The following discussion of our financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and notes to those statements included elsewhere in this Form 10-Q and with the audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K, for the year ended December 31, 2021 (the "2021 Form 10-K"). This discussion contains forward-looking statements that involve risks and uncertainties. You should specifically consider the various risk factors identified in this report that could cause actual results to differ materially from those anticipated in these forward-looking statements.





Business Overview

Air Industries Group is a holding company with three legal subsidiaries, AIM, NTW and SEC. SEC began manufacturing aircraft components in 1941 - over 80-years ago - for use in World War II. NTW was formed in the early 1960's and AIM has been in business since 1971. We became a public company in 2005.

We manufacture aerospace components primarily for the defense industry. Our Complex Machining Segment ("CMS"), which consists of AIM and NTW, manufactures structural parts and assemblies focusing on flight safety, including aircraft landing gear, arresting gear, engine mounts, flight controls, throttle quadrants, and other components. Our Turbine and Engine Component segment ("TEC") segment consists of SEC which makes components and provides services for aircraft jet engines and ground-power turbines.

Products of CMS are currently deployed on a wide range of high-profile military and commercial aircraft including the Sikorsky UH-60 Blackhawk, Lockheed Martin F-35 Joint Strike Fighter, Northrop Grumman E2D Hawkeye, the US Navy F-18 and USAF F-16 and F-15 fighter aircraft, CMS also makes a critical component for the Pratt & Whitney Geared TurboFan ("GTF") aircraft engine used on commercial airliners. TEC makes products used in jet engines that are used on military and commercial aircraft including the USAF F-15 and F-16, the Airbus A-330 and the Boeing 777, and others, and in addition, a number of ground-power turbine applications.

The aerospace market is highly competitive in both the defense and commercial sectors and we face intense competition in all areas of our business. Nearly all of our revenues are derived by producing products to customer specifications after being awarded a contract through a competitive bidding process. As the commercial aerospace and defense industries continue to consolidate and major contractors seek to streamline supply chains by buying more complete sub-assemblies from fewer suppliers, we have sought to remain competitive not only by providing cost-effective world class products and service but also by increasing our ability to produce more complex and complete assemblies for our customers.

We are focused on maintaining profitability and positive cash flows from operating activities. We remain resolute on meeting customers' needs. To take advantage of the long-term growth opportunities we see in our markets, we have made significant capital investments in new equipment in recent years. We believe these investments will increase the velocity and efficiency of production, increase the size of product we can make and allow us to offer additional services to our customers. Some of our investments expand our capabilities allowing us to internally process product that was previously outsourced to third party processors. We are pleased with the positive responses from our customers about these initiatives.

Our ability to operate profitably and generate positive cash flows from operating activities is determined by our ability to win new or renewal contracts and fulfilling these contracts on a timely and cost effective basis. Winning a contract generally requires that we submit a bid containing fixed prices for the product or products covered by the contract for an agreed upon period of time, sometimes for five-years or longer, with negotiated increases to reflect a portion of the impact of inflation. Thus, when submitting bids, we are required to estimate our future costs of production and, since we often rely upon subcontractors, the prices we can obtain from our subcontractors.

While our revenues are largely determined by the number of contracts we are awarded, the volume of product delivered and price of product under each contract, our costs are determined by a number of factors. The principal factors impacting our costs are the cost of materials and supplies, labor, financing and the efficiency at which we can produce our products. The cost of materials used in the aerospace industry is highly volatile. The invasion of Ukraine by the Russian Federation and retaliatory measures imposed by the United States, United Kingdom, the European Union and other countries, and the responses of Russia to such measures, have negatively impacted the availability of certain minerals, such as titanium, for which Russia was a source of supply. We are working with our larger customers, some of which have access to sources of metals necessary to manufacture their products not readily available to us or other companies of our size. Nevertheless, there can be no assurance that disruptions in the markets for metals will not adversely impact our ability to timely meet the needs of our customers.





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In addition, the market for the skilled labor we require to operate our plants is highly competitive. Changes in the available pool of laborers caused by Covid-19 have not materially adversely impacted our ability to meet our production schedules. Nevertheless, as we seek to grow our business, there can be no assurance that the skilled laborers we need to operate our machinery will be available to us or that the costs incurred to maintain our current labor force and those we seek to bring on will not increase.

The profit margin of the various products we sell varies based upon a number of factors, including the complexity of the product, the intensity of the competition for such product and, in some cases, the ability to deliver replacement parts on short notice. Thus, in assessing our performance from one period to another, a reader must understand that changes in profit margin can be the result of shifts in the mix of products sold. Our operations have a large percentage of fixed factory overhead. As a result, our profit margins are also highly variable with sales volumes as under-absorption of factory overhead decreases profits.

Our revenues are principally determined by orders from our customers, generally orders - which we call releases - against LTA's with those customers. These long-term agreements generally have fixed prices for product with negotiated increases to reflect a portion of the impact of inflation, though over the term of a LTA prices often increase and not all of the increase is covered by agreed upon price protection clauses in our agreements. Our direct costs of production include costs for material, labor, and factory overhead; all of these costs may vary based on the efficiency of our factory operations. Our gross profit is highly variable due to the mix of products sold, and by sales volume, which can lead to the over absorption or under absorption of factory overhead costs.

Beyond these direct costs of production, we incur general and administrative costs termed Operating Expenses and financing costs for borrowed money, income taxes and miscellaneous income and expense.

A very large percentage of the products we produce are used on military as opposed to civilian aircraft. These products can be replacements for aircraft already in the fleet of the armed services or for the production of new aircraft. Reductions to the Defense Department budget and decreased usage of aircraft reduces the demand for both new production and replacement spares and could adversely impact our business and our revenue.





Segment Data

In this report, we follow Financial Accounting Standards Board ("FASB") ASC 280, "Segment Reporting" ("ASC 280"), which establishes standards for reporting information about operating segments in annual and interim financial statements, ASC 280 requires that companies report financial and descriptive information about their reportable segments based on a management approach. ASC 280 also establishes standards for related disclosures about products and services, geographic areas and major customers.

Historically we have operated our businesses and reported their results as two separate segments with AIM and NTW comprising our CMS segment and SEC as the TEC segment. Our CMS segment specializes in flight critical components including flight controls and landing gear. Our TEC segment focuses on manufacturing components for jet engines. Each segment having different customers.

In recent years we integrated and consolidated the business of AIM and NTW into one facility on Long Island and the operations of our CMS and TEC segments have become increasingly integrated. We also made significant capital expenditures and all of our operations now share the same manufacturing facilities and use most, if not all, of the same sales and marketing functions. We made these changes to take advantage of the long-term growth opportunities we see in the aerospace and defense market. In early fiscal 2022, we further changed our management approach and are now making decisions about resources to be allocated and assessing performance based on one integrated business rather than two reporting segments. As such, effective with our first quarter ended March 31, 2022, we are presenting our operations as one reportable operating segment.





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RESULTS OF OPERATIONS

Selected Financial Information:





                                                          Three Months Ended
                                                       March 31,       March,31
                                                          2022           2021
                                                      (unaudited)    (unaudited)
Net sales                                             $ 12,062,000   $ 13,712,000
Cost of sales                                            9,984,000     11,915,000
Gross profit                                             2,078,000      1,797,000
Operating expenses and interest and financing costs      2,194,000      2,067,000
Other income, net                                           88,000        118,000
Net loss                                              $    (28,000 ) $   (152,000 )




Balance Sheet Data:



                              March 31,     December 31,
                                 2022           2021
                             (unaudited)
Cash and cash equivalents    $    364,000   $     627,000
Working capital              $ 17,401,000   $  17,478,000
Total assets                 $ 52,446,000   $  53,425,000
Total stockholders' equity   $ 17,481,000   $  17,389,000




Net Sales:

Consolidated net sales for the three months ended March 31, 2022 were $12,062,000, a decrease of $1,650,000, or 12.0%, compared with $13,712,000 for the three months ended March 31, 2021. The decrease in sales resulted principally from the decline of approximately $1,460,000 in sales from two products whose contracts expired or were cancelled by the customer in 2021.





As indicated in the table below, three customers represented 70.8% and 77.9% of
total net sales for the three months ended March 31, 2022 and March 31, 2021,
respectively.



                                             Percentage of Sales
Customer                                  2022                2021
                                       (unaudited)         (unaudited)
Goodrich Landing Gear Systems                  27.1 %              26.6 %
Sikorsky Aircraft                              25.2 %              33.8 %
United States Department of Defense            18.5 %              17.5 %




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Gross Profit:

Consolidated gross profit for the three months ended March 31, 2022 was $2,078,000, an increase of $281,000, or 15.6%, as compared to gross profit of $1,797,000 for the three months ended March 31, 2021. Consolidated gross profit as a percentage of sales was 17.2% and 13.1% for the three months ended March 31, 2022 and 2021, respectively. Consolidated gross profit for the March 2022 quarter was positively impacted by lower sales from the two products referred to above. Margin on these two products was substantially less than the margin on our other products.





Operating Expense

Consolidated operating expenses for the three months ended March 31, 2022 totaled $1,871,000 and increased by $101,000 or 5.7% compared to $1,770,000 for the three months ended March 31, 2021. The increase was caused by increases in employment costs, including employee health benefits increases which were not passed on to employees, increases in investor relations and increased travel costs resulting from the resumption of travel to customers as Covid restrictions eased. These increased costs were partially offset by reductions in stock compensation expense, information technology, and bad debt expense.





Interest and Financing Costs

Interest and financing costs for the three months ended March 31, 2022 were $323,000 an increase of $26,000 or 8.8% compared to $297,000 for the three months ended March 31, 2021.





Net Loss

Net loss for the three months ended March 31, 2022 was $28,000, an improvement of $124,000, compared to net loss of $152,000 for the three months ended March 31, 2021 due to the reasons stated above.

LIQUIDITY AND CAPITAL RESOURCES

Our material cash requirements are for debt service, capital expenditures and funding working capital/operating costs.

As of March 31, 2022, we have debt service requirements related to:





       1)  Our Webster Facility of $15,554,000 consisting of a Revolving Line of
           Credit of $11,555,000 and a term loan in the amount of $3,999,000.
           During the remainder of our fiscal 2022, we are required to pay
           $1,463,000 of this amount plus an amount of Excess Cash Flow we
           generate.

2) Related party debt consisting of a convertible subordinated note payable of

$6,412,000. This debt is not due until July 1, 2026.

3) Various equipment leases and contractual obligations related to our normal


    business.

We have historically met our cash requirements with funds provided by a combination of cash generated from operating activities and cash generated from equity and debt financing transactions. Based on our current revenue visibility and strength of our backlog, we believe that we have enough liquidity to meet our short-term cash requirements. Although the Webster Facility does have certain restrictions on our ability to fund capital expenditures, we are currently in discussions to amend the facility to provide us with the capability to spend up to an additional $2,500,000 for new equipment,

Because we believe our fiscal 2022 sales will be in line with the amount achieved in fiscal 2021, we believe our liquidity in 2022 will continue to improve. As a result of recent increases in the federal funds borrowing rate, interest rates and related expense under our Webster Facility are expected to increase from current levels. Such increases are not expected to material impact our liquidity.





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Our future liquidity may be adversely impacted by various risks and uncertainties, including, but not limited to future and current impacts of global events such as COVID-19 and the war in the Ukraine, increases in inflation, disruptions in the labor market and other risks detailed in Part1, Item 1A of our 2021 Annual Report on Form 10K. Should our cash requirements change beyond our current expectations due to general economic conditions or a strategic decision, we may choose to raise additional funds through equity and debt financing transactions. We believe that we have sufficient access to credit and/or financing from public and private debt and equity markets.

Changes in our cash flow are discussed further below.





Cash Flow

The following table summarizes our net cash flow from operating, investing and financing activities for the periods indicated:





                                                 Three Months Ended
                                                      March 31,
                                                2022             2021
                                            (unaudited)      (unaudited)
Cash provided by (used in)
Operating activities                        $  1,285,000     $    567,000
Investing activities                            (430,000 )       (273,000 )
Financing activities                          (1,118,000 )     (1,068,000 )

Net decrease in cash and cash equivalents $ (263,000 ) $ (774,000 )

Cash Provided by Operating Activities

Cash provided by operating activities primarily consists of our net loss adjusted for certain non-cash items and changes to operating assets and liabilities.

For the three months ended March 31, 2022, the net loss as adjusted for non-cash items provided cash of $686,000. This was a result of our net loss of $28,000, offset by $714,000 of non-cash items consisting primarily of depreciation of property and equipment of $665,000, non-cash employee stock compensation expense of $66,000, amortization of right-of-use assets of $131,000 and non-cash directors' compensation expense of $54,000. The remaining non-cash items totaled $(202,000).

Changes in operating assets and liabilities provided cash in the net amount of $599,000 consisting primarily of a decrease in accounts receivable in the amount of $3,033,000 and an increase in accounts payable and accrued expenses of $354,000, partially offset by increases in inventory, prepaid expenses and other current assets and deposits and other assets in the amounts of $2,467,000, $32,000 and $70,000, respectively, and decreases in operating lease liabilities and deferred revenue in the amounts of $164,000 and $55,000, respectively.

Cash Used in Investing Activities

For the three months ended March 31, 2022, cash used in investing activities was $430,000 used for the purchase of property and equipment.

Cash Used in Financing Activities

For the three months ended March 31, 2022, cash used in financing activities consisted of net payments on our Webster revolving loan and term note in the amounts of $901,000 and $203,000, respectively and payments of $9,000 and $5,000 on our financing lease obligations and loan payable - financed asset.





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OFF-BALANCE SHEET ARRANGEMENTS

We did not have any off-balance sheet arrangements as of March 31, 2022.

Critical Accounting Policies and Estimates

A critical accounting policy is one that is both important to the portrayal of a company's financial condition and results of operations and requires management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

Our condensed consolidated financial statements are presented in accordance with U.S. GAAP, and all applicable U.S. GAAP accounting standards effective as of March 31, 2022 have been taken into consideration in preparing the condensed consolidated financial statements. The preparation of condensed consolidated financial statements requires estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. Some of those estimates are subjective and complex, and, consequently, actual results could differ from those estimates. The following accounting policies and estimates have been highlighted as significant because changes to certain judgments and assumptions inherent in these policies could affect our condensed consolidated financial statements:





 ? Liquidity;




 ? Inventory valuation;




 ? Revenue recognition;




 ? Income taxes;

? Stock-based compensation; and






 ? Goodwill.

We base our estimates, to the extent possible, on historical experience. Historical information is modified as appropriate based on current business factors and various assumptions that we believe are necessary to form a basis for making judgments about the carrying value of assets and liabilities. We evaluate our estimates on an on-going basis and make changes when necessary. Actual results could differ from our estimates.

Recently Issued Accounting Pronouncements

See Note 2 of the Condensed Consolidated Financial Statements for a discussion of recently issued accounting pronouncements.





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