Air Industries Group Q2 FY2022 Earnings Call

Good day and welcome to the Air Industries Conference Call. Today’s conference is being recorded. Now for Air Industries' 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’d like to turn the conference over to Lou Melluzzo, President and CEO. Please go ahead, sir.

Thank you, Anna. Good afternoon, everyone, and thank you for joining us today. Air Industries made progress on several fronts in the second quarter of 2022. Let me focus on comparisons to the first quarter of 2022 as the industry and market conditions were most similar. Our second quarter sales increased by 16.1% from the first quarter of 2022. Gross profit dollars increased 16.7% sequentially and represented 17.3% of sales versus 17.2% of sales in the first quarter of 2022. Operating income increased nearly 20% from the first quarter of 2022. Adjusted EBITDA in the second quarter was nearly $1.2 million, an increase sequentially of 13.3%. As a percentage of sales, adjusted EBITDA was 8.5% for the 2022 second quarter versus 8.7% of sales in the first quarter. Despite this financial progress compared with the first quarter of the year, our results were below the second quarter a year ago, as detailed in the press release today. Supply chain disruptions have been a major factor impacting our performance and that of many other manufacturing businesses throughout 2022, causing significant delays in receiving materials. The supply chain challenges heightened further in the second quarter with raw material delays, compounded by delays in outside processing. For example, there is now a six month to nine month lead time to receive shipments of titanium used in many of our products, as the war in Ukraine drags on and Russian sanctions remain in place. Prior to the war, those two countries were the largest suppliers of titanium to the U.S. While alternative sources are being tapped, the new sources are near capacity. So we expect titanium issues to be with us for the remainder of the year. Even with these ongoing challenges, we made important operational progress in the second quarter; that includes the installation of a paint facility at our Sterling Engineering subsidiary in Connecticut, which is now complete and qualification is underway. I discussed last time that adding a paint capability in one of our facilities is one of the steps in our vertical integration plan. We are proceeding with our strategy to boost the cost and risk of outsourcing major processes and mitigating the sort of delays we experienced in the second quarter. Construction of the assembly area at our Sterling facility has also been completed. As we apply the manufacturing advances we have achieved at our complex machining facility on Long Island, we are leveraging the Sterling capacity to accelerate our marginal growth and drive our EBITDA. The new assembly area will facilitate the assembly process for a substantial customer order. As I’ve discussed previously, grinding and non-destructive testing are among the other processes we are targeting to bring in-house. In fact, in the past three years, our capital investment has totaled $6 million. So far this year, we have written purchase orders for an additional $2.2 million. Our plan is to continually invest in and modernize our equipment, enabling Air Industries to manufacture world-class products more efficiently and more profitably. As many of you know, Air Industries addresses five major platforms, including the Sikorsky Blackhawk helicopter, the US Navy F-18 Hornet and the Northrop Grumman E-2D naval aircraft, the Lockheed Martin F-35 Lightning II fighter, and the Pratt Whitney Geared Turbofan, which is our entry into the commercial aviation market. Since April of 2021, we have won new LTAs and product orders for all these platforms. In the first half of the year, we achieved especially strong growth in our sales for the E-2D and the Geared Turbofan. The E-2D Advanced Hawkeye is the Navy's airborne early warning aircraft. The E-2D and its earlier variants have been an important platform for our Long Island subsidiary for decades, and we manufacture complete, ready to install landing gear as a Tier-1 supplier to the original equipment manufacturer. In February, we announced that we received a $12.4 million order to produce complete main landing gear and ancillary components for the E-2D. Deliveries for this order are expected to begin next year and be completed in 2024. The strength in our Geared Turbofan sales, which are mainly for smaller aircraft including the popular Airbus A220, Embraer E2 jets reflects the accelerating build rates in commercial aircraft overall. Additionally, you may remember that in January, Sterling Engineering was awarded a life of program extension for an LTA to deliver turbine exhaust case components for the PW4000 jet engine, with expected revenue to exceed $6 million over its remaining term. The LTA also met one of our key corporate objectives for Sterling Engineering, which is to transition a larger product mix into long-term agreements. While not listed among our five major platforms, Air Industries is a long-time supplier for the CH-53 helicopter. We saw strong growth in the half-year sales for our CH-53 platform. Another victory for Sterling Engineering this past October—they were awarded an LTA to deliver chaff pods for the new CH-53K, which is the heavy lift helicopter. A sea-based, long-range heavy lift helicopter providing three times the lift capability of its predecessor and exceeding all other DoD rotary wing platforms. Production of this helicopter is forecasted to increase from four aircraft in 2022 to nine in 2023, and 15 in 2026. It is expected that the CH-53K will remain in production until 2032 and beyond. Six months of sales were lower for the balance of our platforms. It is not unusual to see flow vary through the year and between years depending on the status of government funding for different programs and inventory levels at our customers. Turning to the medium and long-term outlook, we attended the Farnborough Airshow this year and found the tone among customers to be upbeat, while we are realistic about ongoing industry production challenges. Relatively, I should note that many pandemic-related restrictions have been lifted and the industry is returning to a more normal cadence of business development, including face-to-face meetings and trade shows. Air Industries has been taking advantage of this normalized environment to ramp up our business development activity. This effort has started to gain traction. We have received a number of requests for quotation RFQs, which represent the first step in the sales process, and now have over 100 active prospects in the pipeline. For example, we have engaged with several new landing gear companies that have already yielded RFQ activity. As part of our growth strategy, we are also targeting adjacent markets that are a natural fit with our capabilities. For example, we have focused on the nuclear submarine industry and recently received our first order. We hope for dramatic growth from this new market over time. We have also received vendor numbers and are seeing RFQ activity from a major space company. It is exciting to be able to meet with clients in person again and pursue new opportunities for Air Industries Group. As we look to the balance of the year, we expect our current challenges to continue as well. However, we still anticipate the second half of the year to be better than the first half, with stronger growth shifting into 2023. That said, we remain highly optimistic about the long-term prospects of Air Industries as we continue to serve major defense and commercial aerospace programs with growing demand, while enhancing our performance by vertically integrating our processes and making strategic capital investments to become even more valuable partners to our customers. Let me turn the call over to Michael Recca, our CFO, for his financial report, which will follow with a questions-and-answers session and some concluding remarks. Mike?

Thanks, Lou. Let me provide some additional color on the next quarter 2022 results. Sales in the second quarter increased by $1.9 million compared to the first quarter of the year, but were $1.4 million lower than in Q2 of last year. For the six months, sales were $26.1 million, reflecting a reduction of $3.1 million compared to the six months of 2021. Of that $3.1 million decline, about half related to two products. First, some landing gear for the A380 aircraft, which you may recall has been taken out of production and this resulted in a stop work/cancellation order from our customer. The second was a helicopter product that we've made for many years, but was at the end of its contract. Both of these products, for various reasons, we sold at a loss. So while sales were lower, we also avoided those losses in 2022. Now, some more comments about the decline in sales when I discuss inventory a little bit later on. Gross profit in the second quarter was $181,000 lower than last year and that's on lower sales. However, for the six months, gross profit was $100,000 higher in 2022. You have to keep in mind that for the most part, we use the gross profit method of calculating gross profit for interim periods of the year. This estimate is then refined following our yearly inventory count and valuation. The gross profit margin percentage we are using in 2022 is higher than in 2021. Operating expenses were essentially flat, increasing by just $9,000 in the second quarter and $110,000, or less than 3% increase, for the six months. I think in the current environment, a less than 3% increase year-over-year is pretty good news. Operating income was positive for all periods, but declined in Q2 by about $190,000 compared to the prior year. For the six months, operating income was essentially flat. Interest expense again was essentially flat for both periods, declining slightly by $44,000 in the second quarter compared to last year. For the six months, the decline was slightly smaller, $18,000, but again essentially flat year-over-year. For the past several years, our interest rate has been at a floor of 3.5% per year. Recent actions by the Federal Reserve have caused it to rise. Interest expense is calculated at 0.65% below prime. The prime now is at 5.5%, thus our interest rate has risen to 4.85% per year. Hopefully, the interest rate increases are now finished. Net income for the quarter was a loss of $7,000, an improvement compared to a loss of $28,000 in the first quarter of the year. For six months, a loss of $35,000 versus income of $87,000 last year. Switching to the balance sheet, it remains strong with no major changes. Our accounts payables and receivables all remain within normal limits. There are two items that I would like to discuss though. First, our term loan. As you may know, with Webster Bank, we have both a revolving credit line and a term loan. The term loan is secured by and used to buy equipment. In May, we renegotiated the terms of our term loan to finance further investments in machinery. We increased the amount of the loan to $5 million, about a $1.9 million increase. Some of that increase is used to reduce the revolver, but it's also used to pay off some capital leases that we had taken out to finance equipment purchases since we received the term loan in the beginning. In addition, we added a capital equipment line of credit for a total of $2 million. This $2 million can be drawn on to finance 85% of the hard cost of new equipment. All advances on the term loan, including the new line of credit, amortize over seven years, which is 84 months. We have already made deposits and progress payments of about $0.75 million for new equipment. It's being constructed, and some of it is currently in inbound shipping. This amount has been drawn from our revolving line of credit. The machinery is installed. These funds will be taken from the equipment line of credit and used to pay down the revolver. Second, I think this is an important point: since year-end, our inventory has decreased by $3.5 million. The majority of this increase is work-in-process and is concentrated on the F-18, the CH-53, and the E-2D platforms. Lou discussed the disruption delays affecting our production. The increased inventory reflects this. If you add the $3.1 million increased inventory to sales for the six months of $26 million, it gives you a total of about $29 million, which is essentially equal to the six months of 2021. Our view is that over time, this excess inventory will be completed and result in increased sales. That concludes my comments. I'll turn the call back to Lou and I look forward to your questions.

Thank you, Mike. Let me close this portion of the call by reiterating two central points that I made on our last call with a brief summary of today's comments. We have improved our relationship with customers and suppliers. We reduced our debt and established a supportive banking relationship. Very importantly, we have rationalized and consolidated our operations and are making critical investments in equipment to further drive our opportunity and profitability. Our operational achievements in the second quarter point to our progress. We also achieved quarter-over-quarter financial growth in the second quarter of 2022 despite heightened supply chain challenges, especially raw material delays that were compounded by delays in outside processing. Unfortunately, those challenges are expected to continue for the rest of the year. Let me also emphasize that we remain highly optimistic about the long-term prospects of Air Industries. We continue to serve major defense and commercial aerospace programs where demand is growing. We are developing new markets including nuclear submarines, space programs as well as other new opportunities. We are enhancing our performance by vertically integrating our processes, and we're making strategic capital investments to become even more valuable partners to our customers. We remain focused on driving our EBITDA growth. That concludes our report. At this time, I would like to turn the call over to Anna to open up the lines for our questions-and-answers session. Anna?

Yes, thank you. We have a caller in queue. Your line is open.

Hi, Lou and Mike. It's John Nobile from Taglich Brothers. You had said in your prepared remarks that you have about a six month to nine month lag in the time to receive titanium. So I was just curious what percentage of your product material cost actually relies on titanium? I mean, total material cost, just to get an idea of how much this is really affecting getting product out?

John, that was an example that I gave because titanium is a vital material for our products, and the war in Ukraine is really affecting that whole section of the globe which is high producing. We're having issues with Inconel as well. Your Turbofan product, which is an Inconel-based product, we won't see any materials for the first three or four months of this year. Now it's starting to trickle in. So there was a lag in time, and that's one of our best selling products that we have in-house. I attended the Farnborough show in England a few weeks back, and everyone there was singing the blues regarding the availability of raw material.

Okay. And in the first quarter of 2022, I know there were several announcements related to new orders. Since then, I haven't really seen any press releases in that regard. So I was curious if there were any new orders placed since the first quarter of 2022, and also if you can comment on what your current backlog is?

There have been no long-term agreements announced. In the first quarter this year, we announced some long-term agreements, and that's really a timing issue. A lot of our long-term agreements were expiring at the end of 2021, so we were able to sign those in the beginning of 2022. We have received orders against those. We will continue for the life of the agreement over the next five years. However, we haven't received any new long-term agreements to announce. We do have a pretty significant pipeline, so we are expecting to announce some soon. We are relatively conservative about announcing orders, releases as we call them, against LTAs.

Okay. In regard to the LTAs, I know, I believe, Lou, you had mentioned that you expect the second half of 2022 to be better than the first half. Is this primarily because of the LTAs in the first half of the year or are other orders that are helping your second half to be better?

Well, the materials that we were expecting late last year and early this year are starting to trickle in. So we're going to do what we can to get them out the door.

Okay. And another question, regarding 2021, I know that overdue product has seen substantial reductions, which is a very good thing. With the current supply chain issues, I'm curious if you've been able to keep that level relatively low or has it been creeping back up?

It remains relatively low. Remember, our past due orders are never zero. The nature of the business means customers order less than lead time. They are bound to end up past due. It has increased in the second quarter, but not materially.

Okay. No, that's good to hear. And speaking about the capital investments now. I'm sorry for cutting you off, Mike.

Go ahead. Part of the increase in past due was due to the Geared Turbofan where we had an interruption of raw material shipments. The products that would have been completed in April could not be made, consequently they were delivered late in June.

Okay. Well, thanks for that insight. You've made significant capital investments. As Lou mentioned, you've seen notable CapEx and that was all in an effort to alleviate the bottleneck issues that have persisted. I was wondering if you could talk a little about the progress that has been made in this area and compare it to maybe where you were a year ago?

Well, it's given us numerous options on what machines we can run products on. One of the problems that we had earlier on when I took over Air Industries was that there were several bottlenecks both in turning and milling, and we didn't have the options. As an example, we've gone from two 5-axis machines to six 5-axis machines of different sizes, and they can handle different size products. So we have some additional options on where to allocate this work to eliminate the bottlenecks. Because of that, we have reduced scrap yield substantially over the last couple of years.

So I mean with fewer bottleneck concerns than a year ago, would it be safe to say that if there were no supply chain issues, the first half results on the top line would likely have been better than last year?

At least equal to last year and perhaps a little bit better.

Okay. The second quarter gross margins were up 0.1% from the first quarter. Meanwhile, revenue grew by almost $2 million and I was hoping you could shed some light on why there was just that minimal change in the gross margins on a comparatively significant increase sequentially in revenue.

I tried to address that. Again, we use the gross profit method at Air Industries for the most part. Our gross profit last year was 18.5%. We use that as a guide, and unless we can discern some change in product mix or some other external factor, we use that during the year. The variance in gross margin is equal to the Air machining sales at 18.5% plus Sterling sales at whatever percent because they use a direct measurement approach. With overwhelming sales coming from CMS, that's why the margin remains at 18.5%. It will only adjust at year-end when the inventory is taken, assessed, and valued. Hopefully, it will go in one direction, which is up, based on our expectations similar to last year.

Yes, I noticed last year. I guess that really answered my question because last year in the fourth quarter, we saw a significant increase in your gross margins. The third quarter was 14% and then you showed 24.9%, almost a 15% increase in gross margin. So I guess this year we should anticipate a similar situation where the gross margins for the first three quarters remain steady, and then when inventory is a known factor at year-end, we will know what the true gross margin is? Do you feel there's a chance for a significant bump in that fourth quarter? I don't know if that's too early to tell at this point.

It's a bit too early to tell, but I do not expect we'll experience the same increase in the fourth quarter of '21 that took our gross margin from 14.5% to 18.5%. That entire increase had to be accounted for throughout the year and was booked in the fourth quarter. Last year, we had about $3.5 million to $4 million worth of products, and approximately $3 million of that was zero profit while $0.5 million had additional sales. We lost about $250,000. Without those this year, if we had not encountered those specific products, John, our gross profit for the year would not have been 18.5% but closer to 20%. I'm hopeful for an increase this year, but I do not expect it to be as significant as it was last year.

Okay. Fair enough. All right, Lou and Mike, I appreciate it. Thanks for making the call and for taking my questions.

Thank you, John.

And will pause for just a moment. We'll now move to our next caller. Your line is open.

Hi, yes. My name is Mike Atkins. My phone cut out right before you said something about a major space company. If you could just repeat that or elaborate a little bit for me. I really appreciate it. Thank you.

So Mike, I guess what we're saying is things are getting somewhat back to normal. It's been a while since the Department of Defense has been working remotely. Companies like Sikorsky, Collins, Boeing, a lot of people still working remotely, but things are starting to get back to normal. We’ve had an opportunity to have face-to-face time and we've really stepped up our business development activity because of it. We've come across a space company—similar to SpaceX and Blue Origin, and we've generated some coding activity. Hopefully, we can make something productive because that's the next frontier. Air Industries is primarily a landing gear company, but we are also a precision manufacturing organization. There are opportunities in each of those respective categories.

Okay. Thank you very much. I appreciate you filling me in on that. Thank you for taking my call.

Thank you for the call, Mike.

It seems there are no more questions from the phone lines. I will now hand the conference back to our presenters for any final comments.

Thank you, Anna. Once again, thank you all for taking the time to be on the call today and for your attention and questions. We look forward to updating you on the progress of Air Industries Group on our next call. Anna, with that, the conference is concluded. Please disconnect.

Yes, sir. Thank you. Once again, that does conclude today's conference. We thank you all for your participation. You may now disconnect.