Air Industries Group (AIRI) 2022 Q2 法說會逐字稿

Good day, and welcome to the Air Industries 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 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'd like to turn the conference over to Mr. 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 a 17.2% of sales in the quarter -- in the first quarter of 2022.

Operating income nearly -- increased nearly 20% from the first quarter of 2020. Adjusted EBITDA in the second quarter was nearly $1.2 million and increased sequentially by 13.3%. As a percentage of sales, adjusted EBITDA was 8.5% for the 2022 second quarter versus an 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 our 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 6- to 9-month lead time to receive shipments of titanium used in many of our products as the war in the Ukraine drags on and Russian sanctions remain in place. Prior to the war, those 2 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 them. I discussed last time that adding a paint capability in one of our -- is one of our steps to our vertical integration plan.

We are proceeding with our strategy to use 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, while taking advantages of 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 discussed last time, grinding and nondestructive testing are among the other processes that we are targeting to bring in-house. In fact, in the past 3 years, our capital investment has totaled $6 million. So far this year, we have read 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 to more profitably.

As many of you know, Air Industries addresses 5 major platforms, including the Sikorsky BlackHawk helicopter, the U.S. Navy F-18 Hornet and the Northrop Grumman E2D 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.

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, we received a $12.4 million order to produce complete main and nose 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, the Embraer E2 jets reflects the accelerating build base of 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 PW 4000 jet engine, which with expected revenue to in excess of $6 million over its remaining term. The LTA also met one of our key corporate objectives for Sterling Engineering, which is to transition in larger part the product mix in long-term agreements.

While not listed among our 5 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. In 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 3x the lift capability of its predecessor and exceeding all other DOD rotary wing platforms. Production of this helicopter is forecasted to increase from 4 aircrafts in 2022 to 9 in 2023 and 15 in 2026. It is expected that the CH-53K will remain in production through 2032 and beyond.

6-month 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 of different programs and inventory levels at our customers.

Turning to the medium- and long-term outlook. The appended Farnborough Air Show this year and found the tone among customers to be upbeat. While realistic about ongoing industry production challenges, relatedly, I should note that many pandemic-related restrictions have been lifted, and the industry is returning between 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 wrap 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 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. Part of our growth strategy, we are also targeting adjacent markets that are a natural fit with our capabilities. For example, we are focused on the nuclear submarine industry and recently received our first order. We hope for a dramatic growth from this new market over time. We also have received a vendor number 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. But 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 growth -- with growing demand, while enhancing our performance by vertically integrating our processes as well as making strategic capital investments to become even more a valuable partner to our customers.

Let me turn the call over to Mike Recca, our CFO, for his financial report, which we'll follow with a question and answer and some concluding remarks. Mike.

Thanks, Lou. I'm going to provide some additional development (inaudible) 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 6 months, sales of $26.1 million, and this is a reduction of $3.1 million compared to the 6 months of 2021.

Of the $3.1 million decline, about half related to 2 products. First was some landing gear for the A380 aircraft, which you may have known has been taken out of production, and this resulted in a stop work/cancellation order from our customer. And the second was a helicopter product that we made for many years but was at the end of its contract. Both of these products because of the various reasons we're sold at a loss. So sales were lower, but 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 $180,000 -- $181,000 lower than last year, and that's on lower sales. However, for the 6 months, gross profit was $100,000 higher in 2022. Keep in mind that for the most part, we use a gross profit method of calculating gross profit for interim periods of the year. This estimate is then refined following our year-end inventory count and valuations. Gross profit margin percentage that we're 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 less than 3% increase for the 6 months. 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. The 6 months, operating income was essentially flat.

Interest expense, again, was essentially for both periods, declining slightly by $44,000 in the second quarter compared to last year. For the 6 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 3.5% per year. With the recent actions by the Federal Reserve it has risen. Interest expense is calculated at 0.65% below prime. The prime now at 5.5%, thus, our interest rate had 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. That's improvement compared to a loss of $28,000 in the first quarter of the year. For the 6 months, a loss of $35,000 versus income of $87,000 last year.

Switching to the balance sheet. Balance sheet remains strong with no major changes. Our accounts payables, receivables, all remain within normal limits. There are 2 items 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 used to secure, buy, 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 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 got 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, amortized over 7 years, that's 84 months. Now we have already made deposits and progress payments about $0.75 million for new equipment. It's being constructed, and some of it's in shipping -- inbound shipping right now. This amount has been drawn from our revolving line of credit, the machine is installed. These funds will be taken from the equipment line of credit and use to pay down the revolver.

Second, I think this is an important point. Since year-end, our inventories increased by $3.5 million. The majority of this increase is with work-in-process and is concentrated on the F-18, the CH-53 and the E-2D platforms. We will discuss the disruption delays affecting our production. The increase in inventory reflects this. If you add this $3.1 million increase to inventory to sales for the 6 months of $26 million, it then gives you a total of about $29 million. It's essentially equal to the 6 months of 2021. Our view is that over time, this excess inventory will be completed and result in increased sales.

And that concludes my comments. I'll turn the call back to Lou, and I look forward to your questions.

Thank you, Mike. I will close this portion of the call by the making 2 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. It's very important. 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 tight 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 program where demand is growing. We are developing new markets, including nuclear submarines, space programs (inaudible). We are enhancing our performance by vertically integrating our processes, and we're making some strategic capital investments to become even more valuable partners to our customers. And 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 question and answer session. Anna?

(Operator Instructions)

Lou and Mike, it's John Nobile from Taglich Brothers. You had said in your prepared remarks that you have about a 6- to 9-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 near and dear and the war in the Ukraine is really -- and that whole section of the globe that's high-producing, I think, that really, we're having issues with the Inconels, we have the Geared Turbofan product, which is an Inconel-based product. We won't see any materials for the first 3 or 4 months this year. Now it's starting to start to trickle in. So there was a lag in time, and that's one of our best-selling products that we have in-house. So the material, I attended the Farnborough Show in England a few weeks back, and we're all seeing in the blues in that arena. It's just the availability of raw material is really captivating at this point.

Okay. And in the first quarter of 2022, I know there were several announcements related to new orders. And 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. The first quarter this year, we announced some long-term agreements, and that's really a timing issue in that a lot of our long-term agreements were expiring at the end of 2021. So they were renewed at the beginning of 2022. We have received orders against those, and we'll continue for the life of the agreement over the next 5 years. But we haven't got no new -- really new long-term agreements to announce. We do have a pretty significant pipeline, so we are expecting to announce some pretty soon. We're relatively conservative about announcing -- we generally do not announce 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 it's just other orders that are helping your second half to be better?

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, in regard to 2021, I know that your hope to do product tests really seen significant reductions, a very good thing. But a question arises, with the current supply chain issues that are out there now, I'm curious if you've been able to keep that level still relatively low? Or has it been creeping back up?

It remains relatively low. Remember, our past due orders are never 0. It's just the nature of the beast, customers order less than lead time. So the they're destined to end up in pass-through. It has increased in the second quarter, not materially.

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

Part of the increase in past due was due to the Geared Turbofan where we had an interruption of material -- raw material shipments. And so those products that would have been made, I'm making this up, in April, could not be made. They were delivered in by June, they were late.

Okay. Well, thanks to that insight. And you've made significant capital investments. As Lou had mentioned, you could see it in our CapEx, and that was all in an effort to alleviate the bottleneck issues that have plagued Air for some time. I was wondering if you could talk a little about that progress that has been made in this area and compare that to maybe where you were a year ago.

Well, it's given us numerous options on what machine we can run product in. One of the problems that we had earlier on when I got to Air Industries is that there were several bottlenecks, both in turning and milling and we didn't have the options. Now as an example, we've gone from 2 5-axis machines to 6, 5-axis machines, in different sizes and can handle different sized product. So we have some additional options on where to put this work to eliminate the bottlenecks and, obviously, because of that, that we have to down the overdues substantially over the last couple of years.

Okay. So I mean, with the less of a bottleneck concern than, say, a year ago, would it be safe to say that if there were no supply chain issues currently that most likely the first half results on the top line would have shown to be better than last year?

At least equal to last year. In fact, a little bit better.

Okay. And the second quarter gross margins, they were up 0.1%, 0.1% from the first quarter. In the meantime, 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 pretty significant increase sequentially in revenue?

I tried to address that. I guess I didn't do that good a job. Again, we use a gross profit method at Air Machining 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. So the variance in gross margin is equal to average the CMS sales at 18.5% plus trailing sales at whatever percent because I use the direct measurement approach. And that's why the overwhelming proportion of our sales are at CMS. And so that they are at 18.5%, it will not move until year-end when the inventory is taken and valued. And hopefully, they will only move in 1 direction, which is up based on that as it did last year.

Okay. Yes, I noticed last year -- I guess, that really answered my question because last year in the fourth quarter, a huge bump in your gross margins. I mean, third quarter is 14%, and then you showed 24.9% -- almost a 15% increase in gross margin. So I guess this year, we should anticipate the same thing basically. Dictated gross margins for the first 3 quarters. And then when inventory is a known factor at the end of the year, we will know what the true gross margin is. And -- do you feel like there's a chance that it's going to be bumped up significantly in that fourth quarter? And I don't know if that's too early to tell at this point.

It's, a, too early to tell; b, I do not expect we're going to get the increase that we got in the fourth quarter of '21 that took our gross margin from 14.5% to 18.5%. But that entire 4.5 percentage point increase had to be accounted for, for the entire year and booked in the fourth quarter. Last year, we had $3.5 million to $4 million worth of product that were -- $3 million of it was 0 profit. And the $0.5 million in additional sales, we lost about $250,000. So we don't have those this year. So that -- if you think about it, last year, if we hadn't had those particular products, John, our gross profit for the year would not have been 18.5%, would have been closer to 20%. So I'm hopeful for an increase in this year. I do not expect it's going to be as significant as it was for last.

(Operator Instructions)

My name is [Mike Atkins]. And 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'd really appreciate it.

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 is still working remotely. Craft, Sikorsky, Collins, Boeing, a lot of people are still working remotely. But things are starting to get back to normal. So we've had an opportunity to get some face-to-face times, and we've really stepped up our business development activity because of it.

So we've come across a space company just like SpaceX and the Blue Origin and stuff of that nature. We've gotten some quoting activity. Hopefully, we can make something stick because that's the next frontier. So we're Air Industries, but the direction of our business development has taken us to the sea, under the sea and into space. And we are a landing gear company, but we're also a precision manufacturing organization, and there's opportunities in each of those respective categories.

(Operator Instructions) And it appears there are no further telephone questions. I'd like to turn the conference back over to our presenters for any additional or closing remarks.

Thank you, Anna. So with that, 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. And with that, the conference has concluded. Please disconnect.

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