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Edited Transcript of AIRI earnings conference call or presentation 16-Aug-17 8:00pm GMT

Thomson Reuters StreetEvents

Q2 2017 Air Industries Group Earnings Call

BAY SHORE Aug 22, 2017 (Thomson StreetEvents) -- Edited Transcript of Air Industries Group earnings conference call or presentation Wednesday, August 16, 2017 at 8:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Michael E. Recca

Air Industries Group - CFO & Principal Accounting Officer

* Michael N. Taglich

Air Industries Group - Chairman of the Board

* Peter D. Rettaliata

Air Industries Group - Acting President, CEO & Director

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Conference Call Participants

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* John Nobile

Taglich Brothers, Inc., Research Division - Senior Equity Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the Air Industries conference call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Michael Taglich. Please go ahead, sir.

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Michael N. Taglich, Air Industries Group - Chairman of the Board [2]

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Hello, this is Michael Taglich, Chairman of the Board of Air Industries, and I want to thank you and apologize for the technical difficulties we had yesterday. So this is our second, and hopefully, better conference call.

I'm going to start with Mike Recca, the Chief Financial Officer of Air Industries, and can waste some of your time reading the safe harbor statement. Mike, would you please go ahead?

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Michael E. Recca, Air Industries Group - CFO & Principal Accounting Officer [3]

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Indeed. Okay. The safe harbor statement is, except for the historical information contained, the matters discussed on this call contain forward-looking statements. The accuracy of these statements are subject to significant risks and uncertainties. Actual results could differ materially from those contained in these forward-looking statements. We refer you to the company's SEC filings on 10-K, Form 10-Q and also onto our recent S1 for our IPO for important information of the company and related risks.

We are going to discuss EBITDA, which is used as a supplemental liquidity measure. Management finds this is useful to understand and evaluate results, including the impact of noncash depreciation and amortization charges, stock-based compensation expenses and other nonrecurring expenses and outlays prior to the consideration of the impact of other potential sources and uses of cash such as working capital items. This calculation may differ in the method of calculation from similarly titled measures used by other companies.

And with that, Pete, I'll hand it off to you.

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Peter D. Rettaliata, Air Industries Group - Acting President, CEO & Director [4]

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Okay. In the announcement, I commented that the completion of our stock offering early July has enabled us to dramatically reduce our accounts payable. This has greatly improved our balance sheet and has increased the confidence of our suppliers and our customers. We have announced a restructuring that will convert more debt and all of our preferred stock outstanding to common stock. When this is completed, our balance sheet will be even stronger.

Our short-term goal is to dramatically increase production, particularly our Complex Machining segment, where we have a past due balance of parts with firm purchase orders, totaling nearly $10 million. To accomplish this, we are actively recruiting additional machinists and accelerating the combination of the 2 companies in that segment into 1. The additional capital from our public offering will enable us to complete this transition, which will reduce our cost and increase operating efficiencies. Increasing the throughput in our factories operating more efficiently and the recent completion of some low profit projects, which constrained our gross profit, should enable us to expand our gross profit both in dollars and in percentage of sales of the balance of the year. Increasing gross profit is a prerequisite to profitability and increased EBITDA.

Our goal for 2017 is to increase sales each quarter. Our revenue for the second quarter was approximately 13% higher than the first quarter. Our 18-month fully funded backlog remains firm at nearly $100 million, and we continue to quote and win new business.

I will not go through the financial results in the announcement because they would be redundant and you can see them, but I'm going to introduce Mike Recca, who will talk about EBITDA and some other comments.

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Michael E. Recca, Air Industries Group - CFO & Principal Accounting Officer [5]

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First, I'd like to discuss gross margin. We referred to some low margin projects. We had a $3 million order for some kits used by the Army to rebuild some tanks. That was at our Eur-Pac subsidiary. That has been a troublesome product line for some time now. The good news is we're 98% of the way through that. And the last kits will be -- last 2 units will be shipped this month, maybe next week.

But the gross margin on that, which was originally forecasted to be a 10% or 15% of $3.3 million, it's going to end up being 0, perhaps even negative. So that has been a drain on our gross margin. Which our gross margin is -- our gross profit is constrained by the low level of revenue, and we have -- our factory throughput, it's not what it should be at $17 million, $18 million. And so we have a lot of expenses being allocated over a smaller number of sales, small volume of sales, and that constrains gross margin.

Now in the first quarter, switching to general and administrative expenses, we were very pleased that our SG&A was reduced by about $1.2 million versus the prior year. For the second quarter, that did not occur, and our expenses were about equal to the prior year and about $1.1 million more than the second quarter -- I'm sorry, than the first quarter. So we didn't have the same benefit. In trying to identify what -- the cause of that, it's almost entirely related to the various financings and 2 bank loan amendments, the bank consultants we had to hire and the expenses of legal and accounting and printing and the like for the IPO. So that's accounted for about $1 million of the increase, almost 100% of it.

Calculating EBITDA. Without the -- considering the extraordinary expenses of the public offering, our EBITDA for Q2 was about $700,000. And for the 6 months, it's about $1.5 million. So we're gratified that it's not -- it's gratifying that's positive. It's a great improvement over the prior year. It's not sufficient. We obviously want to do better, and we will be better as we do -- as we meet our higher revenue goals for later in the year. But it is gratifying it's positive and moving -- and it's consistent moving in the right direction.

Mike, do you have any other comments?

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Michael N. Taglich, Air Industries Group - Chairman of the Board [6]

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We'll be adding additional machinists both this quarter and next quarter, and we're going to be beefing up our accounting staff, which is too thin. And shareholders should see most of the heads will be added, will be in the direct labor as we spool up for -- as we work down our very large backlog.

I think with that, we believe we'll open up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we'll go to our first question.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [2]

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This is John Nobile. Actually, first off, the net loss was $1.97 million. You didn't put that down on a per-share basis. What are we looking at per share on that number?

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Michael E. Recca, Air Industries Group - CFO & Principal Accounting Officer [3]

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We divide that. Look, per-share basis is going to be very tricky this quarter, John, because the number of shares outstanding in July is significantly higher than it was going to be in June. So that's one of the reasons I didn't want to put it in there because if you divide $1.9 million by $7.5 million, you get one number. But as of July 12, we had -- well, as of today, we have about 14 million shares outstanding. So...

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [4]

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14 million outstanding, right. I mean, for the Q, it's going to be on the weighted average over the quarter.

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Michael E. Recca, Air Industries Group - CFO & Principal Accounting Officer [5]

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On the weighted average. And the weighted average, I understand the accounting but the -- and this is one of the situations where the accounting really isn't -- is -- so it's kind of misleading.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [6]

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Right. Okay. Well, I'll see that in the Q. But I understand about the extra shares with the financing. I just have a few questions. But if I had to say, my main question is your backlog, it continues to remain high at nearly $100 million. So my question to you is, how do you plan to actually satisfy that amount of backlog? And how do you plan to get product out the door more quickly? I know in the past, you've had higher revenue numbers on lower backlog. So I just want to understand what is it going to take to get this product out the door.

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Peter D. Rettaliata, Air Industries Group - Acting President, CEO & Director [7]

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Well, there are a couple of things that will be important. The single most difficult problem we had over the last several months was that we were constrained in terms of capital and addressing the issue of bringing in raw material. The raise has solved that problem. For the most part, raw material is flowing in. We're able to now start to move at more appropriate production rates and cycle to achieve the ramp up that we need. The last couple of months, we were kind of hand-to-mouth, and that is very inefficient and very difficult to get any kind of a rate going. Now we're moving past that. That's why we're starting to bring in additional machinists, open up the night shift, work at a higher level of utilization. That will also increase profitability because our hourly rate, our cost rate goes way down as we go through a higher utilization rate through our plants. So this is all good news. But in the last couple of months, kind of difficult to get that ramp moving, and now we're off and going.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [8]

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Okay. So with this more or less alleviated, the ability to get your raw material, in order to satisfy this, we should anticipate a ramp-up, a sequential ramp-up quarterly in your revenue numbers?

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Peter D. Rettaliata, Air Industries Group - Acting President, CEO & Director [9]

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Yes, and that's our plan, and that's what our guidance has been.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [10]

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Okay. Great. And how long do you believe it would take to fully consolidate AIM and Nassau Tool Works? You mentioned that you're in the process of consolidating that. So I wanted to get a time frame for that. And I was hoping you could actually quantify the annual cost savings that you expect from that.

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Peter D. Rettaliata, Air Industries Group - Acting President, CEO & Director [11]

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I can do that in terms of an estimate, but our consolidation of Air Industries Machining and Nassau Tool is paced by a couple of things. The most important aspect is that the Nassau Tool lease ends next October, so we must be through that process by next -- a year from October. So we have over '18. So we must be out by then. We also have to be very careful about machine centers and moving those machine centers when we have the space, to spend 2 or 3 weeks, maybe 4 weeks, reestablishing that machining center in the new location. So this is an iterative process that will take us almost 18 months in terms of the production work. But as I'm speaking, we can start to consolidate departments like engineering and purchasing and contracts and so on, and we're well within that activity already. So the end date will be October of 2018 as it coincides with the lease date. And I think just in the cost of occupancy, we should save about $1 million a year in overhead expenses. The hidden benefit is going to be the operating efficiency in having people working more closely together, less distance for parts to go back and forth from one facility to another. Because both of these companies today do an awful lot of work for each other. So there are 3 or 4 different ways this is going to create some advantage: as we have talked about, higher utilization of the new leaner facility, better working relationships between the 2 company as they're consolidated -- and consolidated of any of the overhead functions, like procurement, contracts, engineering and so on. So this was a very good thing and I think will bring our hourly rate down yet again, over and above simple higher utilization.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [12]

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Okay. So over the next year, especially before you had comments that this quarter had about $3 million revenue from low to negative margin kits, the $3 million in kits that were in this quarter.

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Peter D. Rettaliata, Air Industries Group - Acting President, CEO & Director [13]

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Yes.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [14]

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So with that out of the way, that should improve gross margins this year or should we expect a gradual improvement over the next year or so until this is actually fully consolidated in your gross margins?

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Peter D. Rettaliata, Air Industries Group - Acting President, CEO & Director [15]

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Yes, we believe so. I think we're getting rid of some weight around our neck with some difficult contracts. I think, going to the future, I think that the deliveries that we make will be at higher gross margin levels. That's our projection. That's our belief.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [16]

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All right. Great. And I just have one more question. Well, actually, since January, the new administration in office. I'm just curious if you have seen an increase in the level of new business quotes since January with the new administration in office.

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Peter D. Rettaliata, Air Industries Group - Acting President, CEO & Director [17]

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We have. And our backlog continues to grow, and much of that growth is coming on the readiness side of our business base. Much of what we make is for production aircraft, but what we like to get contracts for, what we go after most aggressively for are parts that also have high utilization and replacement rates in the fleet. So while we make production parts for the BlackHawk, there are 3,000 BlackHawks out in the fleet, many of the kinds of things we make have to be replaced several times through the life of the aircraft. Starting at the end of the Obama administration, the criticism was pretty strong about the low level of availability of aircraft, and they started to fund readiness expenses, and we started to see a little bit of an increase at that time. The Trump administration has been more robust in that way. And the 2017 budget supplement that you've seen on the news and people have been talking about includes a plus up for readiness, which already is starting to affect us. A big part of our increased backlog is for landing gear on military aircraft and landing gear replacement parts for aircraft in the fleet. That's about 75% of our backlog.

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Michael E. Recca, Air Industries Group - CFO & Principal Accounting Officer [18]

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You might want to -- anecdotally, you might want to discuss the mixers.

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Peter D. Rettaliata, Air Industries Group - Acting President, CEO & Director [19]

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Yes, we make the primary flight controls for the BlackHawk. We call them the mixers. And those are very delicate, complex assemblies that sit on top of the flight deck and control the entire flight trim of the aircraft. They probably get replaced 10 times per BlackHawk in the fleet. When they get to a certain amount of flight hours, that aircraft has to come off the flight line. And so now there's a mad rush to get more mixers because the readiness rate of BlackHawks is not very good. And we are, day and night, building mixers, and that's a nice product for us. So we have a number of products like that, and that's a large extent why our backlog is strong. Also, it is the kind of backlog that we like because it increases the percentage of our product offering for parts that we have already developed and know how much they cost, know how to make them, very little nonrecurring expenses or risk involved. So that's a very good thing for us.

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John Nobile, Taglich Brothers, Inc., Research Division - Senior Equity Analyst [20]

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Okay. And how much of this backlog, roughly $100 million, is related to the BlackHawk?

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Peter D. Rettaliata, Air Industries Group - Acting President, CEO & Director [21]

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I would say 25% of it. Actually, the biggest part of the backlog is around military landing gear for E-2s, F-18s, F-16s. But the same story is true for those parts as well.

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Operator [22]

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(Operator Instructions) We'll take our next caller.

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Unidentified Analyst, [23]

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[Ben Felipe] from National Securities. I wanted to follow up on one of the questions that John asked in regards to the backlog. Probably about 4, 5 weeks ago, Sikorsky announced the $5.2 billion BlackHawk award from the U.S. Army. I was wondering if that was included in the backlog or does that have the potential to increase the backlog.

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Peter D. Rettaliata, Air Industries Group - Acting President, CEO & Director [24]

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It has the potential to increase our backlog. The vast majority of the business base that we have with Sikorsky is part of a long-term agreement that we negotiate over a 5-year period, and we're in the first 2 years of this 5-year increment. That agreement says that you get what we get. So it doesn't have a quantity to it. It's a requirements-type agreement. And as they plus-up their annual business base or rate of production, that automatically will plus-up what we will expect to see as individual releases to the period of performance of that 5 years. So we have a requirements-type contract. Their requirements have increased, so our work share will increase. That most recent announcement hasn't found itself into individual line items and contract increases yet, but it will, and that's a good thing.

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Michael E. Recca, Air Industries Group - CFO & Principal Accounting Officer [25]

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And then, just to reiterate, we calculate the backlog a little bit differently than many defense contractors, more conservatively. All of our backlog is supported by firm purchase orders. So they've got a $5.2 billion award. That's going to be converted from purchase orders from the Army to Sikorsky, and eventually, to us, but not yet.

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Peter D. Rettaliata, Air Industries Group - Acting President, CEO & Director [26]

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So we only count in our backlog the actual funded purchase orders that we receive against our longer-term agreements when they are funded and have a delivery date and are positive. But that's pretty conservative. If we were to calculate what it looks like unfunded backlog would be, that would be a number that was unbelievable, and one that we, ourselves, wouldn't want to plan on or try and convince you was accurate.

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Unidentified Analyst, [27]

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Okay. Can you give us some understanding as to -- I mean, I'm trying to get a sense of when you see an announcement like this, an award -- and obviously, because of the methodology by which you calculate your backlog, this isn't part of it but has the potential. But what is the conversion from an announcement of this nature into a funded backlog? What is the time frame for that? And generally, what percentage normally occurs from...

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Peter D. Rettaliata, Air Industries Group - Acting President, CEO & Director [28]

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I would say we would start to see the increases from this most recent award -- 3 quarters of a year from now is when we'll start to see that effect. And the Sikorsky work particularly has the 3 components, and that is the kind of the base production level, the change to that base production level, and then the layering in of the requirements for aircraft in the fleet. So we have actually 2 things happening: the base requirement that we had planned on looks like it's strengthening, getting to be over 100 aircraft a year; and the government is also funding readiness. So we see 2 strong reasons to believe that the Sikorsky work would be much stronger in the next year than it was over the last 2 or 3 years. And all of that starts to strengthen our throughput and reduce our hourly rate, increase our profit because we bid these jobs at kind of the midrange of throughput. And this will start to put us at a strong level of throughput, so that's a good thing. When we price these things, we can only give them one price, and we have to sort of find a midpoint of what we think quantities will be. It turns out the quantity is going to be higher than what we had planned on in our initial negotiation.

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Michael E. Recca, Air Industries Group - CFO & Principal Accounting Officer [29]

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And that's the exact opposite of our experience over the last couple of years.

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Peter D. Rettaliata, Air Industries Group - Acting President, CEO & Director [30]

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Yes, last couple of years, we were losers in exactly that kind of relationship on many of our contracts. And that's part of what hurt us. We were not just putting less work through the facility. The pricing for that work was based on probably a projection of higher quantities than what actually came to us. It's a little complicated, but it's how it works.

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Unidentified Analyst, [31]

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No, understood. There's just one last question for me, and I'll turn it over again. Something like this word that came out where the discussion was 257 units, $3.8 billion equally split between utility and medical evacuation helicopters. Can you get similar margins on both of those type of helicopters? Or are there variations on them?

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Peter D. Rettaliata, Air Industries Group - Acting President, CEO & Director [32]

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It makes no difference to us. Most of the parts we make for either one of those helicopters are identical, and the pricing is identical. What the difference is, is that we've now plussed up the volume and the volume learning curve-type efficiencies. So the difference between a med evac helicopter and a helicopter use for day-to-day transporting troops to us is very, very minute. There's just slightly different equipment in the helicopter.

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Operator [33]

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And we'll now go to our next question.

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Unidentified Analyst, [34]

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Don Wojnowski, Paulson, here. Can you give us a sense of what level of revenue would be -- you consider fully utilizing your capacity?

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Peter D. Rettaliata, Air Industries Group - Acting President, CEO & Director [35]

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We think when we reach $80 million in revenue with the company as it's configured right now -- I wouldn't call that fully utilized. I would say that's when we start to feel pretty -- pretty good. When we reach up into the mid-70s, I think we return to a fully-founded business that will make us feel comfortable. But once we get over $80 million, I think we start to see ourselves as pretty happy and probably looking to buy some more equipment.

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Michael E. Recca, Air Industries Group - CFO & Principal Accounting Officer [36]

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At $80 million, you cut your blood pressure medicine in half. But one thing I would keep in mind here is that to some of the companies -- some of the revenue of the companies that we own as recently as 2012 did $95 million. So we have capacity. Again, gross margin and profitability is inextricably tied to volumes. So $75 million to $80 million, you're feeling okay. $80 million to $85 million, you're feeling pretty good. And at $85 million to $90 million, you're feeling terrific.

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Unidentified Analyst, [37]

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Any sense of the age of the backlog? And is that any concern? Any risk to losing any of it?

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Peter D. Rettaliata, Air Industries Group - Acting President, CEO & Director [38]

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I don't think so. We have positioned ourselves very well on much of the hardware that we make where there are entries -- entry barriers to others, and I'm not worried too much about losing any of this work. Our job is to make sure that we get it out as quickly as possible and get back up to our traditional rates of production.

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Operator [39]

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(Operator Instructions) We'll go to our next question.

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Unidentified Analyst, [40]

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[Steve Bransted] of Avion Investments. Congratulations on the improved quarter. I wanted to ask about the defense spending, though, going through Congress. It seemed to be a big increase from the prior year. Where would you think it would need to be at to benefit you guys, Air Industries, going forward?

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Peter D. Rettaliata, Air Industries Group - Acting President, CEO & Director [41]

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It's benefiting us right now. We have a very strong backlog. We're being awarded more work on a continuous basis. We're already seeing the benefits. Because of what I mentioned earlier, much of what is in the initial increases to the defense budget has to do with readiness for aircraft that we were already on. It's an immediate benefit. As the next couple of years come together, you're going to start to see more spending in the defense budget around new projects that we may or may not be on and that we're working towards. But right now, this is a sweet spot budget for us.

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Michael E. Recca, Air Industries Group - CFO & Principal Accounting Officer [42]

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And if you look at the defense spending cuts during the Obama years, a lot of that by the Pentagon was directed at spare parts and readiness of aircraft. And they wanted to maintain the production of aircraft because they have a contract to do that. And when you have new projects like the JSF, you can't start and stop it. So if you have limited dollars, they allocated them to production, continuing that. And if they had to park some F-18s and park some F-16s, and if the BlackHawk fleet was at a lower level of flyability, they would live with that for the time being. That got to the point at the end of the Obama administration when that was unbearable. There were reports on the TV that the Marine Corps F-18 fleet, about 18% were flight-ready on any particular day. So they over -- the maintenance had built up to the point where they had to do something. And so the new budget really had to address that, and that's been a very big benefit to us.

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Peter D. Rettaliata, Air Industries Group - Acting President, CEO & Director [43]

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What you also see is the planned increase in quantity around the Joint Strike Fighter program through the next couple of years, which had been planned. This is nothing new. But they start to ramp up the quantities for each version pretty severely in the next couple of years, and we are participating on the Joint Strike Fighter.

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Unidentified Analyst, [44]

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Okay. Very good. Say you get -- assuming you get back to $80 million or $90 million in yearly sales, what kind of EBITDA margins would we be looking to see?

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Michael E. Recca, Air Industries Group - CFO & Principal Accounting Officer [45]

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At $80 million, I think you're looking at about between 10% to 15%. I mean, I think we've done a pretty good job. It didn't show up this quarter. In cutting our overheads, we have been diligent about doing that again, particularly on the G&A side. And I'm happy to spend more on direct labor and the like. So historically, at $20 million a quarter, you're probably looking at $2 million or $2.5 million in EBITDA, so 10%, 12%. When we get above that -- basically, the EBITDA, once you get above breakeven, you get to keep your gross margin. So when you get up in the 20 -- one rule of thumb I have here is if gross margin is equal -- as a percentage is equal to quarterly revenue, 17% quarter, 17% gross margin, $20 million quarter, 20% gross margin. And that should grow more quickly from that. So if you have 22%, 23%, 24%, it could be very -- that would be a good result.

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Operator [46]

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(Operator Instructions) I show no additional questions in the queue at this time. I'd like to turn it back to the speakers for any additional questions -- or sorry, comments or remarks.

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Peter D. Rettaliata, Air Industries Group - Acting President, CEO & Director [47]

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Mr. Taglich. It's...

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Michael N. Taglich, Air Industries Group - Chairman of the Board [48]

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I just want to thank all the participants for their time. We apologize again about the SNAFU on the earlier call. We're looking forward to turning our backlog into shipments. I want to thank all the people that participated in our most recent financing, and I'm looking forward to making our projections a reality. Again, thanks for your time.

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Peter D. Rettaliata, Air Industries Group - Acting President, CEO & Director [49]

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Thank you all.

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Michael E. Recca, Air Industries Group - CFO & Principal Accounting Officer [50]

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Thank you. Bye-bye.

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Operator [51]

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