Air Industries Group
Q2 2019 Earnings Call Transcript

Published: 13 Aug 2019

[Operator:]

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 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 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. Please go ahead, sir.

[Luciano Melluzzo:]

Thank you, Edgardo. Good afternoon and thank you for joining us as we summarize Air Industries' results for the second quarter and the first half of 2019. Our results for the quarter is much improved over the second quarter of 2018. Net sales, gross profits are up, operating expenses are well controlled. Although, we had a net loss for the quarter in six months, the industry has reported a positive net operating income for the first time in many years.For the first half of the year, sales increased by 19.1% over last year. Operating expenses decreased by 13.2%. Gross profit improved by 27.6% over last year. These improvements resulted from the many changes we have made at the Company.Some notable improvements during the quarter are, we settled into a manufacturing rhythm with fewer disruptions. The consolidation and divestitures are behind us. We are streamlining operations through continuous improvement initiatives, reassignment of people, better cutting tool technologies, consistent engineering practice, and better control of our supply base.Our improved financial performance and increased financial stability has strengthened our relationship with our customers and suppliers. We are collaborating with our customers to prioritize requirements and accelerate deliveries.With that, I would like to turn the call over to Mike Recca, our CFO for a financial recap. Then I'll return to close the call. Mike?

[Michael Recca:]

Thank you, Lou. As is our practice, I am not going to reread the press release because I presume you all have read it. I'd like to focus on a couple of points. One is our gross profit; second is our operating income; and third is our debt.Gross profit at our operation, the manufacturing operation is highly variable with sales. For the six months, our sales were up 20%, but our gross profit was up 30% and this illustrates our earnings leverage. We have at both locations, a high percentage of fixed cost, we call manufacturing overhead, as sales increase and we control those expenses, they get spread over a much larger level of sales.For example, on our Long Island operation, which we call CMS complex machining, our manufacturing overhead, each dollar of sales had to carry $0.39 of costs in 2018 and this fell to $0.32 per dollar in 2019, significantly increasing our gross profit.Sterling Engineering, our Turbine and Engine segment is even more variable as each dollar of sales at Sterling had much lower material costs due to customer supply material. So a dollar of sale at Air Machining, which maybe 50% material, 50% labor, and Sterling is more like 80% to 90% labor and 10% to 20% material.So they have even greater earnings leverage and we have for dollar of sales. And an example of that is, for the six months, sales at Sterling are up by $575,000 over a year-ago and gross profit is up by $150,000 from a negligible amount in 2018 to $150,000 in 2019.Even though our overall gross margin was only 5 percentage points at Sterling for the six months, the incremental increase in gross margin was 25%, 26%. So once you get above the breakeven, you are adding to your margin a much higher rate. So as sales continue to improve, which we believe they will, we should show more significant increases in gross profit as time goes up.As Lou mentioned, we had a positive net income for the six months and for the quarter and that is very significant. So first operating profit, we’ve had in a long, long time. For the six months, we had a profit of $156,000 and that is measured on a GAAP basis, no add-backs, no pro formas, no nothing. So it's a very satisfying to recognize that, particularly when you look in 2018, we had an operating loss of $1.1 million.To put this in some perspective, two years ago, the year ending 2017, we had an operating loss of $6 million, 2018, we had cut that by two-thirds to $2 million, and in 2019 so far, we have an operating profit and I know everybody is very desirous of having net income after everything. But before we get to that, we had to get to net operating profit to be able to pay those additional expenses.In terms of our debt, our total debt capital leases about the same level as they were at the end of 2018. Our cash interest expense is paid about one-half in cash, our interest expense [indiscernible] one-half in cash and one-half to crude. Within that, there are some very positive inclinations for our cash flow.We are reducing our term loan with PNC Bank and our capital leases secured by equipment at the rate of about $3 million a year. So that's $250,000 a month. That is a big crimp in our operating cash flow. By the end of this year, the term loan is paid off, and by mid-2020, most of the capital leases are paid off.So beginning January, we are going to increase our flexibility by $1.5 million a year from the elimination of the term loan. For the first half of 2020, our amortization of our capital leases will not be $700,000, but rather like $400,000. And for the second half of 2020, the capital leases will be about $0.25 million.So we will be significantly adding to our cash flow each and every month, which we think will further enable us to ramp production to keep our accounts payable in line and increase our operating income and strive towards the net income.Those are my comments. Lou, back to you.

[Luciano Melluzzo:]

Thank you, Mike. I'll close the call with a few thoughts on the remainder of the year. Our results for the quarter in the first half of 2019 demonstrate that we are succeeding at driving revenues, increasing gross margins and achieving operating profitability. We are dedicated to and remain confident about fulfilling our backlog of orders to our customers and continuously improving our operations.This concludes our formal remarks this afternoon. I would like to open the call up to participant questions. Edgardo, please open up the lines to participant questions.

[Operator:]

[Operator Instructions] We'll take our first question. Please state your name before posing in.

[John Nobile:]

Hi. This is John Nobile at Taglich Brothers. How are you guys doing today?

[Luciano Melluzzo:]

How are you doing today, John? Fine. Thank you.

[John Nobile:]

All right. First off, it was good to see a second sequential quarter of growth, averaging close to 20% now for the first half of the year. So I imagine you're starting to whittle away your backlog, which is still pretty high, around $100 million backlog. So I was hoping you could give us an update on any progress that has been made in the effort to ship backlog?

[Luciano Melluzzo:]

Yes. I can do that, John. Obviously, we've been – we’re talking with our customers on a daily basis. Some product has been not reassigned, but rescheduled. So we are working to new schedules to be able to allow us to – you would think that with $100 million backlog will be delayed on everything. That's not the case.There's been a lot of communication in rescheduling product to where it needs to be and we keep chipping away at it to the tune of about what's the first two orders this year averaging about 13 and change per…

[Michael Recca:]

13.1 to 13.6.

[Luciano Melluzzo:]

13, 13.6 per quarter. So we're making progress towards that, John.

[John Nobile:]

Okay. That's great. And I know on the previous call, I worked it out, it was almost like $16.7 million per quarter to really push that out in about an 18-month period. So I just wanted to make sure we're progressing in that direction. And actually recently…

[Michael Recca:]

20% a year is a significant improvement. Backlog hasn't gone down because we've replaced with new orders. But we are not going – we are fulfilling our needs. We'd love to be at $15 million and essentially in someday we will be.

[John Nobile:]

Keep doing this type of growth and it shouldn't take that much longer 20% on 20%. But there was a recent increase in the [front spending that was signed into law]. I was curious, if you knew what programs in particular would likely be favorably impacted by this that would actually benefit Air.

[Luciano Melluzzo:]

The spending is across the Board. I mean, what we've line of sight to – there's some additional spend on some E2D product. F-35, we know that spend has been approved and that's a very viable and that program is swinging into full gear.On the rotorcraft, they're still funding a lot of BlackHawk parts. The BlackHawk still has probably a 40 to 50-year run. So there's been some additional funding, but that some new programs, heavy-lift chopper for Sikorsky and rotorcraft. That's got some additional funding.There's a lot of platforms that they're still spending on. They had their budgets. Obviously, whatever comes out of Washington is not enough for the OEM, so they're lobbying for more. In some cases they've been successful in getting additional requirements.

[John Nobile:]

And that's great to hear. Thank you for that update. And just getting back to Sterling, I know actually for the first two quarters of the year, it was showing a gross profit. And I was curious as to your outlook for Sterling in the second half of this year and beyond, and how great of an impact do you believe an increase in sales at Sterling would have in your gross margins?I don't know, I know you mentioned like a certain percentage increase in sales and it basically doubled your gross profit. So looking at this going forward, what is your outlook and how might say a $1 million increase in sales might that impact your gross margins in Sterling?

[Michael Recca:]

If we've got a $1 million of increase in Sterling over the next six months compared to the first six months, I would expect that would take our gross profit from $157,000, let’s call it $200,000 to somewhere in the $450,000 to $500,000 range.

[John Nobile:]

So you're looking at like a 20% to 30% increase in gross margin from that?

[Michael Recca:]

That is correct. And again that's because – what I try and – the mantra I use around here is $1 sales at Sterling in terms of gross margin benefit it’s equal to $2 at CMS because $1 sales at Sterling is essentially a 100% labor, which shows our – hopefully our markup on and not just trading material, buying it and then reselling it to raw material just reselling at cost of an event.

[John Nobile:]

Okay. I mean, I know you had $1.5 million, $1.6 million in actually sales for Sterling. So I mean that's a nice jump there to see the $3 million in the quarter, but let's just say a lesser number like, incrementally you go up a couple of $100,000. At what level in Sterling, do you think that you would get to that point of at least a 20% gross margin?

[Michael Recca:]

Okay. Well the rule of thumb I'm using John is $600,000 of increase we had year-over-year for the six months. We generated $150,000 more of gross margin or about 26%. So if you want to get to a 20% gross margin, it’s [15 points]…

[John Nobile:]

Okay. Well, I'm not saying 20% exact, but just to get into that 20% range, so – all right.

[Michael Recca:]

I probably need another – on a six-month basis, I would probably need another $1 million, $1.2 month.

[John Nobile:]

On the six-month basis, so $0.5 million in a quarterly basis, so if you were to get to say about a $2 million sales run rate at Sterling, you can see gross margins in the 20% range is what I'm trying to get?

[Michael Recca:]

That is correct.

[John Nobile:]

And how do you feel about that in the second…

[Michael Recca:]

[Indiscernible] to the top, John.

[John Nobile:]

That’s good to hear, but further on the…

[Luciano Melluzzo:]

$2 million a quarter for Sterling. Yes, it's not out of reach, but it would be healthy increase to the out of limits of what we can expect.

[John Nobile:]

Do you have any visibility into the second half? I mean you’re already in the second half, but the Sterling as far as seeing any incremental increases in revenue.

[Luciano Melluzzo:]

Yes. That business is still dependent on customer supply material. So at the cadence that it comes, we'll put it out. We're working to change some of that to be more in line with – we’re looking to procure some material so we have better visibility. Right now, a lot of our material is confined up there.

[John Nobile:]

Okay. Just one final question. Just to get an idea because I see even in the press release, it's really talking strictly defense, but what would you say is your current defense/commercial sales mix? And where do you just see this about a year from now? Just to get an idea of how the different sectors might be growing? I mean, Sterling, we are really looking commercial sales, correct? A lot of it?

[Luciano Melluzzo:]

About half, but commercial – we have a higher percentage of commercial, but they have some work defense work also. And some of the contracts that we are negotiating up there are also defense work.

[John Nobile:]

Okay. So where do you currently stand if you had a – your best guess on the quarter or even a half a year in defense and commercial sales. What percentage?

[Michael Recca:]

About 75%, 25% military versus commercial.

[John Nobile:]

Okay. We have 75%, 25% that' impressive given that the defense sales have gone up. So obviously commercial sales I think historically have been less than this. So it sounds like you're gaining some traction in the commercial area then?

[Luciano Melluzzo:]

Yes. Our business development folks were looking ahead. I know the President we have in office right now. Don't know who will be in two years, and just got to kind of do a due diligence.

[Michael Recca:]

I remember your favorite product [truss struts].

[John Nobile:]

You remember that one? Okay.

[Michael Recca:]

I remember, [indiscernible] they are a big component there that’s probably…

[John Nobile:]

Because I remember, I mean I brought that up years ago, it was supposed to be a pretty significant ramp in those sales. How will we be looking today, I mean it's been maybe a year since I've really looked into that. How does it look right now as far as those sales are concerned?

[Luciano Melluzzo:]

We are producing quickly and we're selling everyone – we've taken everyone we can. And the ramp up in the sales is all based on Geared Turbo-Fan deliveries. And as you can see – you can confirm in the papers that airbus is annoyed with Pratt & Whitney because they're behind in engine deliveries. So as they're delivering the engines and getting those problems behind them with their supply chain, we are delivering the best struts.

[John Nobile:]

All right. Well that's all I have. I'll open it up for others, who may have question. Thank you for taking the questions.

[Luciano Melluzzo:]

Thanks, John.

[Operator:]

[Operator Instructions] We'll now take our next question. Please go ahead.

[Unidentified Analyst:]

Hi. Congratulations on your sales growth and…

[Luciano Melluzzo:]

Thank you.

[Unidentified Analyst:]

I have about six questions. Some are pretty quick like the first one, is the new boring mill in full operation?

[Luciano Melluzzo:]

The boring mill is setup and waiting for our part that we're transferring into it. Tooling has been done. It’s fired up. The part will be hitting at probably in the next few days. Done some test runs on it. We've made some small parts on it, but we really bought it for a big commercial part that we're doing for one of our OEMs.

[Unidentified Analyst:]

Okay. So in this quarter then?

[Luciano Melluzzo:]

Yes.

[Unidentified Analyst:]

Okay, great. In a previous call you mentioned looking to hire five additional machinists. Was that done? Or you able to do that?

[Luciano Melluzzo:]

We've hired people on both first and second shift and we probably hired more than five. I mean as aggregate, we brought some in. We've lost a couple. We're still ahead of the numbers.

[Unidentified Analyst:]

I was wondering if you could provide some color on the greater than $2 million increase in work-in progress? Something like is it for shipping this quarter, next quarter, next year?

[Luciano Melluzzo:]

$2 million increase in work-in process is largely attributed to the increase in sales. Of course from my position, any increase in inventory is a horrible thing. But I get taught that by the manufacturing people. It is entirely due to gross and sales, not really any kind of a bottleneck or backlog.One thing to keep in mind, you'll see raw material, finished goods and work-in process. Our finished goods are really a misnomer. We build to customer orders only. That’s an absolute statement, which is not absolutely true. Sometimes we build to speculate. We have an order for three and you make them two at a time, as you might as well make four and have one leftover. But generally we tried to manufacture two customer orders and that's all.During the manufacturing process, any of our products have multiple, sometimes hundreds of individual components. And at any point in time, a percentage – half of them are some percentage of those components are finished. But they are not – they are saleable to customer, and we have no order for them. We made them for the next higher level to be incorporated into a larger component and that's for which we do have a customer order.So the product begins life as raw material. It becomes a work-in process, then it maybe finished, it goes into finished goods and then reenters work-in process to be incorporated into another product and go through the same cycle until you finally have a full up landing gear. They may have 200 or 300 components in it. And it sells for a couple of $100,000. So almost everything we have beyond raw material is whipped.

[Unidentified Analyst:]

Okay. I think I could be mistaken, but I vaguely remember from a previous conference call the landing gears take – is it six months?

[Luciano Melluzzo:]

Easily six months. And what's happening is with the supply base, the secondary process houses and stuff are so busy that where we would typically broadened to say, 10 to the cadence of 10 a month and make our commitments to our customers. That's becoming very difficult to do that because everything on the outside is taking longer than it should. So in some cases we're deciding to run a few more to be able to keep up with the demand or be able to deliver to our customers when they need it.

[Unidentified Analyst:]

Okay. And so the work-in progress would go up.

[Luciano Melluzzo:]

That's correct. Yes.

[Unidentified Analyst:]

Okay. Thank you for that by the way. I believe it was in the last conference call that you stated that you’re incurring some expedited costs. Is that still happening?

[Luciano Melluzzo:]

That's still the case, but it's well controlled now. The expediting cost is being shared with the OEMs.

[Unidentified Analyst:]

Okay. Thank you. Two more questions. I have a question on your sales guidance. Sales have increased really nicely to $27.2 million for the first six months of this year. As you maintained that level for the next six months, that would bring your sales to $54.4 million for 2019.And in John Nobile's, last estimate, which I read off in the website, he has estimated $55.1 million for 2019. Can you provide some color about your 2019 sales and continuing operations to exceed $50 million?

[Michael Recca:]

Well, if you look back at 2018, we ended the year on continuing operations, that's $44.5 million. And so when we gave guidance in the first quarter, we upped that, we said we would beat that number. And then now with the results of the six months, we want to say we're going to do better than $50 million. This is something of a turnaround situation as you're all aware.

[Unidentified Analyst:]

Yes.

[Michael Recca:]

And my expected turnaround that it's rare when they are a straight line. Now we were able to have a very good first half in my opinion. And so to repeat that, you're correct, we'll be doing $55 million. But in terms of our guidance that’s a little bit of a cushion and we may have a hiccup quarter.Another thing to keep in mind is when you're selling the pieces that cost $200,000, $300,000 a piece, having one piece slip from September to October can dramatically hurt the quarter.

[Unidentified Analyst:]

Yes.

[Michael Recca:]

And so it doesn't come back from the chrome shop. It doesn't come back from here to other place, and so it slips from September 30 delivery to October 10 delivery, and then the third quarter it has a blemish. So we're still cognizant of that, and we’re confident…

[Unidentified Analyst:]

Yes. You're being conservative a bit, okay. Very conservative, okay.

[Michael Recca:]

So related to EBITDA guidance. In the press release you said, our EBITDA was $2.5 million, but if you extrapolate that out it should be $5 million. We've said $4 million to $4.5 million and the reason is that in the $2.5 million, it's about $600,000 of lease term – lease abandonment expense and stock compensation.Lease abandonment is a one-time thing, will not be repeated. And the big charge for stock compensation was in Q1 much, much smaller amount in Q2. So the way I look at it was about $1.8 million to $2 million of operating EBITDA, total $2.5 million. So if I repeat the $1.8 million and $2.5 million that's $4.3 million, so $4 million to $4.5 million is the guidance.

[Unidentified Analyst:]

Okay. Thank you. My last question is really an outlier, but since it's made big news, I figured I would ask. Lockheed Martin in last conference call has reported – they have said that it is working to establish alternate supply sources for F-35 parts in the U.S. after the Pentagon decided to remove Turkey from the fighter jet program. I'll just ask it. Have you all been in contact with Lockheed Martin about this?

[Luciano Melluzzo:]

We have very close ties with Lockheed Martin, NGC Boeing and everybody, and we're in the supply chain. We're in the food, if things come down when they determine. Yes, we have. When it come down, we will probably see our share of it.

[Michael Recca:]

And in fact in the old days when the F-35 was just beginning its low rate initial production, we lost a product to a Turkish company that before this Russian anti-aircraft missile program [indiscernible] started, we already won it back.

[Unidentified Analyst:]

Okay. All right. Thank you, and congratulations on the progress again.

[Luciano Melluzzo:]

Thanks for the call.

[Operator:]

Now we’ll take our next question. Please go ahead.

[Unidentified Analyst:]

Good afternoon, gentlemen. Congratulations on the good quarter.

[Luciano Melluzzo:]

Definitely.

[Unidentified Analyst:]

Could you give us some color on – you said new business awards for nearly 150% ahead of the prior year. So if you – would that mean if you had $1 million prior year, you had $2.5 million this year?

[Luciano Melluzzo:]

We had $1 million last year. We would have $1.5 million this year. I don't have the exact number what we had last year, but it’s significantly ahead of last year.

[Unidentified Analyst:]

Okay. And I noticed you in the beginning of the year had announced substantial contract awards. We don't get much information between quarterly conference calls. I mean if there are big awards, do you expect to have any kind of press release?

[Luciano Melluzzo:]

Yes, we do. And we are negotiating some as we speak. We are not at the point [indiscernible]. Remember, we get awards every day because let me explain how the business works? We have what we call long-term agreements with our customers. That can extend for two, three, four and five years.So we win that award. And then every month they will issue what I call releases against those long-term agreements. So Sikorsky is an example, as the right to buy a 500 of a certain product from us over the next five years, 100 a year. Every month they may order 10, 20 or 30 against that 500. We don't announce each one of those. Those are just regular purchases orders. Our long-term agreements which we do announce, they're infrequent, but they're substantial.

[Unidentified Analyst:]

Okay. Thank you.

[Luciano Melluzzo:]

But that builds our backlog offer. And remember, our backlog is only what has been released. We have been ordered to make this product by our customers. We have not said we expect, we hope, we pray that the congress will fund the money and the customers will make the orders because our long-term agreement say, it's up to 500, not 500 in my example.

[Michael Recca:]

The way we reported backlog is not traditionally the way a lot of companies do it. Typically they will – if there is a [indiscernible] they will take the median line for the five years and report a backlog of a 500 million. And we're very conservative of what we say we're going off 18 months where we really have hard [indiscernible]orders forand that's what we report.

[Luciano Melluzzo:]

Think of it in another way, if we have no new orders, we would have to produce our backlog of $100 million, whatever it is over the next 18 months period.

[Unidentified Analyst:]

That's understood. But wouldn't we have to get up to about $16.7 million per quarter to fulfill – to fill those orders, the $100 million orders in 18 months at some point?

[Luciano Melluzzo:]

Yes we would.

[Unidentified Analyst:]

And what's holding us back? Is it plus we can't buy enough inventory or is it just timing or is it – what rate are we pushing out the door, orders, I mean like timeliness – I forgot what the term is, but I think you mentioned it was like 70% last quarter? That's what the orders are sent out on time.

[Luciano Melluzzo:]

Where are we scheduling to our customers' requirements, basically way it boils down to. There is a bottleneck across the industry because of the flood gates opening up. And it's not just an Air Industries problem. It's across the Board. People can hire fast enough. They can't get materials fast enough. They can't get the secondary services fast enough.We've got people that all they do here is expedite products to the outside supply base, that's all they do, where four or five, six years ago those people were not even heard of. They weren't on a payroll. They were – you did the internal expedite and this outside supply base did what needed to be done.Now that's where a bottlenecks mostly are created because for every machine shop you might get, you might have – for 10 machine shops, you might have one heat treater or one guy that does anodizing or any of these secondary. And when you've got everybody using them, they just can't fill the orders as quickly. So it's a matter of getting on our earlier question was expedite. It becomes now necessary to get first in line with everything. So we've got people trying to get us first in line across the Board.

[Michael Recca:]

That segment of the industry has shrunk from say 2010 to 2017 or so. So not many people going in the chrome plating business this year. If you started to try and get the permits to do so, we have to start at a very young age, so that you'd be alive by the time you got up. So those companies have not expanded. They've asked for the number of that are shrunk down when the demand for their services as a result of the OEMs orders have dramatically increased. That is the bottleneck that everyone is facing.

[Luciano Melluzzo:]

So the things that we can't take control of, we are. But we can't take control of everything. We're never going to be a heat treat house. It's got too many environmental impacts. We are a plater, we're never going to be a plater. It's got too much EPA requirements, we'll never get it.

[Unidentified Analyst:]

Okay. So the $100 million that we need to theoretically push out the door in 18 months, if we do have $27.2 million every six months, we're only up to $81.6 million. What would happen with the other $19 million or $18.4 million that we didn't get out in the 18 months?

[Luciano Melluzzo:]

It would be pushed back by the customers to one we can get it out.

[Michael Recca:]

That's what the scheduling is all about.

[Unidentified Analyst:]

Right.

[Luciano Melluzzo:]

They have solved the problem too. Frequently they are placing order with us. For some it takes four months to manufacture and they'll place it today and they want it in September. And so obviously it's late I got here.

[Unidentified Analyst:]

So does some of this prevent you from taking on other contracts or other work?

[Luciano Melluzzo:]

No. We’ve got work – gear into business development right now. So we are looking to diversify across all platforms. Like I said, we're 75% military, 25% roughly commercial. I'm looking to even the playing field where I can't.

[Michael Recca:]

And right now we're negotiating contracts that are going to begin maybe in 2020, probably closer to 2021. So there is a long lead time involved in a sense.

[Unidentified Analyst:]

Okay. Thank you, gentlemen.

[Operator:]

It appears there are no further questions at this time. I'd like to turn the conference back to the presenters for any additional or closing remarks.

[Luciano Melluzzo:]

So with that, once again, thank you everyone for taking the time to be on the call today and for your attention in questions. The management and employees of Air Industries look forward to building on the promising results this year's first six months.With that, I'd like to turn it over to you Edgardo for the conclusion.

[Operator:]

This now concludes today's call. Thank you for your participation. You may now disconnect.