Astronics Corp Q3 FY2025 Earnings Call

Greetings, and welcome to the Astronics Corporation Third Quarter Fiscal Year 2025 Financial Results. As a reminder, this conference is being recorded. It is now my pleasure to introduce Craig Mychajluk. Thank you. You may begin.

Yes. Thank you, and good afternoon, everyone. 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 third 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 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 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 table that accompany today's release. So with that, I'll turn it over to Pete to begin.

Thanks, Craig. Hello, everybody, and welcome to our third quarter call. We feel it was a very positive quarter, and we are pleased to share the results. As is our practice, I'll start off with a summary of the headlines for the quarter, then Nancy will go through the financial fine points, then we will discuss expectations for the future for both the fourth quarter and also we'll take an early look at 2026. Finally, we'll open up the lines for questions. The first headline for the quarter is that we had solid volume with revenue of $211.4 million. This is our second highest quarterly level ever and just marginally below our record. That sales level is a tick up from the first couple of quarters of 2025 and is the result of broad-based demand across our product lines, markets and customers as well as improved performance in our supply chain and better efficiencies in our production system. Our Aerospace segment led the way with sales of $192.7 million, a level consistent with recent periods. Our Test business had sales of $18.7 million, which is down from the third quarter of 2024, but higher than the earlier 2 quarters of this year. The second headline has to do with margins. As one would expect, higher revenue together with efficiency improvements have led to higher margins. Operating margin of 10.9% in the quarter was higher than last year's 4.1%. Adjusted operating margin, taking into account expenses related to restructuring, litigation and acquisitions was 12.3% for the quarter. Our Aerospace segment specifically had operating margin of 16.2%, generating all of our operating income for the quarter. Test operating margin was essentially breakeven at negative 0.1% while no one is happy with 0% operating margin, this actually represents progress and is a testament to the cost reduction initiatives we have put in place in recent periods. To break even on a modest revenue level of $19 million in the quarter promises good things in the future since we expect test sales to increase. Adjusted EBITDA was at 15.5% of sales, our highest since the pandemic struck in 2020. Our third headline has to do with bookings. Even though third quarter shipments were on the strong side, bookings kept right up. Total bookings of $210 million yielded a book-to-bill of 1.0. We ended the quarter with backlog of $647 million, a very high level by historical norms, which sets us up well for the coming periods. Our fourth headline has to do with acquisitions. We have made a couple of smaller acquisitions recently, one early in the third quarter and one just recently early in the fourth. The first one was Envoy Aerospace, which we previously discussed in our second quarter call in August. 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 by which the FAA extends its capacity and reach. We believe having an ODA is a competitive differentiator as we are often involved in aircraft retrofit programs and FAA certification is becoming a more important capability in the eyes of our customers. Having certification authority lessens program and schedule risk, both for us and for our customers. Envoy has external sales of about $4 million annually. Prior to the acquisition, we were consistently one of their largest customers. The second acquisition is that of Bühler Motor Aviation or BMA. Located in Southern Germany, BMA is an established manufacturer of aircraft Seat Actuation Systems with a broad product portfolio that includes actuators, control electronics, pneumatics and lighting. BMA competed with our PGA operation in France in the seat actuation market, and now they will work cooperatively with each other to better serve the needs and opportunities of that market. We expect BMA to have sales of $20 million to $25 million in 2026, and we paid less than one-time sales for the acquisition. Much of the costs related to the acquisition, legal and diligence and the like were included in our third quarter expenses. The acquisition's operating contributions will be captured in the fourth quarter and onward. Finally, our last headline, we completed a couple of important refinancing actions in recent weeks, one in the third quarter and one just after its close. These financings lowered our cost of debt, improved our financial flexibility and importantly, reduced future dilution potential. Nancy will cover the accounting treatment, which is a little bit complex, but basically, in the third quarter, we issued a new $225 million 0% convertible bond to buy back a majority of an earlier convertible bond that was significantly in the money, meaning it was already fairly expensive to settle. And if our stock continued to rise as we expect it to do, it would get even more expensive. Using proceeds of the new convert plus some borrowings under our existing revolver and available cash, we successfully repurchased 80% of the previous 5.5% convertible note, effectively lowering our cost of debt while also eliminating 5.8 million shares of potential dilution. As part of the transaction, we also bought a capped call on the new 0% notes that effectively raises the equity conversion price to $83, meaning that there will be no dilution on the new bond unless and until the market price of our stock exceeds $83. So this transaction significantly reduced the potential dilution we would otherwise be facing. The earlier convert had a face value of $165 million. Since we bought in 80% of it, there is now 20% still outstanding or $33 million. We can pay the smaller bond off when it comes due in about 4 years in either cash or stock. We intend to use cash. But even if we use stock, the dilution will be a maximum of 1.4 million shares or about 4% based on our existing share count. This is a significant reduction in the potential dilution risk that existed before the buyback. We also benefit in terms of interest, obviously. The new bond has a 0% coupon, while the older bond is at 5.5%. So we replaced some more expensive debt with much cheaper debt. Our second refinancing step completed just a couple of weeks ago was a transition from the ABL facility we had in place to a cash flow revolver. The size of the ABL was $220 million and the cash flow revolver is sized at $300 million. The interest expense is comparable, but the new facility offers less administrative burden and increased financial liquidity for the future. The financial implications of the new convertible bond and the repurchase of the majority of the previous bond is fully reflected in our third quarter financials. The ABL to RCF transition will be reflected in our fourth quarter financials. Now I'll turn it over to Nancy.

Thanks Pete. I'll review profitability and various accounting and other events related to our Q3 2025 financials. We had gross profit of $64.5 million, up nearly 17% compared with the prior year period as the benefits of higher volume, pricing actions and productivity improvements helped to offset the $4 million impact of tariffs in the quarter. Last year's third quarter also had a $3.5 million impact from an atypical warranty reserve. Gross margin of 30.5% reflects the 31.4% gross margin realized by the Aerospace business, which was muted somewhat by the Test segment gross profit of 21.6%. R&D expense declined $2.3 million to $10.2 million or 4.8% of sales based on the timing of projects. We believe we're at a more normalized run rate currently at about 5% of sales. Of course, this can vary based on the timing and opportunity of new projects. The $3.1 million decline in SG&A expense was primarily the result of a $4.3 million decline in litigation expense. While it's been quite a while since we can claim any form of normalcy, historically, we've operated the business with SG&A at about 14% to 15% of sales. Operating income was up over 2.5x to $23 million. We recorded a loss on debt settlement of $32.6 million. I'll cover the details of the accounting treatment for the new 0% convertible bond in the cap call here in a bit. We had a $1.2 million tax benefit as we reversed the valuation allowance for R&D expenses that can now be deducted in the current year for tax purposes as a result of recent tax reform. Notably, we generated $34 million of cash in the quarter and had free cash flow of $21 million, driven by strong cash earnings combined with lower working capital requirements. I should point out that $3 million of the cash from operations was from a tenant improvement allowance reimbursement. This is offset by the CapEx investments in the build-out and consolidation for our new Redmond, Washington facility. We expect an additional approximately $5 million in reimbursement for the project in the fourth quarter. This project is what's driving our fourth quarter CapEx to be around $20 million to $30 million. Year-to-date, we've generated $47 million in cash from operations and have had $20 million in capital expenditures for free cash flow of $27 million. We would expect to be free cash flow positive for the year. Our fourth quarter cash flows will reflect the purchase of BMA, both in terms of the purchase price and the operating activity from the acquisition date forward. Turning to our balance sheet and refinancing actions. Let me talk a bit about the convoluted accounting treatment for the new 0% convertible notes that Pete discussed. First, I'll point the impact to the income statement. We recognized a noncash loss on the settlement of debt of $32.6 million, which represents the inducement charge for bondholders to redeem the $132 million in principal of the 5.5% convertible notes. Second, let me talk to the source and use of funds related to the new convertible note as well as the implications to the balance sheet. Proceeds from the new convertible bond were $217 million after payment of $8 million in fees and expenses. That $217 million, coupled with an $85 million draw on our ABL revolver plus $11 million in cash on hand were used to repurchase 80% of the old convertible note for approximately $286 million and to purchase the capped call for $27 million. Debt increased about $175 million from the end of the second quarter to $334 million. That's a function of 3 factors. First, we incurred new debt of that $217 million related to the new convertible bond, which is the $225 million netted down by $8 million in issuance fees and expenses, which are required under GAAP to be presented as an offset to the debt on the face of the balance sheet. Second, as I mentioned, we borrowed $85 million on our ABL to fund part of the repurchase transaction. And third, debt was reduced by $128 million, representing the $132 million in principal paid off on the previous convertible, net of $4 million in associated issuance fees that also needed to be written off. Shareholders' equity declined as a result of the transaction. The premium paid of $121 million plus the cost of the capped call of $27 million, plus $4 million write-off of the unamortized debt issuance costs related to the repurchased 5.5% notes resulted in a $152 million reduction in shareholders' equity. The net result is, as Pete discussed, lower cost debt, significantly reduced potential dilution and combined with the refinancing of our revolver to being cash flow based, meaningfully greater financial flexibility. I should point out that we currently have $95 million outstanding on the $300 million cash flow revolver and liquidity of $169 million. And let me hand it back to Pete.

Thank you, Nancy. I'll now turn the discussion to the future and what we expect for both the fourth quarter and our initial expectations for 2026. We expect the fourth quarter to be a step change for the company. We have generated average revenue of $207 million over the first 3 quarters of 2025. In the fourth quarter, however, we are expecting revenue to climb to a range of $225 million to $235 million, which is a significant step-up. The increase is due in part to our recent German acquisition, but mostly to the various market forces that are driving our business. The higher volume should mean good things for our income statement as we typically see 40% to 50% marginal contribution on incremental revenue dollars. Further, we think the higher volume expected in the fourth quarter will provide a baseline for 2026. We are not ready yet to issue formal revenue guidance for next year, but we are well along in our budgeting process, and it appears 2026 will be a year of solid growth. Our belief at this point is that we will see 10% growth or better. We are working to refine the range and expect to release initial revenue guidance closer to year-end 2025. You may ask what is driving the growth? Our company has been and continues to benefit from a wide range of industry trends. I'll cover the major ones briefly, and I'll try to be concise. First and most obviously, increasing OEM build rates are a big positive for us. Narrow-body and wide-body production rates are trending up at both Airbus and Boeing and to a lesser extent, across private aviation OEMs also. Our typical content for major aircraft programs is spelled out on our investor presentation, which is available on our website. And quite simply, when OEMs make more planes, we ship more product. Second, we are heavily involved, as you all surely know, in passenger connectivity and entertainment in aircraft, and it is a well-established secular trend in our world today that people want to be connected and entertained at all times, including when they are riding in airplanes. This reality, combined with the fact that the consumer electronics industry is characterized by high levels of innovation and short life cycles, means that adoption rates on new aircraft are increasing and retrofit and upgrade opportunities across the existing fleet are regularly present. We work with more than 200 airlines around the world, along with the broad set of in-flight entertainment and connectivity providers to help ensure that the expectations of airline passengers around the world are met. These expectations are high and getting higher, which provides an excellent field of opportunity for us. Third, we are specialists in developing technically advanced flight critical electrical power distribution systems for smaller aircraft in particular. And our electrical power franchise is gaining acceptance on a wide range of new and innovative aircraft types that are in development today. We started with business jets and turboprops, but today, we are also involved with a wide range of emerging types, including eVTOLs, electric vertical takeoff and landing aircraft, unmanned drones and smaller military aircraft, both rotary and fixed wing. A high-profile example, which is getting lots of attention these days is Bell's V-280 aircraft, now known as the MV-75, which is the U.S. Army's replacement for the Sikorsky Black Hawk. This program is in development currently, and Bell has chosen Astronics to supply the electrical power distribution system. There's a lot I could say about this program, but suffice it now to say it has the potential one day soon to be a very significant aircraft production program for our company and to run for a very long time. Finally, there are some other important new programs, which we expect to come online in short order, particularly for our Test business. One of the most significant is the radio test program that we've talked about before on this call for the U.S. Army called 4549/T. We have been in development on this one for some time and expect production turn on at year-end or shortly thereafter. It's a $215 million IDIQ contract to start that will run for the next 4 to 5 years. Our Test business with all the cost reductions that we've implemented is running at breakeven currently. But when the 4549/T program gets layered on top, the financial profile in that segment will be much improved. We believe these industry trends and opportunities have legs. We've been benefiting from some of them for a while, but others will only begin to positively impact our business in coming quarters. Collectively, we feel they provide an excellent opportunity set as we move into 2026 and beyond. So again, the growth from these drivers should have a positive impact on our earnings as we ramp. And as such, we expect to turn in a strong finish to 2025 and believe 2026 will be a very good year for Astronics. That ends our prepared remarks, so we can open up the lines now for questions.

First question comes from Greg Palm with Craig-Hallum.

Congrats on the results, the execution and probably most impressively, the profitability or operating leverage in the quarter. I wanted to maybe first maybe bridge Q3 to Q4 in terms of the expectation, what is built in for Test relative to the revenue that you achieved in Q3?

We expect Test to take a little step up. I don't have that in front of me. I guess it's in the $20 million, $21 million range. They were at $18 million in the third quarter. So that will be a little bit of a step-up, but it will be their strongest revenue quarter for 2025. So it hopefully lays a good foundation as we round the corner to 2026 also.

Okay. So that implies that aerospace should see a bigger step-up even excluding the impact of acquisitions. So I guess it begs the question, what are you seeing there, whether it's increased build rates, whether it's higher retrofit activity, anything in military with the FLRAA program? Just a little bit more color on maybe the step-up there expected in Q4.

Yes. I have a few points to share. First, we anticipate a general increase from Q3 to the first quarter. While we are still in the budgeting process, our early projections for 2026 indicate a sustained rate that will exceed our forecast for the fourth quarter. In Q4, we expect to see significant overall business growth, but there are several major programs underway, which contributes to the broad range in our revenue forecast for that quarter. We are uncertain if many of these programs will be completed in Q4 or if they will push into the new year, leading to a slightly wider range than we would prefer at this stage. Ultimately, it boils down to the scheduling of major programs.

It's a mix.

Yes, I understand. I wanted to connect this to my question about fiscal '26, specifically regarding the confidence level in expecting low double-digit growth. Can you clarify what assumptions are included regarding the Army test program at this stage? Considering the shutdown, I wouldn't have anticipated strong visibility, but it seems like you still expect that ramp-up to start by the end of this year or early next year.

Yes, that's a great question. We're making some educated guesses here, which is why we're being cautious. To sum it up, when the government shutdown occurred, we were hoping to see production ramp up towards the end of this year. It could happen this year, or it might extend into next year, likely late in the fourth quarter or early in the first quarter. Right now, we don't have strong reasons to believe there will be significant delays. It makes sense to expect some daily adjustments in relation to the shutdown duration. The longer the shutdown lasts, the more uncertain the year-end production becomes. We've had informal conversations with program managers and executives who have confirmed that funding remains secure. The end users are eager to see the product in action. At this moment, it's unclear if there will be a major delay or not. We'll need to make decisions about what to include in our projections. Overall, we still believe that this will be a substantial contributor in 2026.

And just to be clear, in terms of that full year '26 expectation, there's some, I guess, presumably significant level of contribution that's baked in or not necessarily?

No, there will be, absolutely. We expect that program to be an important contributor, both to the top line and the bottom line.

Next question, John Tanwanteng with CJS Securities.

This is actually Jeremy on for John. Kind of working off of what we were just talking about, how should we think about the FLRAA program revenue and margin over the medium to longer term as it transitions out of development and into production?

It's a bit too early to determine the timeline for production because we don't have clarity on the ramp-up or pricing agreements with the customer. There's also an ongoing discussion in the industry about the actual start of production. The Army is looking to accelerate the program, which could lead to production starting a couple of years earlier. As for our projections, we anticipate revenue of approximately $28 million in 2025, with expectations of growth to around 38% to 40% in 2026. It's important to note that we've been conducting development work at essentially zero margin as we finalize the development program. However, once that program is established, we expect to recover the margins we would have gained earlier. This should significantly boost our performance as we move into 2026. Would you like to add anything?

Okay. That's right.

Very helpful. And then switching gears a little. Could you just talk more about the Bühler and the capability it brings to the table and the accretion you're expecting over the next year?

We are a smaller company and anticipate revenue in the range of $20 million to $25 million, which we expect will be profitable. It is reasonable to assume that our margin profile will align with the rest of our company. The reporting will be handled through our PGA operations, effectively combining two competitors into one. This consolidation can lead to certain efficiencies, leveraging their market knowledge and reach. Their products serve similar purposes to many of ours, particularly in high-end aircraft seating like first-class and business-class seats with various moving features such as reclining capabilities. While our product lines complement each other, they are not interchangeable; their products are tailored for specific seat companies, while ours are designed for customers who use our systems. We should be able to achieve some efficiencies, including possible pricing advantages from market concentration, which will become clearer over the next few years. Although it's a niche market that we don't discuss often, together we anticipate generating around $80 million annually.

Next question comes from Alexandra Mandery with Truist.

This is Alexandra Mandery on for Michael Ciarmoli, Truist Securities. Great results, guys. Can you talk about the integration of these 2 recent acquisitions and any additional capabilities you may look for in the future?

The integration of BMA or Bühler will be reported through our PGA operation in France. That process is already underway, and we plan to keep both operations running. In my view, while moving and consolidating can often seem simpler to calculate in terms of savings, it's usually more challenging to actually realize those savings. Therefore, that isn’t our goal. Our aim is to operate efficiently with two setups in Germany and France. We're still in the early stages since this just closed a couple of weeks ago, so there’s a long way to go. However, as it is a smaller operation, we should be able to manage it relatively quickly. We don’t believe it poses any systemic risk. I see Envoy primarily as a consulting firm composed of engineers familiar with FAA rules and regulations. Envoy is reporting through our CSC operation, which handles most of our connectivity and in-flight entertainment electronics from Waukegan, Illinois. Essentially, Envoy is part of CSC. The next step in the integration process will be to determine how we can utilize Envoy’s expertise across our other operations. The key advantage of Envoy is that it enables us to maintain the ODA, our objective being to certify our own development programs. This gives us a competitive edge, as it allows us to better ensure program success and scheduling for our customers, since they know we can self-certify with FAA approval. That’s the main point, and we’ll provide updates over time. We also engage in a considerable amount of retrofit work, and having an ODA simplifies that process considerably.

Okay. Great. And then I just had one follow-up. I might have missed it, but can you add more color on 4Q guide for interest expense, CapEx and depreciation and amortization?

In terms of interest expense, as Pete mentioned, the interest rates on the ABL and the RCF are quite similar. We expect a significant CapEx in the fourth quarter, so an increase in debt under the revolver is anticipated. We currently have $33 million in debt related to the 5.5% convertible bond, which will also factor in. The remaining $225 million of debt is at 0%. Regarding depreciation and amortization, I don't have those figures on hand, but I expect a slight increase there as we assess the valuation of the two acquisitions. It’s reasonable to assume that part of that will be allocated to intangibles, which will have a life assigned and begin to amortize during the quarter. I don't expect any major changes from our regular quarterly run rate.

Thank you. This does conclude today's teleconference. We thank you for your participation. You may now disconnect your lines at this time.