Earnings Call Transcript - AIRI Q1 2021

Operator, Operator

Good day, and welcome to the Air Industries Group Conference Call. Today's conference is being recorded. 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 Form 10-K and 10-Q for important information about the company and related risk. 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 Lou Melluzzo, President and CEO. Please go ahead.

Luciano Melluzzo, President and CEO

Thank you, Todd. Good afternoon, and thank you for joining us this afternoon as we summarize Air Industries' results for the first quarter of 2021. And we apologize for yesterday's confusion for anyone who tried to call in. Business has returned to normal, and it is not a new normal. During December of last year, we experienced some COVID-19-related absenteeism, which delayed some shipments in Q1. Despite this, we were able to achieve a modest increase in sales. The industry has begun to stabilize. A lot of companies are requesting that their employees return to the workplace, and businesses across the board are starting to get back to capacity. We now find ourselves, like many other companies, competing with the stimulus packages put out by the government, and these are creating difficulties in finding employees. We currently have 8 to 10 open positions for CNC machinists alone, and like so many other businesses, we are struggling to fill them. I would also like to give an update on our capital investment program. Last year, we invested over $4 million in new equipment, a total of 5 large new machines. All of this equipment is up and running. We also moved some equipment from Long Island to our Sterling engineering facility in Connecticut. These machines are starting to produce military products as an offload from our New York operation. In essence, we have partially solved the problem of finding help by filling some open capacity created by the decline in commercial work. These investments have been very well received by our customers. Perhaps, in part, this accounts for the rebound we have seen in RFQ, that is request for quote activity and new business bookings. During the first quarter, we booked over $22 million in new business. We closely monitor our book-to-bill ratio, the ratio of new business booked compared to sales. Our goal is to maintain a ratio of 1.2:1. For the trailing 12 months ended March 2021, we are just 1 point shy of this goal at 1.19:1. These bookings have kept our backlog strong at $84.7 million. And again, this represents firm fully funded orders from our customers. As you may know, Air Industries business is predominantly defense, about 85%, with the balance in commercial aerospace. The negative effects of the COVID-19 pandemic have been felt primarily in the commercial segment of the market. We have been very lucky. While we have seen some cancellations of commercial orders for landing gear products, these have been fully offset by increases in products we make for jet engines for both ground-based and airborne applications. One of our products is used on smaller regional airliners, which is in high demand from the airlines. I would like to turn the call over to our CFO, Mike Recca, for the financial recap. Then I'll return with my closing thoughts and open up the call to questions. Mike?

Michael Recca, CFO

Thank you, Lou. As Lou mentioned, sales for the first quarter were slightly higher than the first quarter of 2020, with the increase being about 2%. Gross profit for the quarter was a little disappointing. Gross profit declined by about $400,000 compared to last year, and it was about 13% of sales. Now this was caused by several factors: first, we had increases in manufacturing overhead costs, in particular, costs for employee benefits and depreciation. Employee benefits, particularly health insurance, increased as a new plan year began in January, and depreciation increased because we spent $4 million on new equipment. Gross profit as a percentage of sales was also depressed due to the cancellation of the commercial aircraft order, where we just recovered our cost and had no profit but had revenue. Also, as Lou said, we've had difficulty finding help. We have fewer production employees in 2021 than we did in the prior year, which reduced total production hours in the shop. For the quarter, we were about 5,000 hours less this year than last year in 2020. The good news is that sales increased with fewer hours. The bad news is that each of these hours carried a higher overhead burden. So hopefully, when the special incentives to remain unemployed end, we can fully staff up. Then hours should return to levels in 2020, and additional hours should absorb the increased costs. The decline in gross profit was more than offset by lower operating costs. Operating costs for the quarter were about $500,000 less than in 2020. So gross profit was down $400,000, operating costs down by $500,000, with a net gain of $100,000 for the quarter. As a result, operating profit increased by $108,000 as we had an operating profit in the first quarter this year compared to a loss in Q1 of last year. For the quarter, we had a small net loss of $152,000 compared to a profit in 2020. However, the profit in 2020 was entirely due to a COVID legislation-related tax benefit of about $1.4 million. Without this, our net loss last year would have been $356,000. So in 2021, we reduced the loss by more than half. For the quarter, we had EBITDA of $1.2 million and generated positive cash flow of $500,000. We reduced our bank debt by $160,000. Our cash on hand and accounts receivable increased by $360,000, and accounts payable and accrued expenses declined by close to $50,000. As a result, our liquidity position remains more than adequate. And with that, I'll turn the call back to Lou, and I look forward to any questions you might have. Lou, you're up.

Luciano Melluzzo, President and CEO

Thank you, Mike. Now let me close the call with a few thoughts. The disruptions of COVID-19 are becoming less and less frequent. Our clients are starting to allow some face-to-face meetings, and some are getting back into the office. We see these as positive trends towards conducting business as we are accustomed to. The new equipment is producing product. Internal bottlenecks are being addressed, so we remain very optimistic about our future. With that, I would like to open the call up to participant questions. Todd, would you please open up the lines?

Operator, Operator

And we'll take our first question. Caller, please go ahead.

John Nobile, Analyst

This is John Nobile from Taglich Brothers. I tried yesterday, but to no avail. So I have a few questions. First one, last month, you received orders in excess of $6 million for landing gear components for the F-18, and you expected to receive additional orders of this kind. I was hoping that you could talk a little about what your expectations are and possibly quantify this for the F-18 program going forward.

Luciano Melluzzo, President and CEO

Well, F-18, we are licensed to produce F-18 landing gear. That's an ongoing thing, so we're always quoting parts. This was a spot buy that's deliverable over, I think, Mike, was it 18 months or 2 years?

Michael Recca, CFO

I think it was 18 months.

Luciano Melluzzo, President and CEO

So we've got a lot of irons in the fire on F-18 parts, and it's just a matter of when they get around to placing an order or the requirements or the need is. As far as other orders, this is a year of LTAs for us. I got here in September of 2017. We were just taking off on a new package of LTAs that had just been introduced. Everything is coming due pretty much in 2021. There is the NY-10 with Sikorsky that is hopefully going to be ironed out before the end of this year.

Michael Recca, CFO

Multiyear.

Luciano Melluzzo, President and CEO

That's a 5-year contract with Sikorsky. F-35, it's another multiyear with another client that's going to be ironed out this year. The F-18, as we said, we received our first initial order, so I'm sure, over the course of the year, we will have other spot buys and other products that we're going to get involved with. There are a few irons in the fire.

John Nobile, Analyst

Okay. And in 2020, you made large capital investments in new machinery. I think it was $3.4 million. It was close to $4 million, all to help reduce...

Luciano Melluzzo, President and CEO

Yes. It was $4 million.

John Nobile, Analyst

Yes. $4 million. And this was all to help reduce the bottleneck that you had experienced with suppliers because you had a huge backlog, trouble getting the backlog out in I guess it was the 18-month period. So I just wanted to see if you could talk a little about the progress that you've made in this regard. And specifically how much of your backlog do you believe that you would be able to ship in the next 12 months with this new equipment?

Luciano Melluzzo, President and CEO

The new equipment has accomplished several key objectives for us: it has cleared our backlog and allowed us to work with larger parts. We purchased five pieces of state-of-the-art 5-axis machines, which are essential in manufacturing because they enable the production of nearly any component and complex geometries. This advancement has streamlined our processes, allowing us to program and manufacture parts in one go instead of relying on multiple machines. As a result, we have significantly increased our throughput capacity and gained the ability to tackle more intricate designs that were previously beyond our reach. In addition, we enhanced our honing capabilities by upgrading our machine, increasing the stroke from 48 inches to 60 inches, enabling us to handle larger components like axles. We also expanded our diameter capacity from 8 inches to 16 inches, enabling us to work with much larger diameters. We are now actively pursuing products that we could not address before, though these initiatives require time for definition, quoting, and in-house development. This is the direction we are heading in.

John Nobile, Analyst

So would you say that you've, for the most part, really alleviated the bottleneck, those problems, which really hindered your backlog from going out? I believe it's an 18-month firm backlog. Would you say that with this equipment at this point that you could successfully ship backlog in the next 18 months, the $84.7 million should not really be an issue at this point?

Luciano Melluzzo, President and CEO

I mean, no. Internally, our backlogs, I believe, have been addressed. So we did what we needed to do. There’s the outside processing that we’re still working on. We're trying to double up on everything. So there are still issues we're working through, but we made great strides, especially during the 12 months of COVID to seek out other avenues. There was one processing house in New York, but now we have another processing house in Connecticut or New Jersey or Georgia or sometimes in Ohio or California. So we had a little bit of time to kind of take a deep breath and kind of double up on everything. So we are working on the outside processes as well, which should make delivering on the backlog much more efficient.

John Nobile, Analyst

Okay. A substantial improvement in that, I mean, a large CapEx. So another question here, specifically, the COVID conditions, I believe they're starting to ease, and airlines are definitely enjoying more business from people traveling more. So I'm just curious to get your outlook for Sterling and if you expect profitability from this segment in 2021. I think you eked out a small gross profit in the first quarter. So I just wanted to get your outlook for the rest of the year.

Luciano Melluzzo, President and CEO

Yes, you are correct. We achieved a small gross profit in the first quarter at Sterling. The commercial market, particularly in smaller regional jets, is recovering faster than expected. Airline activity is clearly increasing, which is reflected in the rise in ticket prices. Initially, during the COVID period, commercial work began to pick up. However, when the parts supply from Pratt & Whitney and GE was delayed, they brought everything back in-house due to significant layoffs affecting thousands of employees at both companies. Now, as they have adjusted to the situation, we're starting to see a return of the work that had been pulled back. Consequently, our commercial sector is showing signs of vitality earlier than we had predicted.

John Nobile, Analyst

Well, that's good to hear, and I anticipate, obviously, gross margin is picking up sequentially going forward only due to Sterling being really a hindrance on the overall gross margin. So that's a big plus to see it in the plus column, at least on a gross margin perspective.

Luciano Melluzzo, President and CEO

I would like to point out that we have invested a considerable amount of effort in the military-related work on the machines we relocated from Long Island to our Sterling facility. The work has been transferred along with the machines. As a result, we are experiencing challenges in finding employees. We did not have significant layoffs, and despite the downturn in the aerospace commercial sector, we have kept our workforce intact and moved some work we had here to that location.

Michael Recca, CFO

Yes, John, in 2020, Sterling had approximately $400,000 in unabsorbed manufacturing overhead, which affected our margins. This year, our aim is to absorb that cost with the Long Island product to improve throughput. This would contribute to the profit recognized in the other segment, but the associated cost offset could be between $400,000 and $500,000, significantly enhancing their margins.

John Nobile, Analyst

No. That's great to hear. And you mentioned in the press release, $22 million in new business, which definitely helped your book-to-bill ratio. I was wondering if you could provide a breakdown of the specific programs of that $22 million in new business.

Luciano Melluzzo, President and CEO

Do not really have that at hand.

John Nobile, Analyst

The majority of it?

Luciano Melluzzo, President and CEO

There are numerous spot buys contributing to that figure, sourced from various clients and different avenues. It's not all coming from a single customer.

John Nobile, Analyst

All right. I wasn't sure if it was really geared towards a majority into 1 customer. So...

Luciano Melluzzo, President and CEO

No.

John Nobile, Analyst

Yes. I wanted to ask a question about the capital expenditures because last year it was close to $4 million. It was a necessary investment, but I understand that's not going to be the usual amount moving forward. Could you provide an estimate of what the capital expenditures might be for 2021?

Luciano Melluzzo, President and CEO

Well, John, we had some years of catching up to do. So we do...

John Nobile, Analyst

No. I know that. I mean I'm not going to expect $4 million in CapEx for 2021. I just wanted to get an idea.

Luciano Melluzzo, President and CEO

Yes. I mean, we're going to continually upgrade equipment on a yearly basis. It's not going to amount to $4 million, but there's always something better, faster, quicker. And we have our eyes set on that stuff because the only way to become world-class is to have new, great equipment to do work the most efficient possible way. So we're always going to make an upgrade. We're always going to make a repair. We're always going to try to buy a piece of equipment that can greatly enhance our workflow.

John Nobile, Analyst

Okay. Fair enough. And...

Luciano Melluzzo, President and CEO

It won't be to the magnitude that we had last year.

John Nobile, Analyst

No, I didn't expect that. I was hoping you could provide a number. For instance, you had $273,000 in the first quarter. I'm not sure if I should assume that number will remain consistent as what we should expect in the future.

Michael Recca, CFO

That seems reasonable. However, the $273,000 in the first quarter primarily consisted of soft costs related to the final installation of the existing $4 million invested in 2020. Sticking to a steady estimate of $275,000 for the year would not be excessive and would be a sensible projection.

John Nobile, Analyst

Okay.

Luciano Melluzzo, President and CEO

As an opportunistic opportunity, a good opportunity.

John Nobile, Analyst

I just wanted to understand what to expect. Also, for modeling purposes, could you tell me what the fully diluted share count should be? I had previously estimated a little over 38 million shares on a diluted basis, which I would like to include in the report. What would be a reasonable number to use for your diluted share count going forward?

Michael Recca, CFO

We have 32 million shares outstanding right now, but 38 million would be ideal. There are three sources of dilution: convertible debt, options, and warrants. For the warrants, there are about 1.2 to 1.3 million currently outstanding, but approximately 500,000 to 600,000 of them will expire unexercised because their prices are significantly higher than our current levels, ranging from $2.50 to $3.50, with most in the $3 range. These will start expiring in November, and the last ones will expire in May of next year. There are about 700,000 warrants priced at $1.50. Regarding options, there are 1.6 million outstanding, with a combined exercise price of around $1.30. Lastly, we have $4.8 million of convertible debt convertible at an average price of $1.18, which accounts for about 4 million shares. In total, we can issue about 6 million shares, along with $8 million in proceeds from this issuance.

John Nobile, Analyst

Right. Understood. Good. So bottom line is, at least with the share count, and obviously, it's going to help your cash flow, but 38 million is a pretty safe number to assume going forward because I know when you have a loss. It's anti-dilutive, so you can't use that. But assuming a bottom line profit, 38 or so million, is a good number to use.

Michael Recca, CFO

That's correct.

John Nobile, Analyst

Okay. Just one last question. Looking at the last four quarters, you've kept operating expenses below $2 million each quarter. It's great that you've managed to cut costs during the COVID era. However, I wanted to know if we should expect this level going forward because last year's first quarter was almost $2.3 million, and now we're down to about $1.8 million. So moving ahead, should I consider it to be under $2 million, or should I anticipate an increase in business that might push it up a bit from here?

Michael Recca, CFO

Well, the first quarter of last year was abnormally high due to a bad debt write-off. We don't have bad debts in the sense that our customers go bankrupt or the like. We have bad debts because it's on dispute as to how much was billed, how much was returned and the like. But there's an age to the point where for GAAP purposes, it was bad. So we wrote off, I think the amount was around $350,000. There was a $350,000-ish. We recovered about $90,000 of that this year. So the swing is not going to recur. That was a quarter-specific expense. So $1.8 million to $2 million a quarter going forward, I think, is appropriate.

Operator, Operator

Mr. Melluzzo, at this time, we have no questions in queue.

Luciano Melluzzo, President and CEO

Okay. Thank you, Todd. So with that, once again, thank you, everyone, for taking the time to be with us on this call today and for your attention and questions. Todd, you may conclude the call.

Operator, Operator

Thank you, ladies and gentlemen. This concludes today's conference. You may now disconnect.