Earnings Call Transcript - ATRO Q1 2020

Operator, Operator

Good day, and welcome to the Astronics Corporation First Quarter 2020 Financial Results Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Deborah Pawlowski, Investor Relations for Astronics Corporation. Please go ahead.

Deborah Pawlowski, Investor Relations

Thanks, Christina, and good morning, everyone. We certainly appreciate your time today and your interest in Astronics. Joining me on the call are Peter Gundermann, our Chairman, President and CEO; and Dave Burney, our Chief Financial Officer. You should have a copy of the first quarter 2020 financial results that were released this morning. And if not, you can find them on our website at astronics.com. Let me mention first that we may make some forward-looking statements during this 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 earnings release as well as with other documents filed with the Securities and Exchange Commission. These documents can be found 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 per GAAP. We've provided reconciliations of non-GAAP measures to comparable GAAP measures in the tables that accompany today's release. So with that, let me turn it over to Pete to begin. Pete?

Peter Gundermann, Chairman, President and CEO

Thank you, Debbie, and good morning, everybody. We are going to talk through a brief summary of our first quarter, to talk through some of the higher issues, but it's probably not what people are most interested in. And we're going to spend most of the time on the call, we believe, talking about the COVID-19 situation, how it's affecting Astronics and what we're doing about it or have done about it. Before we get into it all though, I thought I would briefly cover three goals that we are trying to simultaneously achieve as a company. And they're all three important and they all three have to happen. The first is to protect our employees and the safety of our workplace. We had, at the beginning of the quarter, close to 3,000 employees working in 18 locations around the world. And as the pandemic took over, it became obviously paramount to learn some new tricks and to develop some new practices. And we feel like we've done that pretty well and pretty successfully, and we continue to do that in the future. Secondly, we wanted to keep serving our customers with the service and products that they expect and need. We were reminded over and over in the first quarter, and have been recently, that we're an essential business and that a lot of very large companies in the U.S. and around the world are highly dependent on our products, and they expect us to keep producing. And we feel like we've done that reasonably well through the first quarter and up to today. The third thing that we have set out to do is to position our company not only for survival during the pandemic, but for success afterward. We want to come out of this thing as strong or stronger than we have been in the past. And we feel like we've taken solid steps to do that, and we'll talk through some of those in the second half of this call. First quarter review. Going back to the beginning of December, we actually thought that the first quarter was going to be a strong start for 2020. Our internal plan at that point was to see revenues somewhere in the neighborhood of $190 million. We thought that would be the slowest and lowest quarter of 2020. Turns out we were obviously wrong. The reason we had those assumptions was that we felt we made a lot of success in the fourth quarter resolving and cleaning up some issues that have been plaguing us operationally for some time. Many of you who follow the company probably remember some of them, they had to do with what we used to call our three 'problem children' or problem companies. We also were under the assumption in early December that the 737 MAX would be recertified at year-end. That was important for us because the grounding, as it went on through all of last year, had begun to create a capacity crisis for airlines, or capacity challenges, maybe I should say, for the airlines which we felt was depressing our aftermarket sales simply because they didn't want to take aircraft out of service to put on our kind of IFE-related products, which we saw in the aftermarket and which is an important part of our business. Turns out that assumption was obviously wrong. The MAX recertification slid into the new year and at this point, it's still a little bit up in the air. Conventional wisdom, or most people anyway, think that that's likely to occur late summer, early fall. We're hoping that's the case. But things actually even degraded a little bit further from that. We have a pretty good line fit position on the 737 MAX. We were delivering through all of 2019 to the tune of about 40 ships a month at $95,000 per ship, making it one of the largest aircraft production programs that we had as a company in 2019. Everybody on the call is probably aware that Boeing suspended production of 737 as we entered the new year. So our first quarter went from 40 ships a month essentially to zero, which hurt our revenues. We issued an update on February 3, and it covered a lot of these topics. It covered a development effort that we called Avenir, which we wrapped up in the fourth quarter. I talked about restructuring of our antenna business, an IP dispute, and suspension of stock buybacks and withdrawing guidance because of the 737 situation. But there was no mention in that press release on February 3 of COVID-19, kind of interesting to look back. A week later, that situation started to change. That's when it became clear that the pandemic was affecting Europe and the U.S. and even hitting some of the communities that our operations are active in. Kirkland, Washington is one of our largest operations and one of the first places where an outbreak was reported. We proceeded through March to do all kinds of things to our operations that we've never thought about really before involving social distancing and work from home. Approximately half of our employees by the middle of March were working from home and continue to do so today. Half of them are working in our facilities. For the most part, we feel that we've been pretty successful keeping those facilities up and running as essential businesses and effectively doing what we're supposed to be doing. We have a few shutdowns by government action. We have a facility in France that was down for a week. We have an engineering operation in India that is very limited in terms of being on-site, but people are working from home. Across our company, we started the quarter with about 3,000 employees. We did have a handful of positive diagnoses, maybe 12 to 15, but we did have a handful of shutdowns for deep cleaning in our operations. Our top line, our revenue for the first quarter came in at about $157.6 million. That is actually in the range of what we expected when we issued our February 7 update release, but it was our lowest quarterly revenue level since way back in 2017. We reported a net loss of $67 million. But as you know, we had a significant write-down of intangibles during the quarter of $74.4 million that is directly related to a change in expectations in the market related to COVID-19 and specifically to airline aftermarket and aircraft production rates at some of our more recent and larger acquisitions where we carried a lot of our goodwill. That $74.4 million is a non-cash expense, and it essentially removes half of the goodwill and intangibles off of our balance sheet. We used a new measure of profitability, adjusted EBITDA. Ignoring the write-downs, with the reduced revenue level, we were still able to put in an adjusted EBITDA of 10.3% of sales. That's a measure that you can probably expect to see in our financial statements going forward. Bookings in the first quarter were relatively strong at $167 million for a book-to-bill of 1.07. There were some significant wins in there that we'll be talking about in the future, but we're not really able to talk about right now. So long story short, that's really the depth that I intended to go into for the quarter: depressed revenue levels, a big impairment charge, adjusted EBITDA that was perhaps a little bit higher than people might have expected on that revenue level, and pretty good bookings, all things considered. So we'll take questions later on this if anybody wants to go into more detail. I want to dive instead into the COVID-19 situation and how it is affecting our business, and what we are doing or have done about it. We have done a lot, in my opinion. The first thing we did is really started studying our customer base and our demand streams or the forces of demand that bring business to our company. These are categories that are a little bit different than how we typically describe ourselves, and we're kind of custom crafted for the situation at hand. The first demand stream that we assessed was the government and defense demand stream. This is largely our Test business and military aircraft or military aerospace. If you add those two together, you end up with a total that was about 20% of our 2019 revenue. From our assessment, this portion of the business appears stable and strong and, if anything, even seems to be accelerating. This is our Test business that does a lot of government work. It's missile programs that we do some power conditioning, some structures work, and it’s military aircraft like Joint Strike Fighter, which is a very large program for us. The bigger chunk of our business, the second one I want to talk about, has to do with commercial airplane production, specifically airplane production for commercial transports and general aviation or business jets. This means that an airplane is produced. To complete the airplane, our products need to be put on it, which means we supply to the OEMs or the top-tier suppliers who then supply it at OEMs. This category or demand stream is a little more than half of our revenue last year. Of the two, commercial transports and GA or business jets, transports are by far the most important. I'm sure many people on the call follow the industry closely have been looking at the announcements, so it's not a surprise to see that most producers across the board have talked about planned production rate reductions of about 30% to 35%. This planned reduction presumably will affect us almost directly. The third demand stream is significantly different; it's aftermarket. For us, aftermarket is mostly selling IFE-related equipment to commercial airlines around the world, IFE’s in-flight entertainment. Our expectation based on the status of the airlines, not only in the U.S. but around the world, is that this source of demand is going to drop dramatically. We figure perhaps 80% to 90% by the end of the year. Combining these three demand streams with our existing backlog and our first quarter results, we imagine that 2020 sales could drop somewhere in the region of 30% to 35% from 2019. That puts us in the range of $500 million to $540 million of revenue. I don’t mean to suggest this as guidance. Like many companies in the industry, we're not willing to go out and stake a claim at this point or a commitment on what we're going to be able to do, but I want to provide color as to how we think the market is evolving. And of course, when you're running a company and you see that kind of demand change, it implies significant organizational and structural and cost changes to stay solvent. So for now, we are shooting for a revenue level in that range based on the logic and analysis that I just talked through. What have the changes been that get us to where we think we need to be to achieve the three goals I talked about earlier? With a big drop in demand comes the drop in material expense, material expenses on the order of 35% of sales, and those kinds of reductions are pretty much automatic. There are some challenges with reducing ongoing purchasing requirements, and the cash may be a bit of a challenge as we adjust to the lower volume, but we're well on our way with that. More significantly, we have reduced our headcount across the company by about 30% already. We started the first quarter at about 3,000 active employees. Today, we're operating at about 2,000. It's a very painful step down for our organization, as you can imagine, but it's one we think lines up our cost structure with what our expected demand picture is likely to evolve like. We have a number of employees on furlough at this point, hoping to bring them back if demand warrants it. In some cases, we expect we're in a little bit of a short loop of low demand, which will come back in the second and third quarters. We expect to bring some people back from the furlough list. We've also frozen pay adjustments for the year. We've eliminated cash incentives. One of the things that we do as a company is have some pretty broad cash incentive programs that stretch throughout the organization. It's not just higher-level employees or managers that are affected here; everybody is affected in our little family. So at a minimum, people are seeing 5% to 10% pay reductions at the higher levels in the organization. Cash wages will be down closer to 30% to 50%. We've reduced all discretionary expenses, travel, trade shows, that kind of stuff. We've taken an aggressive cut to our capital spending plan. We thought we’d be in the neighborhood of $20 million to $25 million. Our current plan has that closer to $8 million. We've dropped acquisition initiatives and stock buyback initiatives. We think these cost management, cost reduction initiatives have shaved about $135 million from where we thought we would be in 2020 when we began the year. We believe that if demand turns out to be in the $500 million to $540 million range that we should be cash positive. That's an important benchmark for us because while we've always been conservatively financed, obviously, when you take that bigger hit to your revenue and a big hit to EBITDA, covenants can come into play. We weren't in a crisis situation with our banking arrangement at the end of the first quarter, and we anticipate if demand continues as we expect, that we could be by the end of the year. We drew down $150 million on our existing revolver at the end of the first quarter. We had a reasonable quarter for cash, ended up with $188 million cash on hand. As Pete mentioned, we expect to be cash flow positive. If you use the range of EBITDA that he mentioned earlier of 6% on $500 million, the math comes out to $30 million of EBITDA. We expect about $8 million of CapEx and about $7 million of interest expense, not anticipating any cash taxes. That gets us into about a $15 million cash positive range for the year. I think that's it, Pete.

David Burney, Chief Financial Officer

Thank you, Pete. As Pete mentioned, we started working with the bank group to resize the credit facility down from $500 million to $375 million. We suspended the maximum leverage coverage covenant through the second quarter of 2021. Beginning in Q3 of 2021, the maximum leverage covenant will come back into play at 6x adjusted EBITDA and will step down in subsequent quarters down to 5.5x in the fourth quarter of 2021, and beyond that into 2022. The new minimum liquidity covenant needs to be at least $180 million, a plan that we will pay down the outstanding revolver balance to carry about $50 million of cash on our balance sheet. This will give us about $50 million of space on that covenant or liquidity versus the $180 million requirement. We have a new minimum interest coverage ratio of 1.75x that will be measured quarterly. We typically see some cash flow pick-up as our working capital drops. We're expecting to get stretched by some of our customers on our cash collections, but we’ve taken actions to extend our payables by a couple of weeks to our supply chain. I think that could be upside for us to manage our inventory levels proportionately to the sales drop.

Peter Gundermann, Chairman, President and CEO

Thanks, Dave. Again, our three goals: protecting employees and creating a safe workplace. We feel like we've done that pretty well. Standards will change as the pandemic fight continues. We'll continue to do the best we can with that situation. I think we've done a good job hitting our customers' delivery requirements. In many cases, we continue to deal with ongoing development of new programs, especially on the military side, which have not abated at all as part of this process. With the modified facility with our banking group, which has been very helpful to us, we feel like we're well situated not only to survive the situation but to prosper on the other side. Christina, you can open it up for questions now.

Operator, Operator

We will go to our first question from Jon Tanwanteng with CJS Securities.

Jon Tanwanteng, Analyst

Good morning, guys. Thank you for taking my question. Thanks for all the color and detail on the call, just a little bit better than most people have been fearing. I think, first, how should we think about the pacing of the quarters as you see it? Knowing what you have in backlog and when that will deliver and assuming the down 30% to 35% commentary maybe as you exit the year, what kind of production run rate in air traffic are you kind of assuming when you exit?

Peter Gundermann, Chairman, President and CEO

Look, it's a good question. We are expecting that the second quarter could be materially lighter because of shutdowns and customer shutdown and things like that. But we haven't seen the level of cancellations, particularly on aftermarket programs that we expected. The safe assumption is that we're going to be materially lower in the second quarter, but it will strengthen in the fourth quarter, which we think will be the strongest.

Jon Tanwanteng, Analyst

Got it. So do you expect Q2 or Q3 to be your trough at this point given that you do have backlog?

Peter Gundermann, Chairman, President and CEO

We don't know. It depends on how the customer deliveries play out. Our current expectation is that Q3 will be a bit stronger than Q2, but it could go the other way.

Jon Tanwanteng, Analyst

Okay. Fair enough. And Dave, you gave some good color on what your expected cash flows are for this year, again, assuming that range. What was that kind of $15 million in free cash flow inclusive of cash restructuring costs at all? And then what would those be?

David Burney, Chief Financial Officer

Yes. It wasn't inclusive of that. As of now, we haven't called out any restructuring charges at this point to isolate those, but they're netted in with those cost reduction numbers.

Jon Tanwanteng, Analyst

Okay. So that's included in the $15 million?

David Burney, Chief Financial Officer

Yes.

Jon Tanwanteng, Analyst

Got it. And then, Pete, any update on how the commercial aviation is going? But any update on the business jet side and how they're looking from last year to this year?

Peter Gundermann, Chairman, President and CEO

I think we're in good shape. Armstrong has merged into CSC at this point. CCC completed their Avenir development in December. The first quarter was the weakest quarter of the year, but we expect results there to strengthen. One of the watch items is that the kinds of airplanes that by their type of equipment are disproportionately operated out of the Middle East, and oil prices are a driver of wealth there, so we're watching that closely. Our antenna business, AeroSat, has been significantly restructured and focused on a tail antenna program with Rockwell Collins. That’s going really well for Collins Aerospace. We think it's on a good track. So far so good with all three of those things.

Jon Tanwanteng, Analyst

Okay. Fair enough. And would you say, as you've taken the cuts and restructuring, are there any changes to your incremental margins as you come out of the trough?

Peter Gundermann, Chairman, President and CEO

It's hard to see how or when this situation changes. We have clarity to the end of the year, but nobody knows how this pandemic will be tamed and what the ramifications are for the airline industry. Our thought is that it's unpredictable to know how and when the recovery will come. We've been involved in development programs that are more than what a typical $500 million company might do. So how the margins play out is dependent on the obligations and opportunities that do not go away.

David Burney, Chief Financial Officer

I would add that coming through an experience like this, I would be surprised if we don't find ways to be more efficient. I expect that we will find those opportunities.

Peter Gundermann, Chairman, President and CEO

That’s an incredibly optimistic perspective from Dave. I'll let that go.

Operator, Operator

We'll go to our next question from Michael Ciarmoli with SunTrust.

Michael Ciarmoli, Analyst

Hey, good morning, guys. Thanks for taking the question. Just looking at the forecast for the year, what's your confidence level in shipping the $268 million out of backlog? Is there a risk that backlog is canceled or pushed out?

Peter Gundermann, Chairman, President and CEO

There is definitely some risk to that. We’ve been a little surprised that we haven't seen more deferrals and cancellations than we have. Some of our biggest customers' customers are airlines, and airlines are in chaos. A lot of what we've been involved in from an aftermarket area are fleet modifications. As long as those programs continue, we see evidence that could be a meaningful driver of our business moving forward.

Michael Ciarmoli, Analyst

What about the inventory in the channel? Could that exacerbate some of the OEM declines? Does that run a risk to your working capital tailwind?

Peter Gundermann, Chairman, President and CEO

We really don't think so. We have been on a fine-tune just-in-time type of situation there for a long time. I don’t feel like we think that's a major concern for our business. There could be some inventory in the aftermarket. But even in the aftermarket, it's usually lease purchases and materials bought fresh for an airplane.

Operator, Operator

We'll take our next question from Austin Moeller with Canaccord.

Austin Moeller, Analyst

Hi. This is Austin on for Ken. Just a quick question about the Boeing resumption of production on the MAX. Where does Astronics stand with MAX shipments? Have they restarted? How do you expect volumes to ramp this year on the MAX?

Peter Gundermann, Chairman, President and CEO

We are building plus 20 ships set a month. We’ve been shut down for January, February, and March, but we've resumed that now. Our best information is that we'll continue with that. I've read Boeing expects to start slow and ramp to 30.

Austin Moeller, Analyst

So you're expecting to maintain 20 a month?

Peter Gundermann, Chairman, President and CEO

That's the best information we have, yes.

Austin Moeller, Analyst

What kind of risk do you see associated with that? And do you see any changes in that airline industry associated with the risk around the Lufthansa Technik lawsuit?

Peter Gundermann, Chairman, President and CEO

No, not at all. That's something we're wondering about because we have some events scheduled for this summer. I think it’s clear everything we've done since then is not subject to that suit.

Austin Moeller, Analyst

Can you comment at all on the public Test business?

Peter Gundermann, Chairman, President and CEO

We’re working hard on our New York City program and others that we’re pursuing. We expect a couple of other program wins and announcements. Those are long-range, very expensive. I think there’s a commitment that public transportation is going to become more important in the future.

Austin Moeller, Analyst

Even in New York City, that’s continuing forward irrespective of the demand shock?

Peter Gundermann, Chairman, President and CEO

Absolutely.

Operator, Operator

We’ll go to our next question from Scott Lewis with Lewis Capital Management.

Scott Lewis, Analyst

I was just wondering about the, I don't know, I think approximately 400 MAXs that Boeing has parked. Has IFE been delivered for purchase for those airplanes yet, or might that be some additional revenue?

Peter Gundermann, Chairman, President and CEO

It's a good question. I haven’t specifically dug into it. My working assumption is that most of those airplanes were ordered long ago and when they were ordered, we weren't operable on the airplane. Most of the airlines are in the habit of installing IFE after delivery.

Operator, Operator

It appears there are no further questions at this time. I'll turn the call back to management for any additional or closing remarks.

Peter Gundermann, Chairman, President and CEO

Thank you for your attention. We feel like we've been through the ringer here a little bit over the last quarter. We're kind of looking forward to the second quarter being a little quieter. Thank you for your interest in Astronics.

Operator, Operator

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