Astronics Corp Q2 FY2025 Earnings Call

Thank you, and good afternoon. We appreciate your time today and your interest in Astronics. Joining me here are Pete Gundermann, our Chairman, President and CEO; and Nancy Hedges, our Chief Financial Officer. Our second quarter results crossed the wires after the market closed today, and you can find that release 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 and 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 earnings release as well as 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'll also discuss some non-GAAP measures, which we believe 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, I will turn it over to Pete to begin. Peter?

Hello, everybody, and welcome to the call. I'll open the call with my comments on the second quarter, which had a number of positives and negatives, but also showed consistent progress towards improved performance for the business, which has been our goal as we work our way through 2025. I'll then turn it to Nancy to cover the details. And later, I'll talk about our strengthened outlook for the remainder of the year. Sales for the quarter were just under $205 million, similar to the first quarter and up 3.3% from the second quarter of 2024. This was driven by record sales for our Aerospace segment, which compensated for lower Test segment sales. Test sales were low due to a $6.4 million adjustment driven by our ongoing program review process, which has caused us to reevaluate our financial position on a few programs. Year-to-date sales are $411 million, up 7.2% from $383 million last year. So our sales momentum remains solid. Our margins continue to make progress also driven by the success of our Aerospace segment. We had adjusted EBITDA of $25.4 million or 12.4% of sales in the quarter. On a rolling 12-month basis, adjusted EBITDA as we calculate it, has been $114.7 million. This is up from $71 million for the previous 12-month period. So we have continued to make pretty good progress. Second quarter bookings were on the light side at $177 million for a book-to-bill of 0.86, primarily as a result of timing following a record level of bookings in the first quarter. Market demand for our products remains strong. Our book-to-bill for the first half of 2025 is positive at 1.11 and for the last 12 months, also it's positive at 1.02. So while our revenues have been ramping over recent periods, our bookings have been keeping up just fine, which is a good indication of continued strength going forward. Our quarter results were colored by some large and unusual adjustments resulting from the business review we described in our first quarter call. That review, as I mentioned a minute ago, led us to a $6.8 million EAC-related adjustment in our Test segment. The EAC charge is to level set certain long-term development contracts in our transit business specifically. Our review concluded that we are not as far along on the programs as we thought, leading to the reset. Our work is being verified currently by an outside consultant firm hired to help us implement management systems to minimize any recurrences in the future. Our program review also led us to step away from a couple of Aerospace segment product lines that we have concluded are noncore to our future. This simplification initiative resulted in $6.2 million of restructuring charges in the Aerospace segment. These product lines have proven to be low growth and low margin and the charges relate to write-downs of inventory on certain facility assets. These two product lines, which include satellite antennas and contract engineering and manufacturing programs are expected to contribute sales of only $4 million to $8 million in all of 2025. We expect to exit a couple of facilities related to these actions over the next 12 to 18 months. As an aside, including these two facilities, we've closed eight facilities in recent years, significantly reducing our footprint and simplifying our organization. The contract engineering and manufacturing initiative is one that we entered into in the heat of the pandemic to leverage some manufacturing space and engineering resources that were underutilized at the time. Over time, we found the program risks were too high and the resulting margins did not justify the effort. The discontinuation of any further development of our satellite antenna product line, which has been focused on large business jets and commercial transports operating with geosynchronous satellite constellations, was the result of having a low market share and recognition that conditions have slowed as customers contemplate emerging low Earth orbit constellations. We decided that the investment in developing new antennas specific to either the LEO and/or GEO market would be too risky to justify the required financial investment. But to be clear, the antenna decision does not mean we are walking away from LEO as a technology. To the contrary, the vast majority of our in-flight entertainment and connectivity capabilities are as relevant to LEO networks as they are to GEO and to air-to-ground, ATG, topologies. The market is in a state of flux currently as customers consider the merits of the competing technologies, but we are optimistic that we will be able to create value in the emerging LEO world as we have in the past with GEO and ATG. We made a small acquisition in our Aerospace segment at the beginning of the third quarter. Envoy Aerospace is an ODA, which stands for Organizational Designation Authority. ODA is a program in which the FAA grants certification approval authority to outside organizations through which the FAA extends its capacity and reach. We believe that having an ODA will be a competitive differentiator as we are often involved in aircraft retrofit programs and FAA certification is becoming a more important capability in competitive situations. Having certification authority lessens program and schedule risk for both us and our customers. Envoy has sales of about $8 million and will report through our Astronics CSC operation. I'll turn it over to Nancy now to cover segment results and other details relating to our second quarter results.

Thanks, Pete. I'll review the key drivers and other impacts to our consolidated Q2 performance and then touch on segment level results. As Pete noted, revenue in the second quarter grew 3% over the prior year period and was in line with the trailing first quarter. This was despite the $6.4 million impact to revenue of the adjustment to the estimated cost of completion of certain Test systems projects. Growth was driven by record quarterly aerospace sales. Operating profit and margins reflected the $6.9 million total P&L impact associated with the EAC adjustments and $6.2 million in costs for footprint rationalization and the portfolio reshaping that Pete discussed. Additionally, as part of a further follow-up hearing in the latter part of May with respect to the U.K. patent dispute, we were ordered to make a partial reimbursement of the plaintiff's legal fees associated with the damages phase amounting to $3.5 million. This was partially offset by a $1.7 million reduction in legal fees and a reduction of R&D expense in the amount of $2.6 million due to project timing. On an adjusted basis, gross margin expanded 120 basis points over the prior year to 29.2% and operating margin expanded 250 basis points to 8.9%. Adjusted EBITDA was $25.4 million or 12.4% of sales, up from 10.2% last year, primarily reflecting improved profitability from higher volume and increasing productivity in the Aerospace segment. As a reminder, we did not add back the EAC impact in our adjustments, and it had a 2.9 point negative impact to our adjusted EBITDA margin. Interest expense declined 47% year-over-year to $3.1 million in the quarter, reflecting our successful refinancing last November of the prior term loan and the ABL. The lower interest rate on our convertible debt provides meaningful savings in both interest and reduced cash payouts and provides a solid liquidity cushion. GAAP earnings per share was unchanged year-over-year at $0.04. Non-GAAP adjusted EPS for the quarter was $0.38, nearly double the $0.20 from the prior year period. Turning to our segment level results. Our Aerospace segment delivered another quarterly sales record of $193.6 million, a 9.4% increase year-over-year. Commercial transport sales was the primary driver and was up 13%, driven by continued strength in cabin power and inflight entertainment and connectivity products. Military sales were also strong, increasing 11%, driven by increased demand for lighting and safety products. Operating profit in Aerospace was impacted by the portfolio realignment previously discussed. Adjusted Aerospace operating profit was $31.5 million in the quarter compared with $23.5 million a year ago. And on an adjusted basis, Aerospace achieved 48% operating leverage on the higher volume. Adjusted operating margin improved by 300 basis points year-over-year to 16.3%. Turning to the Test segment. As we discussed on our last call, the Test business was expected to be weak in the quarter, but the EAC adjustment further deteriorated the results. Sales of $11.1 million reflect the most recent estimates for completion, which lowered the percentage of work completed, which reduced revenue by $6.4 million. We reported an adjusted operating loss of $6.7 million in the Test business. Again, we did not adjust for the impact of the EAC change, which was $6.9 million on operating income, including about a $500,000 loss reserve that's reflected in cost of goods sold. These adjustments masked the positive impact of approximately $5 million in annualized cost savings that started to flow through in the quarter. We expect these benefits will be more visible in the second half of the year. Stronger Test bookings in the quarter included a follow-on order under the Radio Test Programs for the Marines. The U.S. Army Radio Test program apparently requires another level of process within the Army that we have to wait for them to complete. We expect this process will push the program out six to eight weeks and still hope to see a production order before the end of the year. We used $7.6 million in cash from operations. As expected, this reflected the $21.6 million in payments related to the U.K. patent dispute for damages, interest and the legal fee reimbursement and $12 million in income tax payments. This was a $9.5 million increase over last year's second quarter income tax payments and included the full year federal payment for 2024 as well as the resumption of quarterly estimated federal payments given our improved liquidity. With those large payments behind us, we expect to generate solid operating cash flow in the second half of the year. We finished the quarter with $13.5 million in cash and factoring in the liquidity block, approximately $178 million of availability under our ABL facility. This resulted in about $191 million in total liquidity at quarter end. We're currently undrawn on our revolver and expect that cash from operations can fund the business in the near term. Our healthy balance sheet provides flexibility to consider value-creating initiatives, including acquisitions and share repurchases. We continue to advance on our financing structure as well. As profitability continues to improve, we will evaluate a transition to a cash flow-based revolver, which is less restrictive and eliminates the current liquidity block. We may evaluate other options as well, especially given the positive progression of our operational performance, solid visibility into future demand and the related stock price improvement. Capital expenditures in the quarter remained low at $4.6 million and are $6.7 million for the first half of 2025. We continue to expect a much higher level of CapEx for the full year and are now forecasting spend to be in the range of $40 million to $50 million. We have advanced on the project for the facility consolidation and capacity expansion for our electrical power and motion products in Redmond, Washington and expect that spend to measurably step up in the second half of 2025. I should note that even with the elevated CapEx spend in the second half, we are projecting positive free cash flow. On the tariff front, the changes enacted in recent weeks result in an impact to our cost of about $15 million to $20 million. We believe mitigation efforts can reduce these costs by at least half. While price adjustments are already being pursued, now that the situation has stabilized to some degree, we can consider other mitigation actions like free trade zones, duty drawbacks and bonded warehouses in addition to evaluating our supply chain options. Other actions we have taken with the business to drive profitability will help to offset the tariff impact as well. Overall, we're pleased with the strong first half. We expect with the resilient strengthening of underlying performance trends in our core aerospace business and expected improvements in Test Systems, we will have an even stronger second half of 2025. We remain focused on disciplined capital allocation, productivity to drive further margin expansion, accelerating our working capital turns, free cash flow generation and consistently executing on continuous improvement. And with that, let me turn it back to Pete.

As Nancy said, we are expecting a strong second half to 2025. Our Aerospace business will continue to enjoy the strong tailwinds prevalent in the industry, including increasing passenger traffic, aircraft utilization, aircraft build rates and the increasing adoption of modern passenger entertainment and connectivity systems. We also expect solid improvement in our Test business based on strong recent bookings and the EAC adjustments we have just taken. We expect sales in the second half to possibly double the total from the first half, even with the possibility that the production start of our U.S. Army radio test program known as 4549/T may slide into 2026. Given all this, we are increasing our 2025 revenue guidance to $840 million to $860 million, up from $820 million to $860 million, an increase of $10 million at the midpoint. The midpoint, $850 million would represent an increase of 6.9% sales year-over-year. We expect the third quarter to be up marginally from the pace of the first half with the fourth quarter up more substantially. We expect it will be a positive and exciting second half, setting up another positive year in 2026. And with that, Kate, we'll open it up for questions.

Pete, if you could first talk about the magnitude and, I guess, the drivers overall of the aerospace momentum that you're seeing that's allowing you to raise your revenue guidance. Maybe the Test business as well, where is that coming from? With the backdrop that you're exiting some businesses, you've got the EAC impact as well as the push out of the radio business, help me frame the size of all those things that you have together.

Sure. It's a pretty comprehensive list of things actually. On the aerospace side, production rates, first of all, are a pretty big driver. We've got 737 rates going up, A320, there's upward pressure, all those supply chain problems. 787, A350, those are the four main ones that have increased or are expected to increase in the near future. 737, to give you an idea, we've been shipping somewhere in the neighborhood of low 20, mid-20 shipsets per month and most recently stepping up to the low 30s, and we are on a glide path to step up again to high 30s and even up to low 40s potentially by the end of the year if Boeing gets permission to go there. So that's a big driver as we look forward. Beyond that, we have a program that we've announced with the Airbus A220 up in Montreal that should be a pretty big driver as we move through 2026. So that's a positive picture in general. On the military aircraft side, you noticed some pretty big growth there. One of the drivers is our engineering and development work year-over-year with FLRAA, which shows signs of accelerating. It's a little early to talk about that, but there's demand from the U.S. Army customer to move that in sooner rather than later. And on our Test side, the big drivers are the programs we've talked about quite a bit here, including primarily the 4549/T program for the U.S. Army. We're making a lot of progress on that program. We think it's a very healthy program going forward. The unfortunate situation there is that our customer at the U.S. Army has been delayed by a DoD requirement for a certain health and safety analysis that needs to be completed. This is something that the DoD completes. It's nothing that we do. And that, at this point, seems to be the long pole in the tent. I don't mean to imply it's the only thing going on in that program. There are a number of other under-crosscurrent things going on under the covers, but that's the thing that may push us from starting a production phase out of the fourth quarter into the first quarter. But even with that, we think that our Test business is lined up for a pretty strong improvement in revenue in the second half of the year, including in the current quarter compared to what it did in the first half. So I don't know if that answers your question, Jon. It's kind of a long list of tailwinds really that are pushing us in our activity level, perhaps even higher than what our financials show. I mean we're turning in a quarter of $204 million after the EAC reduction. As a matter of activity, you can imagine what it was like without the EAC reduction. And then we'd be within spinning distance of an all-time record high with revenue for the company in the quarter.

Got it. That's very helpful. Can you discuss your expectations for the margin this year? You have the EAC, and I'm not sure if you can make that up in the second half. With additional tariffs coming, please help us understand your margin expectations as the year concludes.

The margin situation regarding tariffs remains somewhat unpredictable. We have passed the August deadlines set by the previous administration, but the situation is still evolving, with expectations of potential rate adjustments. Nearly half of our tariff burden originates from Malaysia, which has a 19% tariff, similar to many countries in the region. However, the materials we source from Malaysia can easily be obtained from other suppliers, so we are not heavily reliant on them. A significant portion of our total tariff burden also comes from China, which is more challenging to address, and ongoing negotiations there leave us uncertain about the outcomes. Nancy mentioned some actions we might take, and while we anticipate a short-term impact from tariffs related to Malaysia, we believe we can mitigate these by shifting production or suppliers if needed. The situation with China is less clear. We are exploring pricing strategies to pass on costs to customers, as no one wants to bear the tariff expenses. It is still early to predict how this will ultimately resolve. Reflecting on the second quarter, I’m pleased with our aerospace margins improvement. Our adjusted operating margin, excluding two significant actions we took, reached around 16%, indicating solid progress. Nancy also noted a 49% contribution from marginal sales. If we can maintain growth in the aerospace sector, we should be in a favorable position regarding margins by the end of the year. The Test business is less predictable; while we hope the recent adjustments will support us through our current programs, I don’t expect impressive margins from that segment in the latter half of the year. I am aiming for an adjusted EBITDA close to breakeven or slightly positive. Currently, we are predominantly focused on aerospace, which will be the primary driver for margins in the near future until we launch the radio test program, expected around 2026.

Perfect. Just a quick clarification. Is the tariff impact that you mentioned for the remainder of the year, or is that annualized?

That's annualized based on historical purchasing patterns with little or no mitigation in place.

Just to clarify the margin topic, do you believe you can maintain an adjusted level above 16% within Aerospace? I understand that the tariff impact you mentioned was annualized and did not account for any mitigation efforts. However, do you have a clear outlook on Aero margins, especially if there is an increase in volume in the fourth quarter?

Yes, I feel confident about it. Currently, tariffs are somewhat uncertain, so I'm not focusing on that right now. However, we are experiencing some sales growth, and I should also mention that the pricing increases we've negotiated in certain contracts are significantly aiding our margins. These will continue to come into play as we progress through 2025, and I expect to see more of this in the third and fourth quarters. Therefore, I do not consider the adjusted level of 16% to be a temporary fluctuation, aside from the potential effects of tariffs moving forward.

Okay. On that pricing, I wanted to ask on that, are you having success on both the supplier furnished and buyer furnished? I mean, I guess, are you having success pushing price to Boeing and Airbus as well as the airline customers?

We have achieved success in this area. The entire world has come to understand that inflation has altered cost structures, and a new reality must be acknowledged. We have continued to be successful, and I believe we are increasingly satisfied with our pricing levels compared to where we stood about a year or a year and a half ago.

You're implementing many strategic actions, which is encouraging to observe. I understand that the Test segment has been evolving for quite some time. You have the EACs in place, along with outside consultants. Is there a broader evaluation underway regarding strategic alternatives for the entire Test segment, possibly considering a shift to focus solely on aerospace?

We don't have any immediate actions in place along those lines. Frankly, we've got our head down trying to get through this difficult patch that we're in. And we think we have line of sight towards improved performance. It's too early to talk about 2026. But I expect that when we get to the end of the third quarter and we start our budgeting process for the next year, the outlook for our Test business will be much better than it has been or is now. And at that point, we may sit back and take a few deep breaths and figure out where we go from there. But at this point, that is not an active discussion here. Well, thank you all for tuning into the call. We look forward to reporting again to the third quarter when we presume we will have a much cleaner quarter to talk about. Thank you for your attention. Have a nice day.

Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines, and have a wonderful day.