Astronics Corp Q1 FY2022 Earnings Call

Greetings and welcome to the Astronics Corporation First Quarter Fiscal Year 2022 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note that this conference is being recorded. I would now like to turn the call over to our host, Deborah Pawlowski, Investor Relations for Astronics Corporation. Thank you. You may begin.

Thanks Diego and good morning, everyone. We appreciate you joining us here today. On the call with me are Pete Gundermann, our Chairman, President, and Chief Executive Officer; and Dave Burney, our Chief Financial Officer. You should have a copy of our first quarter 2022 financial results, which we released earlier this morning. If not, you can find the release on our website at astronics.com. As you are likely aware, we may make some forward-looking statements during the formal discussion as well as during the Q&A session. These statements apply to future events that are subject to risks and uncertainties, as well as other factors that could cause actual results to differ materially from what is stated here today. These risks and uncertainties and other factors are provided in the release as well as with other documents filed with the Securities and Exchange Commission. You can find the documents on our website or at sec.gov. During today's call, we will also discuss some non-GAAP financial measures. We believe these will be useful in evaluating our performance. You should not consider the presentation of this additional information in isolation or as a substitute for results prepared in accordance with GAAP. We have provided reconciliations of non-GAAP measures with comparable GAAP measures in the table that accompanies today's release. So, with that, let me turn it over to Pete to begin. Peter?

Thank you, Debbie and good morning, everybody, and thanks for tuning in for our call here. Our agenda is as follows; I'm going to start by talking about a couple of prominent forces which have been affecting our company for some time, but have really come to a head here in the first quarter. And then I'm going to turn it over to Dave to talk through financials including some pretty strong cash results over the course of the quarter. I'll take it back and we will talk about a forward look for the remainder of 2022 and revisit our guidance and some of the issues affecting that and then go to Q&A at the end. So, the two prominent forces affecting our company; one negative one positive, if you read our press release, you've seen them both pretty prominently displayed. The negative one is supply chain struggles. We're not unique here and I don't intend to present a thesis, but I do want to describe how the supply chain is affecting our performance; it was pretty significant in the first quarter and it's something that's been growing. The positive force is continued strong demand from the market for our products and for our services. Bookings were really strong, backlog set another record and it's setting up for what will undoubtedly be a pretty exciting second half of 2022. So, the supply chain, this was something that's become more and more of an issue over the last six to nine months, basically as demand started picking up for us, that's when supply chain struggles became more and more apparent. In the first quarter, it was as bad as ever. We went into the quarter thinking that we would have revenues somewhere north of $130 million; we ended up at $116 million and the reduction occurred steadily over the course of the quarter when we realized that necessary components that we needed to build our products were not coming in as expected or really agreed to by our suppliers. It's a very unpredictable situation; products that we buy and have bought forever, that have pretty standard and stable lead-times of maybe three or four, six weeks, or whatever the case may be all of a sudden, can turn into 20 or 30, or even longer. And it's really kind of across the board. Although the worst situations for us are in the area of electronics, a large percentage of what we build and produce for customers involves electronic components and electronic components seem to be the sweet spot of the worldwide supply chain shortage and that is the case with us. I think it's kind of thing that affects pretty much everybody in business these days who produces a product. But it's especially bad for companies that have to buy chips and other electronic components which are designed in the products that they produce. Again, I don't want to turn it into a thesis, but I do have to say that as far as we can tell, the situation is not really improving. I keep asking our people that every time I can and nobody's willing to step forward and say that the situation in general is getting better. We've gotten a lot better at identifying problems early and responding to them as proactively as possible. Sometimes that involves spot buys and special purchase techniques, which can be expensive. So, there's always a little bit of a reality check as to when a problem pops up, what are the possible solutions and how expensive will it get? But it's obviously a worldwide problem; it's affecting a lot of companies and it got us in the first quarter. We'll talk about the rest of 2022 later, but we have incorporated what we know as best we can, with reasonable buffers into our revenue guidance going forward. So, we are sticking with our revenue guidance, but we issue that in our last call. And there is some margin for supply chain problems, which may raise their head. That being the case, however, these things are unpredictable; it's a little bit difficult to know for sure how things are going to work out with any particular product or any particular period, but more on that later. The positive force that continues to drive our business is bookings. We have bookings of $175 million in the first quarter, that's book-to-bill of over 1.5 and it's our second quarter in a row. In the fourth quarter last year, we had a book-to-bill of 1.53. So, two very strong booking quarters in a row have left us with a record backlog. For the last 12 months, bookings have totaled $633 million, that's over sales of $455 million. So, for a rolling 12 month interval, our book-to-bill has been 1.39. It's important to note that in these bookings totals, there's really nothing special in terms of new significant big chunks of business so far. So, it's really been kind of a groundswell of orders from across our product line, which is especially encouraging. That means our markets are coming back and the demand that used to exist for our products pre-pandemic, is increasingly back in play. Aerospace, in particular, has been really strong. Our aerospace book-to-bill in the first quarter was 1.59. Aerospace amounted to 90% of our bookings over the last year and if you look at the rolling 12 months, the book-to-bill is 1.48 for our aerospace business. All these numbers, by the way, are being taken off the table on the back of our press release, the last page of our press release, I should have mentioned that earlier. For aerospace again, very strong terms quarter-to-quarter over that rolling 12-month period. Basically bookings quarter-by-quarter went from $118 million to $142 million to $148 million and now to $161 million. So, aerospace bookings are definitely going the right way. One of the interesting observations in the bookings is that we are seeing some evidence of a wide-body recovery, I guess I would call it, some kind of resumption of wide-body orders. Some of our products are specific to narrow-body applications, and some of them are specific to wide-body applications, and we're seeing early signs of some kind of rebirth of wide-body demand, which has really been dormant for most of the time during the pandemic. Our test business demand has been a little bit weaker with lower bookings in early 2021, resulting in low sales now. Our quarter one backlog consolidated, as I mentioned, as the new record of $475 million, that's an increase from early 2021, when our backlog was at $283 million. So, obviously the bookings have positioned us well, in terms of work to be executed, we need to have our supply chain cooperate, so we can do the work and turn the backlog into new revenue. Last time we had a backlog anywhere near current levels was really late 2018. At that time, our annual sales level was running at around $800 million a year. So, those are the two big forces that I think about when I think of our first quarter; supply chain struggles and strong demand from the market. And I'm going to pass it over to Dave now to talk through the specifics of our income statement. And I'll take it back and we'll talk about our forecasts for the rest of 2022 at the end here.

Thanks Pete. Consolidated revenue was $116 million in the quarter, up almost 10% from last year's first quarter, flat sequentially from the fourth quarter of 2021. It's still not where we need to be to get to breakeven, which is around $160 million per quarter in revenue to hit GAAP breakeven. We don't expect to get to breakeven until the second half of the year. As Pete mentioned, we're expecting some significant growth on the topline in the third and fourth quarter this year, as well as improved topline growth in the second quarter. Although we're expected to get to the point where we'll be GAAP breakeven in the second quarter. Aerospace revenue was $101 million and test revenue was $15 million for the quarter, and consolidated gross margin was $19.9 million or 17.2%, with a loss from operations of $4.2 million and a slight adjusted EBITDA loss of $353,000 after removing the impacts of the AMJP grant, and the gain from the earnout for the sale of the semiconductor business. Margins continue to be compressed as a result of the low revenue in the quarter and increased cost of raw materials. Roughly $3 million of raw material costs in the quarter relate to what we call spot buys as we source materials outside of our typical supply contracts to meet customer demand. Outside of the spot buys, we've experienced general inflation relating to our materials and labor of between 5% and 10%. As Pete mentioned, supply chain continues to be our biggest challenge as lead-times are continually moving around, making planning a challenge and limiting our ability to book and ship orders quickly; but we're managing through it. We've had about $140 million of backlog scheduled for delivery in the second quarter, but we anticipate some of that may push out into the second half of the year. And we have about $220 million of backlog scheduled right now for the second half of the year. As Pete mentioned, we will need to get some book and ship orders, which are within our typical range for the second half of the year. Quarter was not as noisy as the fourth quarter of last year, but we did have some atypical income and expense items. We recognized $6 million of the AMJP grant as a reduction of cost of goods sold. We recognize and received earnout income, which is below operations of $11.3 million for the 2021 turnout period. We also received $10.7 million for the 2020 earnout period, which was recognized in the fourth quarter of 2020. We have a bit of an odd income tax expense rate, which reflects new tests for R&D expenses that require these expenses to be amortized over a five-year period, rather than expenses incurred, and this is part of the Tax Reform Act of 2017. This would typically create a deferred tax asset, which is just a timing difference and has no impact on the tax rate. But because we have a cumulative trailing three year loss, we fully reserve our deferred tax assets at this point. This will reverse when we produce cumulative trailing three-year income in the future. There's a lot of speculation regarding this treatment of the R&D tax expense that may be rolled back or pushed out later this year. If that happens, again, we'll reverse the impact of this. Bookings and backlog continued to be strong. Bookings for the quarter were $176 million and a book-to-bill ratio of 1.5 times with $161 million in aerospace and the book-to-bill ratio of 1.59 in aerospace. Test bookings were $15 million and a book-to-bill about one times and the backlog at the end of the quarter, again, as Pete mentioned, was a record of $475 million. Turning to the segments, the aerospace segment, while not profitable absent the impact of the AMJP program, shows measurable improvement compared to the first quarter of 2021. Sales were up significantly as were bookings, backlog, and our pipeline of opportunities. The segment's operating margin benefited from $6 million relating to the AMJP grant program, which is an offset in operating costs and costs of goods sold. It offsets higher wages and benefits and cost of the materials that we experienced in the quarter compared to the first quarter of last year. Commercial transport market continues to strengthen for us and sales were up $64 million, up 10% sequentially from the fourth quarter and up 68% from last year's first quarter. Military market and business jet markets remain sequentially steady. The test segment continues to be somewhat sluggish with sales down $9.7 million from last year's first quarter, resulting in an operating loss of $1.8 million. The sales drop was primarily in the military market. Orders continue to be light in the segment, but there are several large opportunities that we're pursuing in both the transit area and the military area in the test segment. Turning to the cash and our balance sheet and debt with a strong quarter with respect to cash taking in $36.4 million relate and $5.2 million of that was related to the AMJP grant, $9.2 million was from tax refunds, and $22 million were from earnout payments. Our net debt is now $113 million, down from $133 million at the end of the 2021 fiscal year. Cash flow from operations was slightly positive at $316,000. Cash used by operations reflects increases in net working capital assets that were offset by the tax refunds of $9.2 million and the second AMJP grant installment of $5.2 million. Proceeds from the earnout of $22 million were received in the quarter and reflected in cash flows from investing activities. At the end of the quarter, we were compliant with our debt covenants with our leverage ratio calculated in accordance with the credit agreement of 3.78 times adjusted EBITDA versus a maximum leverage limit of 4.75 times. The maximum leverage covenant will remain at 4.75 times through the second quarter, then drop to 3.75 times going forward. We continue to forecast compliance even as our maximum leverage covenant drops to 3.75 times in the third and fourth quarter and we're forecasting profitability to increase as we move through the year. Our revolving credit facility expires in May of 2023 and we're working to replace the revolver over the next few months with the goal of having a new long-term facility in place before we report in the second quarter.

Looking ahead, we are keeping our revenue guidance for the remainder of 2022 between $550 million and $600 million. Our internal forecast actually exceeds this range slightly, indicating the margin we are creating for potential supply chain issues. Supply chain factors will likely remain important as we continue through 2022. The midpoint of this range would represent approximately 30% growth over 2021, when we had sales of about $450 million, with the high end indicating about 35% growth. We believe these numbers are realistic. Our trailing 12 months of bookings were $632 million, so forecasting between $550 million and $600 million aligns well with that figure. Additionally, our first quarter backlog was a record $475 million, with $364 million scheduled to ship in the remainder of 2022. This suggests we need roughly another $100 million in book-and-ship business, which should be achievable. We expect the second quarter to range from $125 million to $135 million. If we add this to the first quarter midpoint, this would indicate 42% of the 2022 volume in the first half, with a greater 58% to 60% in the second half. We anticipate substantial growth, and if conditions hold steady, the second half should show more positive financial results. We are monitoring demand closely; recent bookings have primarily come from a broad increase in business without significant special items. Moreover, we are working on several substantial opportunities that may not impact 2022 significantly, but we are preparing our business activity list for 2023 and beyond. In the coming months, I am hopeful we will have notable new wins to discuss. Throughout my tenure at this company, I don't believe we've encountered such a diverse array of significant opportunities in both segments, some of which remain undisclosed. One major potential opportunity is associated with the Army's future lift competition taking place in Florida, where we are part of the Bell team and play a significant role in developing the electrical power generation and distribution system for their aircraft. This is related to our trademarked product line called core power, which provides flight-critical electrical power for small aircraft and has been built over several years. I believe this franchise will become increasingly important for our company, especially if Bell secures that contract. Additionally, we announced today our role in core power and flight-critical electrical power distribution for small aircraft amidst the rise of electrical aviation, aimed at reducing carbon footprints and noise pollution, as well as introducing new business models. The electric vertical takeoff and landing (eVTOL) market is emerging rapidly, capturing interest from both established OEM airframe businesses and numerous startups raising significant investment. While forecasts vary widely, we're adapting our core product line to meet the eVTOL market's needs and engaging in fruitful discussions with various participants. We expect to play a significant role in this market going forward, and while we don't have specific announcements today, we anticipate having updates in the next six to twelve months. I've interacted with some companies and seen their aircraft designs, and it’s certainly an exciting opportunity for us. This concludes our prepared remarks, and now Diego will open the floor for questions.

Thank you. And at this time, we will conduct our question-and-answer session. Our first question comes from Pete Osterland from Truist. Please state your question.

Hey, good morning. This is Pete on so for Mike Ciarmoli this morning. Thanks for taking our questions. First just wanted to ask on the 737 Max, what monthly rate are you currently producing to? Are you aligned with the underlying production rates at Boeing? Are there any differences in your rates, whether driven by inventories or availability of materials?

We expect some fluctuations, but we believe we are generally aligned with Boeing's production. After the shutdown, there was an inventory buildup, but they have largely cleared that inventory. Currently, our production matches their rate, which is in the high 20s trending towards 30.

Okay. Great. And then just a follow up on aero, you mentioned in your release that you're seeing signs of a pickup on the wide-body market as well. Just because you get a little color on the main improvements you're seeing there. And, you know, maybe whether you're seeing any incremental headwinds from the delays on the 787. And now, if you could just, as a reminder, what about is your revenue mix currently, in terms of wide body versus narrow body?

I have a lot of thoughts on that. The slowdown in 787 production has already been absorbed by the system, and we're no longer feeling the negative effects. From this point onward, I see it as positive. Regarding our products, some in-flight entertainment systems are common in wide-body aircraft but less so in narrow-body ones, and we supply components for those systems. We've seen an uptick in orders for those products. They are exclusive to wide-body models, indicating that demand for wide-bodies is likely improving, although production rates might not reflect this immediately since, as you mentioned, the 787 production is not currently increasing. However, there might be a resurgence in the aftermarket, possibly with airlines reintroducing stored airplanes to service. Before the pandemic, our commercial transport business had a balanced mix, approximately 50% wide-body and 50% narrow-body, evenly split between line fit and aftermarket. That balance has been disrupted, particularly during the MAX shutdown, which shifted the focus heavily toward narrow-body aftermarket. Both wide-body and narrow-body line fits declined significantly. The return of the MAX has provided a substantial boost and contributes to our optimism for significant improvements in 2022. We don’t expect to see wide-body production rates recover in the near future, and Boeing cannot provide accurate comments on that. Nonetheless, we've observed increases in sales. Additionally, we produce motion systems for high-end aircraft seating typically found in long-haul wide-body first and business class sections, and we’ve also seen a rise in orders for those programs. Most of these items do not fit narrow-body aircraft. While it's still early and the impact isn’t greatly significant, there are industry predictions suggesting a recovery in the wide-body market throughout 2023 and 2024. For the past year, we've mainly seen strong demand driven by narrow-body aircraft returning to service. It's fascinating to witness early signs of increasing orders for wide-bodies. This could indicate that even if production rates do not rise, stored aircraft may be reintroduced, and airlines might be considering upgrades or refurbishments to prepare for increased operations possibly as soon as this summer. Did that address your question?

Yes, it does. Thanks a lot for the color. I'll jump back in the queue.

Thanks.

Thank you. Our next question comes from Jonathan Tanwanteng with CJ Securities. Please state your question.

Good morning. Thank you for taking my questions. My first one is, if you're not seeing much improvement in the supply chain, what gives you the confidence to increase sales to the guidance levels for the second quarter and the second half? Are your suppliers indicating that they can meet those volumes? And what is their track record for being able to do that at this point?

It's a fair question. Explaining our experience in the first quarter while discussing the anticipated ramp in the second half is a bit tricky. However, we have scheduled the necessary work and have sourced the components, which are on order. If the supply chain performs as expected, we should see that ramp. The challenge lies in whether we will continue to encounter surprises and delays, which we believe we will. We just don't know which parts will be affected or the cumulative impact they will have. Nonetheless, the overall momentum is set to increase unless there is a major disruption. Since we have placed these orders and engaged our supply chain, we can handle a reasonable amount of delays while still achieving significant growth in the second half. That's the basis of our revenue guidance and forecast. We believe we can absorb some slippage and remain within the projected range.

Yes, it does. Thanks for clarifying that. And then second, just in terms of your own internal capacity, have you made progress at all in closing the labor gap that you've been talking about in prior quarters? And can you meet that production level internally?

It's another good question. The reality is that if our supply chain were to face an immediate issue, I would likely discuss a labor shortage. I mentioned in the last call that we were a couple of hundred people short of our target. At that time, we had 2,200 employees, and we aimed for 2,400. We are making notable progress on the labor front. While the challenges are still present, we are seeing some improvement in different markets where we operate. This isn't true for all markets or positions, but the labor we need for the production floor is starting to loosen up. For example, there is an increase in the number of applicants for new positions. It's possible that labor could become more of a concern as we increase our volume in the second half of the year. However, our current priority is more focused on supply chain issues rather than labor.

Okay. Great. That makes sense. And if I could slip in one more, just you talked about these touch projects that could be awarded midyear. What's the relative scale of those? And what would that mean for year-over-year growth and into 2023 if you landed those?

The programs are expected to exceed $500 million over their lifetime. I'm estimating from the data that there are likely six, seven, or eight in each segment. Additionally, if we succeed with FLRAA, it may last for 20 years and involve a couple thousand airplanes. These figures could easily surpass a billion dollars.

Got it. Now that seems like a big opportunity. Good luck there.

Thank you for the follow-up. I have a quick question. Considering the guidance for sales to improve sequentially through the year end, do you believe it's possible to break even on a free cash flow basis this year? Or are there other working capital factors that could keep your free cash flow negative, even with an improving top line?

I don't anticipate that we'll generate significant free cash flow as we progress through the second half of the year. The inefficiency is primarily related to inventory within our working capital. Currently, we are holding more inventory than usual; compared to pre-pandemic levels, it could be around $40 million more than what our sales would typically support. However, we cannot slow down our inventory turnover, and I expect we will maintain a stable free cash flow throughout the year. As our margins increase, we will see more working capital tied up, but eventually, this will turn into a positive factor as we transition to a more normal supply chain environment next year. Our inventory turnover has slowed significantly since before the pandemic due to supply chain issues, where even having nearly everything needed to ship a product can be derailed by the absence of a single component. Nonetheless, I believe that depending on how our working capital and inventory evolve, we should be able to maintain our cash flow situation.

Great. Thanks a lot.

Thank you. Our next question comes from Jon Tanwanteng with CJS Securities. Please go ahead.

Hi. Yes. Thanks for the follow-up. Just one on pricing. I was wondering, because we've seen a lot of companies do this in the quarter, if you've been able to pass on some of the more extraordinary inflationary costs that you've been seeing, that $3 million excess spot costs that you talked about in the first quarter, if your customers have been amenable to that, I think, being transparent with that, has helped a lot of other companies that we've covered; I'm wondering if you've seen any receptivity at all.

We have seen that and, yes, we've been passing on price increases where we can, when we can, and frankly, for the most part, we're pretty surprised with how cooperative everybody is about it. And everybody's experiencing the same thing. So it never comes as a surprise. That doesn't mean that customers are happy to pay more. But for the most part, we have seen and have taken advantage of that ability to the extent that we can. And at the same time, we do have long-term contracts on certain things where that's not as easy to do. But even in those cases, we are initiating conversations occasionally and trying to keep the situation from spiraling out of control. But at this point, we don't view that as our biggest headache; our bigger headache is just getting parts in here in the first place and executing the demands the customers are placing on us.

Got it. One more follow-up. You mentioned the big projects that were in the pipeline, but I was wondering if you have any general thoughts on military spending, considering the current high security concerns in the world, specifically regarding existing programs and how that affects your operations.

I'm not sure but I think the Army’s future lift initiatives will likely become more of a priority. Not too long ago, people were saying there would never be another ground war, questioning the need for a ground force. Recent events have likely changed that perspective significantly. Therefore, I expect spending in this area to increase. However, I'm not certain this will lead to a rise in Joint Strike Fighter programs or most other aerospace applications. I believe the helicopter programs will likely become more important, not less, in relation to the Army's version of the future battlefield.

Understood. Thank you.

Thank you. There are no further questions at this time. I'll hand the floor back to management for closing remarks.

Well, thank you for your attention and time today. Obviously, interesting times for our company, and we look forward to reporting second quarter results probably early August. Thanks for your time. Have a good day. Bye.

Thank you. That concludes today's conference. All parties may disconnect. Have a good day.