Astronics Corp Q3 FY2022 Earnings Call

Greetings. Welcome to the Astronics Corporation Third 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 this conference is being recorded. I will now turn the conference over to your host, Deborah Pawlowski. You may begin.

Thanks, Ciarmoli, and good afternoon, everyone. We certainly appreciate your time today and your interest in Astronics. On the call here 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 third quarter 2022 financial results, which we released just after the market closed today. If you do not have the release, you can find it on our website at astronics.com. As you are aware, we may make some forward-looking statements during the formal discussion and the Q&A session of this conference call. 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, uncertainties, and other factors are provided in the release and with other documents filed with the Securities and Exchange Commission. You can find those 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 tables that accompany today's release. So, with that, let me turn it over to Pete to begin. Peter?

Thank you, Debbie, and good afternoon, everyone. I appreciate you joining us for our call. As usual, we will primarily focus on discussing the third quarter of 2022, and we will conclude with some projections for the fourth quarter and an initial outlook for 2023. I'll start, then pass it to Dave, and wrap up my comments afterward. Looking at the third quarter, there are both negative and positive headlines. The negative aspect is that the revenue growth we anticipated starting in the third quarter was delayed, resulting in a shortfall. We had expected revenue of about $150 million but ended up at $131 million. This delay necessitated a revision of our second-half expectations and was mainly due to supply chain challenges and program delays, split about evenly between the two. The delay also pushed the anticipated revenue growth from the third quarter into the fourth quarter of 2022. Regarding the supply chain issues and program delays, the general struggles are widely known; I won’t elaborate extensively on them. However, we've noticed some encouraging signs. When the supply chain challenges first arose in the latter half of 2021, lead times dramatically increased. As demand surged during that period, we faced lead times that extended beyond 52 weeks, which hindered our ability to respond to the demand increase. Fortunately, those lengthy lead times have now come to an end, and parts are beginning to arrive. Our inventory levels have increased in the most recent quarter—a situation that negatively impacts working capital but positively positions us for the anticipated rise in shipments in the coming quarters. Additionally, we feel somewhat contrarian in our view of the supply chain situation. While it has disrupted business significantly over the past 18 months, we are seeing signs of improvement. We regularly conduct reviews of our various operations and consistently ask about the supply chain outlook. For the first time in many quarters, feedback indicates that the situation isn’t worsening and may even be slightly improving, although not universally. We remain cautiously optimistic that lead times will continue to decrease, and prices will normalize over time. On the topic of program delays, we have encountered several award delays that we expected would drive our second-half performance, but they now appear to be pushed into 2023, possibly even later. One specific example is the FLRAA award, where we are collaborating with Bell on a future long-range assault aircraft for the Army. This program was anticipated to be awarded in mid-2022 but has now been postponed, likely until year-end. If Bell secures this award, we expect to play a significant role, which would involve considerable engineering and development efforts. Another example is the radio test down select from the U.S. Army, which we were awarded on August 24. We initially expected this process to conclude earlier in the year, but delays pushed it back. Although selected, we must negotiate a directed procurement contract with the Army, which will now span into 2023 and beyond. This represents a noteworthy program for us, with expected values between $150 million and $200 million. Due to the combination of supply chain issues and program delays, along with some atypical costs of $4.6 million in the third quarter, we had to revise our expectations for the second half. We are also in the process of exiting a long-term lease, which involved some termination costs, a customer accommodation, and a legal settlement. Some of these costs might be reimbursed in the fourth quarter, but the accounting rules require us to recognize them in the third quarter. Inflation has also impacted our input costs, which led to margin pressure—resulting in an adjusted EBITDA of negative 0.6%. On a positive note, we continue to see strong demand for our products, with third-quarter bookings at $184 million against shipments of $131 million, resulting in a book-to-bill ratio of 1.4—nearly back to pre-pandemic levels. Historically, we would typically expect to book between $190 million and $200 million in most quarters. Over the last four quarters, we've recorded bookings of $685 million against shipments of $493 million, resulting in a record backlog of $547 million, our highest ever. Before handing it over to Dave, I’d like to clarify how we define bookings. We have a conservative approach to counting bookings, requiring a delivery order with a firm price and delivery date. For instance, in the case of the 737 MAX, we track actual delivery orders received each quarter rather than relying on long-term agreements. This method provides a more accurate picture of true demand in our business. Overall, we have seen great bookings in the third quarter, continuing a strong trend over the last five quarters, positioning us well as we head into 2023. Now, I’ll turn it over to Dave to discuss some specifics from the third quarter.

Thank you, Pete. Although our sales are showing improvement, we are still facing challenges with margins and cash flow, along with $4.6 million in what I refer to as unusual costs for the quarter. Consolidated sales rose to $131.4 million, largely driven by a continued expansion in the recovering commercial transport market, which grew 36% compared to the same quarter last year and 13% sequentially from the second quarter. General aviation sales increased by $2.6 million to $14.8 million due to higher volume, mostly from our antenna sales and enhanced vision systems in that sector, while military aerospace sales dipped by $4.6 million to $12.5 million, mainly due to a drop in non-recurring engineering revenue compared to the previous year. Sales in the test segment grew by $3.2 million to $19.3 million, fueled by increased instrument and transit test volumes. Despite this top-line growth, our margins remain under pressure. The sales growth of $19.6 million compared to the same quarter last year typically would mean an operating profit increase of around $8 million, representing 40% to 45% of that sales growth. However, we actually saw our operating loss grow by $9.8 million, increasing from a loss of $4.5 million to a loss of $14.3 million. Some key factors contributing to these challenges this quarter compared to a year ago include continued high spot buys to source inventory, estimated to cost around $4 million this quarter. We anticipate that these spot buys will decrease as we move into the next 12 months with supply chain improvements. Additionally, we incurred several atypical costs that are not expected to recur, including $4 million for settling an ongoing legal dispute and customer accommodations. We do anticipate receiving indemnification for part of these costs in the future. We also accrued $450,000 in lease termination costs due to relocating our Irvine test operation. The impact of inflation on material and labor costs is estimated at 7% to 8%, translating to about $8 million to $9 million this quarter compared to last year. Over time, we expect to pass these costs to our customers with future contracts, although there will be a delay. Some contracts have already been renewed with more favorable pricing, some are currently in negotiation, and others won’t be open for another year or two. Additionally, we haven't been achieving our usual margins on several of our newer test segment development programs, but we do expect improved margins on the follow-on orders related to those programs going forward. Lastly, in last year’s third quarter, we recognized $1.1 million in grants from the AMGP program, which helped offset costs that we do not have this year. Moving to the balance sheet, we faced challenges regarding cash. Our net debt rose to $156 million at the end of the quarter, up from $133 million at the start of the year. Operational cash flows in the third quarter were negative $28.8 million, primarily driven by a $16.1 million increase in inventory, influenced by our growing sales backlog and delays in some sales programs, exacerbated by supply chain issues. Receivables also rose by $16.7 million this quarter, worsened by the breakeven EBITDA margins we experienced. We do have some progress to report regarding an amended credit facility completed yesterday, which involved extending the expiration of our revolving credit facility to the end of November 2023. This extension allows us more time to establish a long-term credit agreement, as the process has been slower than anticipated. As you may recall, we aimed to finalize this by now three months ago. While we haven’t completed this yet, we are in the final stages and expect to have a new facility in place before the year ends. Some changes to the revolver terms include maintaining the revolving credit at $180 million until December 20, which will then decrease to $170 million. The pricing spread will increase starting at SOFR plus 550 basis points through January 16, and then will rise to SOFR plus 850 basis points thereafter. We are required to maintain trailing 12-month adjusted EBITDA of $15 million for the quarters ending December 31 and March 31, increasing to $25 million for the following quarters. Minimum liquidity must be $10 million through December 31, increasing to $15 million thereafter, along with a 10 basis points amendment fee. That concludes my remarks.

For the remainder of this presentation, I would like you to focus on the bar chart included in the last page of the press release. I will elaborate on this to provide context on our company's journey during the COVID period. The chart you have should ideally be in color rather than black and white. The green bar on the left represents our bookings for each quarter from the first quarter of 2020 to the third quarter of 2022, while the blue bar on the right indicates our shipments. I will first discuss the green bars, which reflect our booking trends. You can see that after the lockdown in the first and second quarters of 2020, our bookings dropped drastically from $165 million to about $60 million. Following that, they rebounded somewhat but stabilized around $120 million for three quarters, a period characterized by restricted travel and remote work due to COVID. Around the third quarter of 2021, when lockdowns ended, demand surged. While we aren't focusing on narrowbody aircraft much in this call, it's worth noting that we are also seeing signs of increased demand for widebody travel, which is encouraging. Our bookings skyrocketed to $160 million and $180 million, reaching $184 million in the last quarter. This indicates a rapid recovery in bookings, particularly in the past year. The blue bars on the right show our shipments, which decreased in line with bookings for a couple of quarters, hitting a low point in the third quarter of 2020. They then plateaued around the $100 million to $120 million mark until two quarters ago, when we surpassed $120 million and eventually $130 million, though we are still significantly lagging behind demand. This is when supply chain issues began to emerge, coinciding with the rise in demand from the previous year; we struggled to keep pace and continue to do so. However, we began ordering materials earlier, and they are now starting to arrive. Dave discussed our inventory ramp-up, which gives us confidence in fulfilling future orders. In the last four quarters, we achieved total bookings of $685 million against sales of $493 million. Our sales need to catch up, which is both our mission and challenge. Looking ahead, we expect revenue for the fourth quarter, which we are currently in, to be between $140 million and $150 million, with a goal at the higher end of that range. Although we have some challenges, we believe this range is achievable based on our current volume trends. As we approach the new year, we are finalizing our budgeting process for 2023. Given our current bookings and a record backlog of $547 million, we anticipate revenue next year to fall between $640 million and $680 million, indicating substantial growth compared to this year's expected results of about $525 million to $530 million. This presents a significant challenge, mainly dependent on securing necessary parts. Our indications suggest that while the supply chain is improving, it isn’t worsening. We are optimistic about our planning to acquire these parts and convert them into revenue. We believe 2023 will be a very strong year, though we will provide more updates as we progress. There are important details to finalize, such as with the FLRAA and 4549/T, but we feel prepared to turn this vision into reality. I will now conclude my prepared remarks and open the floor for questions.

And our first question comes from Jonathan Tanwanteng with CJS Securities. Please proceed with your question.

Hi. Good afternoon, guys. Thanks for taking my questions. I was just wondering, does the inventory that you've built give you that confidence to shift your revenue guidance? Or are you still waiting on parts that could push out things towards the end of the quarter?

Are you talking about the fourth quarter, Jon?

Yes, correct.

We think we have pretty good line of sight to inventory for the fourth quarter. There are a couple of hotspots. There always are. And we're working those pretty aggressively. But our internal target is at the high end of that range or just beyond it. And so, by putting that range in there, we think we're giving reasonable allowance for material problems that could still pop up. But at this point, we're obviously pretty well into the quarter and we're encouraged that we're on track so far. So, we think we're all right.

Okay. Great. Dave, I was wondering what your new estimate of when you might achieve breakeven just on a pretax income or a cash flow basis, just given the inflation underlying, the pushout of the ramp, and obviously, your expectations for how the refinancing might play out?

Yeah. I think our quarterly GAAP pretax breakeven points in the neighborhood of $160 million when the spot buys go away. We experienced $3 million or so in spot buys this quarter. So with those, I'd say our GAAP breakeven point is probably about $165 million right now with those spot buys.

Okay. Great. And then just any best estimate for what's left to complete the refinancing? What are the items left and kind of the time that you think it will take?

Our goal is to finalize everything by the end of the year. We are exploring a couple of options that still follow the structure we discussed earlier, which includes an asset-based loan backed by working capital, receivables, and inventory, along with a term loan supported by real estate and machinery. We aim to complete this as soon as possible. I am optimistic that we will reach an agreement in the first half of December. Based on the recent amendment, it is clearly advantageous for us to finalize things sooner rather than later. Therefore, I am confident that we will accomplish this in December.

Good evening. Thank you for the question. Dave, regarding the credit facility, you mentioned the EBITDA levels on a trailing basis. It appears you won’t achieve EBITDA positivity in the fourth quarter. Can you clarify what the bank's definition of EBITDA was this quarter? Additionally, it seems there will be challenges in reaching a sustainable EBITDA level.

I would say that we will be cash or EBITDA positive in the fourth quarter. So, our forecast has us being compliant.

Okay. Even though you just said breakeven?

Michael, with that we wouldn't have entered into an amendment that we were forecasting to not be compliant with.

Right. Okay. Yeah. I mean, I just haven't seen one of these take this long. So, I would imagine the EBITDA levels are a bit of a challenge, but okay. And then, Pete, you provided a detailed analysis regarding the bookings. Within the bookings, what are you seeing for near-term production rates? Looking at 2023, the supply chain might be getting a little better, although there are still challenges. We have some major suppliers, such as those for the engines, and the supply chain issues are expected to continue throughout the year. What are the underlying rates that are supporting this guidance?

You mean for the OEM production rates?

Yeah.

Yes, they are quite consistent with what has been published. Boeing has us operating at 28 to 30 units per month for the 737 MAX. Volumes for business jets are increasing, and military volumes are relatively predictable. The demand for several of our cabin electronics products, such as in-seat power and wireless access points, which are optional in narrowbody aircraft, is strong, reaching about 70% of new aircraft production for both Boeing and Airbus. This is certainly beneficial for us. I also mentioned that the resurgence of widebodies is advantageous. Before the pandemic, half of our commercial transport sales were from widebodies rather than narrowbodies. The narrowbody sector has rebounded with the return of domestic short-haul travel. Ten months ago, it was predicted that many parked widebodies would not return, but they have, demonstrating a recovery in demand. I'm particularly optimistic about recent developments in China, which is a major player in international long-haul travel, as half of the world's largest airlines are based there, currently operating at around 5% of their pre-pandemic international routes. These trends seem favorable. Our products for widebodies are definitely seeing an uptick. It's important to note that our business is driven by more than just production rates; pre-pandemic, half of our commercial transport sales came from the aftermarket. We are pleased that the 737 MAX is returning to rate and are hopeful for the 787 to resume production, but we do not solely rely on these aircraft for a resurgence in demand. The current trends in the widebody market are predominantly driven by aftermarket needs rather than new installations.

Okay. Understood. And one last question, perhaps for Dave again. Regarding free cash flow expectations, it seems that working capital is impacting many companies, but some of that should improve over time. I'm curious about the various factors at play. It appears that the facility will exceed 11% if utilized. How should we approach our understanding of free cash flow or conversion as we look toward 2030?

We will turn to cash flow positive as we move through the year. We experienced a significant increase in inventory over the past six to nine months. We anticipate that this inventory build will reduce as we progress through next year, leading to lower inventory levels. This shift, combined with revenue growth and the associated margins, will provide a favorable impact. We expect that as we move into the year, particularly the first quarter, there will be growth in sales and a decrease in inventory. I believe that our cash flow from operations will improve considerably, especially in the latter half of next year.

Hi, Pete. Thanks for taking my follow-up. Just wondering within the guidance that you have laid out for next year over those brackets, how much on FLRAA and Army radio business have you included in there? And if you haven't, how quickly could those start becoming a tailwind for you, assuming that you win FLRAA, of course?

Jon, I couldn't hear your question clearly. Were you asking about how much FLRAA is included for next year or about FLRAA and 4549?

I assume you have some of the Army radio, I don't remember the number, but is it not yet?

We have a number that reduces risk. I would estimate it to be in the range of $20 million to $25 million for next year.

Okay. Got it. And then …

So, we think there's pretty significant upside potential there, especially on the 4549/T, depending on how the Army chooses to execute the program.

Okay. Understood. I have a question about pricing. You mentioned that some of these programs are one to two years away from having their contracts reset. Is there any chance of revisiting those contracts with your customers to adjust the pricing based on the inflation you've been experiencing? It seems to me that you might be operating at a negative margin on these projects right now, which doesn't appear to be a sustainable situation.

I wouldn't say that the long-term contract nature of our business is a significant concern regarding repricing. Some products are better priced than others, and we are addressing that. However, a considerable portion of our product portfolio has a quick turnover, typically within a year to a year and a half. In many instances, we are successfully repricing these products. There are situations where we can deliver, but we need to pay a premium for certain components. We are often approaching our customers to cover those costs, and they are receptive. In other cases, we decide to absorb the costs ourselves to maintain good customer relationships. It will take time for everything to stabilize, and we are not ahead of the cost increases. Like most companies, we are responding to them. There is downward pressure, but we are doing what we can to proactively manage the situation.

Got it. Thank you.

Hey, thanks Pete. Just to stay on the pricing, what are you seeing with the current bookings on the aftermarket side of the business? I mean, do you have picked an airline customer, do you have some flexibility to increase the price on whether it's break-fix type work or if they are doing some retrofits? I mean, are you getting some reasonable pricing there?

I would say we're quite satisfied with the prices we're achieving. The main pressure we’re experiencing comes from older pricing levels that have been established for some time. However, we believe that the more recent demand is coming in at reasonable price points. Regarding our backlog and the larger programs we've announced, those aren't reflected yet. For example, we mentioned a major award with Southwest, and at the end of the third quarter, we only had about 10 ship sets included. There’s more to come. The 4549/T isn’t included either, along with some other programs. We believe that if we can increase the volume and start bringing new programs into production, our margin profile will improve significantly from its current state, where we're dealing with inventory premiums, spot buys, and pricing from six months to a year ago when conditions were different. We need to work through that, but I believe we'll manage it. It’s just a matter of time.

Got it. Perfect. Thanks, guys.

And we have reached the end of our question-and-answer session. I'll now turn the call back over to Peter Gundermann for closing remarks.

Thank you, and thanks, everyone, for joining us. We look forward to speaking with you again after the fourth quarter wraps up, likely in early February. Have a great day.

And this concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.