current backlog, I don't know, either as of September or today?

Our current backlog is just above 80, around 82, John.

Okay. So the current backlog is around $82 million. Were there any shipments expected for Q3 that you think will be delayed into future quarters?

Well, John, we have that kind of every quarter. Every quarter, there's something that pushes. We've got enough work in the works that we kind of have that built into our budgets. It's not a perfect world. So we've always got more than we think we can do just for that to happen. There's always tie-ups here. There's tie-ups there. There's little hiccups along the way. Sometimes it's very small, sometimes it's major, but that's something we live with.

All right. I mean would you classify it as either small or major or somewhere in between for the third quarter?

There was a substantial amount this quarter.

I couldn't quantify it exactly, but there was a considerable amount of product that got delayed due to processing or other issues. So that effectively moved to a later time frame.

Sometimes, John, you have questions out to the government. And you know how quickly they react. So...

All right. But you anticipate that the fourth quarter numbers will be better than the third quarter?

Yes. I would see an improvement.

Okay. Okay. And you mentioned in your prepared comments that you projected to make anywhere from $2 million to $2.5 million in capital investments on new machines in an effort to grow your in-house processing. So I believe you said you already spent year-to-date approximately $1 million. So just doing the math, we're looking at about a $1 million to $1.5 million fourth quarter in investments in these machines. Is that correct?

Yes, that's right, John. We have a significant lathe arriving soon, hopefully within the next few weeks. I visited it last week, and it's ready for shipment. It should arrive around the third week of November for installation. This is part of the budget we've already allocated. To take more control over our operations, we've decided to set up in-house processing. In our Connecticut facility, we've designated about 23,000 to 25,000 square feet for this purpose. We are currently installing a paint booth and have already hired staff for it. This project is underway, and once it's operational, we will explore additional processing activities like grinding, Nital etch, and NDT. These processes are subject to strict regulations, particularly concerning permits from local and state authorities, which can be quite extensive. Nonetheless, we are making progress. Once we achieve this phase, we will proceed to the next steps. However, we will not become a chrome plating or NAT CAD facility, but there are many processes we can handle ourselves to improve our efficiency and enhance our inventory turnover.

We need to be faster and more reliable. Currently, when you send something for processing, it typically takes two weeks. When you follow up after those two weeks, you might hear that it's going to take another week, which means you're looking at a three to four-week gap in your budget. This can significantly disrupt your planning.

No, that's a good thing. I agree that doing as much in-house processing as possible is beneficial. I know your backlog is very healthy, and in the past, you haven't been able to make significant progress due to a bottleneck with suppliers. The more you can handle internally, the better your chances are of shipping out the 18-month backlog within that timeframe. I wanted to...

Over the summer, we experienced a slight improvement because the commercial aspect of the business is nearly nonexistent. This allowed some suppliers to serve us a bit more effectively. However, we are questioning how long this situation will continue, so we are proactively planning for the future. Commercial business will return, and when it does, we want to ensure we have control over our future.

I would like to ask about the CH-53 helicopter. I noticed you recently announced a $5.2 million long-term agreement for it. This seems to be based on existing orders. Could you clarify whether these existing orders are tied to the initial production of four aircraft scheduled for 2022, or if they are based on anticipated increases in production through 2026? I'm interested in understanding the specific existing orders for the helicopter mentioned in your press release. Additionally, are we considering long-term projections, possibly anticipating an increase to 15 aircraft in a few years?

I believe it's close to 10. It's not for the 4 aircraft in the next couple of years, but rather the first low-rate initial production. Now that $5.2 million is at the minimum that our customers indicated they will be producing, and we should be prepared for potential additional orders beyond that. This helicopter will likely receive additional orders from both U.S. military and foreign military sales.

It's a new platform, correct, the CH-53?

The derivation of CH-53 has been around. This is the K version.

Okay. So based on existing orders of approximately 10 of these helicopters. I just wanted to get an idea because you got 4 in 2022. I know the press release says 9 in 2023. That already is over 10, that's 13. And you're increasing to 15 aircraft, I believe, annually by 2026. So...

This is the rock bottom. We're very conservative on the numbers that we put out. We know that they're going to sell more helicopters than what we state in that release. Again, this doesn't include any foreign orders, anything. So we know that there's going to be a ramp-up in this thing once you get off this initial run.

For the third quarter, I don’t think Sterling experienced a loss; rather, they broke even on a gross profit basis. They showed strong gross profit over the past nine months. Looking ahead, with internal production and the addition of the CH-53 order, their gross profit should be significantly profitable moving forward.

Okay. Because I know that has a big effect on your overall gross margins when you had either breakeven or a negative gross margin in your Sterling subsidiary. All right. So in the fourth quarter, we should anticipate showing some revenue from this CH-53K?

Negative, John. Just because we received an order doesn't mean we'll start production immediately. These are long lead items, and we're currently developing them. You'll see some revenue from it sometime next year, but not in the fourth quarter.

All right. And speakers, we have no further questions in the queue.

Thank you, Chelsea. So with that, once again, thank you all for taking the time to call in and for your questions. With that, Chelsea, can you please conclude the call?

Thank you, ladies and gentlemen. We appreciate your participation. This concludes today's teleconference, and you may now disconnect.