ASTRONICS CORP 10-Q

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (The following should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the Company’s Form 10-K for the year ended December 31, 2020.) OVERVIEW Astronics Corporation (“Astronics” or the “Company”) is a leading supplier of advanced technologies and products to the global aerospace and defense industries. Our products and services include advanced, high-performance electrical power generation and distribution systems, seat motion solutions, lighting and safety systems, avionics products, aircraft structures, systems certification, and automated test systems. Our Aerospace segment designs and manufactures products for the global aerospace industry. Product lines include lighting and safety systems, electrical power generation, distribution and seat motions systems, aircraft structures, avionics products, systems certification, and other products. Our primary Aerospace customers are the airframe manufacturers (“OEM”) that build aircraft for the commercial, military and general aviation markets, suppliers to those OEM’s, aircraft operators such as airlines, suppliers to the aircraft operators, and branches of the U.S. Department of Defense. Our Test Systems segment designs, develops, manufactures and maintains automated test systems that support the aerospace and defense, communications and mass transit industries as well as training and simulation devices for both commercial and military applications. In the Test Systems segment, Astronics’ products are sold to a global customer base including OEM's and prime government contractors for both electronics and military products. Our strategy is to increase our value by developing technologies and capabilities, either internally or through acquisition, and using those capabilities to provide innovative solutions to our targeted markets where our technology can be beneficial. Important factors affecting our growth and profitability are the ongoing impacts of the COVID-19 pandemic and the timing and extent of recovery (as discussed more fully below), the rate at which new aircraft are produced, government funding of military programs, our ability to have our products designed into new aircraft and the rates at which aircraft owners, including commercial airlines, refurbish or install upgrades to their aircraft. New aircraft build rates and aircraft owners spending on upgrades and refurbishments is cyclical and dependent on the strength of the global economy. Once designed into a new aircraft, the spare parts business is frequently retained by the Company. Future growth and profitability of the test business is dependent on developing and procuring new and follow-on business. The nature of our Test Systems business is such that it pursues large, often multi-year, projects. There can be significant periods of time between orders in this business which may result in large fluctuations of sales and profit levels and backlog from period to period. Test Systems segment customers include the Department of Defense, prime contractors to the Department of Defense, mass transit operators and prime contractors to mass transit operators. On February 13, 2019, the Company completed a divestiture of its semiconductor test business within the Test Systems segment. The total proceeds of the divestiture amounted to $103.8 million plus certain contingent purchase consideration (“earn-out”). The transaction included two elements of contingent earnouts. The First Earnout is calculated based on a multiple of all future sales of existing and certain future derivative products to existing and future customers in each annual period from 2019 through 2022. The First Earnout may not exceed $35.0 million in total. The Second Earnout is calculated based on a multiple of future sales related to an existing product and program with an existing customer exceeding an annual threshold for each annual period from 2019 through 2022. The Second Earnout is not capped. For the Second Earnout, if the applicable sales in an annual period do not exceed the annual threshold, no amounts will be paid relative to such annual period; the sales in such annual period do not carry over to the next annual period. Due to the degree of uncertainty associated with estimating the future sales levels of the divested business and its underlying programs, and the lack of reliable predictive market information, the Company will recognize such earnout proceeds, if received, as additional gain on sale when such proceeds are realized or realizable. No amounts were payable for the year ended December 31, 2019. In February 2021, the Company was notified by the buyer that they have calculated $10.7 million as being payable to the Company under the contingent earnouts related to the year ended December 31, 2020. In April 2021, the buyer provided a revised calculation, indicating, rather, that $7.1 million is payable to the Company for the 2020 earnout. The Company and the buyer are currently reviewing the calculations and underlying data and are engaged in negotiations. The Company expects to record the additional gain for whatever amount is realized on the sale when that review is complete and agreement is reached. 25 Table of Contents The timing and amount of any amount realized is uncertain and subject to risks and uncertainties as we continue the review and negotiation process. CONSOLIDATED RESULTS OF OPERATIONS AND OUTLOOK Three Months Ended ($ in thousands) April 3, 2021 March 28, 2020 Sales $ 105,857 $ 157,584 Gross Profit (sales less cost of products sold) $ 14,273 $ 35,719 Gross Margin 13.5 % 22.7 % Selling, General and Administrative Expenses $ 23,785 $ 28,867 SG&A Expenses as a Percentage of Sales 22.5 % 18.3 % Impairment Loss $ — $ 74,408 Interest Expense, Net of Interest Income $ 1,758 $ 1,333 Effective Tax Rate (0.9) % 3.3 % Net (Loss) Income $ (11,909) $ (66,963) A discussion by segment can be found at “Segment Results of Operations and Outlook” in this MD&A. CONSOLIDATED FIRST QUARTER RESULTS Consolidated sales were down $51.7 million compared with the first quarter of 2020. Aerospace sales were down $59.7 million from the 2020 first quarter, which had been largely unaffected by the COVID pandemic. Test System sales increased $7.9 million. Consolidated cost of products sold in the first quarter of 2021 was $91.6 million, compared with $121.9 million in the prior-year period. The decrease was primarily due to low volume related to the continued impacts of the COVID-19 pandemic on the global aerospace industry, coupled with the associated workforce and other cost reduction measures discussed further below. Gross margin declined from 22.7% to 13.5% due to leverage lost on lower volumes. Selling, general and administrative (“SG&A”) expenses were $23.8 million in the first quarter of 2021 compared with $28.9 million in the prior-year period. Contributing to the decrease in SG&A in 2021 were workforce reduction activities and cost reduction measures which were not put into effect primarily until the second quarter of 2020. Further, non-cash goodwill and other asset impairment charges of $74.4 million in the Aerospace segment were recognized in the first quarter of 2020 due to revised expectations regarding future operating results as the COVID-19 pandemic took hold. Interest expense has increased due to the higher interest rate upon the amendment of the credit facility in May 2020. The effective tax rate for the quarter was (0.9)%, compared with 3.3% in the first quarter of 2020. The 2021 tax rate was impacted by changes in the valuation allowance recorded against federal deferred tax assets as well as State and Foreign income taxes. The 2020 tax rate was impacted primarily by the initial recording of a valuation allowance against federal deferred tax assets. Consolidated net loss was $11.9 million, or $0.39 per diluted share, compared with net loss of $67.0 million, or $2.17 per diluted share, in the prior year. The after tax impact of the prior year impairment was $68.8 million, or $2.23 per diluted share. Bookings were $120.0 million, for a book-to-bill ratio of 1.13:1. Backlog at the end of the quarter was $297.5 million. Approximately $217.2 million, or 73%, of backlog is expected to ship in the remainder of 2021. Impact of COVID-19 and Operational Adjustments As previously discussed, we face risks related to outbreaks of infectious diseases, including the ongoing COVID-19 pandemic. The challenges posed by the COVID-19 pandemic on the global economy, and more profoundly on the aerospace industry, increased significantly as 2020 progressed, and has continued into 2021. COVID-19 has caused disruption and volatility in the global capital markets, and has authored an economic slowdown in the Aerospace industry in particular. In response to COVID-19, national and local governments around the world have instituted certain measures, including travel bans, prohibitions on group events and gatherings, shutdowns of certain businesses, curfews, shelter-in-place orders and recommendations to practice social distancing. While these actions and restrictions are easing in some geographies, there 26 Table of Contents remains continued impact. Although our operations have been deemed essential and we follow the COVID-19 guidelines from the Centers for Disease Control (“CDC”) concerning the health and safety of our personnel, these measures have resulted in attenuating activity and, in some cases, required temporary closures of certain of our facilities, among other impacts. The duration of these measures is unknown, may be extended and additional measures may be imposed. In response to the global COVID-19 pandemic, we implemented actions to maintain the health of our employees as well as our financial health and liquidity. These actions, which began in 2020, included: • Implementing social distancing measures, the use of masks, restricting visitors and unnecessary travel, and working from home whenever possible; • Workforce reduction activities to align capacity with expected demand, reducing headcount by approximately 20% to approximately 2,100 employees currently; • Eliminated consultants and temporary labor where possible; • Implemented significant cost conservation measures; • Suspending cash bonus plans and certain benefit programs; • Amended our revolving credit facility on May 4, 2020, as further described in the “Liquidity and Capital Resources” section below; • Suspending share repurchases; • Reducing capital spending where possible; and • Restrictions on marketing, trade shows, travel and discretionary spending. Analysis of Impact on Demand and Market Trends The Company evaluates three revenue streams to monitor demand and analyze the impact of the pandemic to its business. These are (1) the commercial aircraft market, which includes OEM line fit and airline aftermarket business, (2) defense and other government markets, and (3) general aviation. Commercial aerospace has been heavily impacted by the pandemic and contributed $38.2 million, or 36% of consolidated revenue in the quarter, compared to $102.8 million or 65% of consolidated revenue in the first quarter of 2020. Airframe manufacturers adjusted to current market conditions by reducing planned production rates for new aircraft. Driven by the production rate reductions, the Company also experienced a slow-down in orders related to destocking in the supply chain. Narrow body aircraft build rates are expected to improve through 2021 from current levels as production of the 737 MAX picks up. The aftermarket is expected to strengthen over the course of the year as aircraft utilization and load factors increase. Defense and government markets have remained relatively strong through the pandemic. Sales to these markets were $45.4 million, or 43% of first quarter consolidated revenue in 2021, up from $33.0 million, or 21% in the comparative period of 2020. This includes our military aircraft programs and our Test business, excluding the divested semiconductor business. General aviation, which consists of our business jet market, were $14.0 million, representing 13% of the first quarter revenue in 2021. This compares with $15.0 million, or 10% of revenue in the comparator period. Most of general aviation revenue is line fit production driven by the manufacture of new aircraft, although there is some amount of aftermarket business as well. Demand for private aircraft has recovered quickly and is expected to in result in higher aircraft production rates in the near future. Additionally, Astronics has pursued business opportunities from other markets, taking advantage of its technical design expertise and manufacturing capabilities, which are currently underutilized. Other revenue was approximately 8% of revenue in the first quarter of 2021. These opportunities can be meaningful, and some are directly related to the fight against COVID-19, such as the Xenex® program, whereby Astronics is providing manufacturing support to Xenex for the production of its unique LightStrike robots, which use patented pulsed xenon ultraviolet (“UV”) light disinfection technology to neutralize SARS-CoV-2, the virus that causes COVID-19. Outlook We are pleased with the continued strong demand for our Test business, which had core sales up 64% over last year. We also are encouraged by the consistent sequential ramping of Aerospace bookings since the second quarter of last year. We are optimistic that demand will strengthen as 2021 progresses, but it is too early to forecast results confidently. However, we expect our revenue in the second quarter to be about $115 million. Our goals remain to generate cash and reduce debt. Evidence suggests that our largest market, which is dependent upon the health of the commercial airline industry, will recover when and where the pandemic comes under control. While we are making strides in the U.S., we look forward to progress in this regard worldwide through the remainder of this year. 27 Table of Contents Our expectation for capital expenditures for 2021 remains unchanged at $10 million to $11 million. Consolidated backlog at April 3, 2021 was $297.5 million. Approximately 73% of the backlog is expected to be recognized as revenue in 2021. The ultimate impact of COVID-19 on our business results of operations, financial condition and cash flows is dependent on future developments, including the duration of the pandemic, vaccination rates and efficacy and the related length of impact on the global economy and specifically on the markets we are active in, which is uncertain and cannot be predicted at this time. SEGMENT RESULTS OF OPERATIONS AND OUTLOOK Operating profit, as presented below, is sales less cost of products sold and other operating expenses, excluding interest expense and other corporate expenses. Cost of products sold and other operating expenses are directly identifiable to the respective segment. Operating profit is reconciled to earnings before income taxes in Note 16 of the Notes to Consolidated Condensed Financial Statements included in this report. AEROSPACE SEGMENT Three Months Ended (In thousands) April 3, 2021 March 28, 2020 Sales $ 81,430 $ 141,137 Less Inter-segment Sales (14) (67) Total Aerospace Sales $ 81,416 $ 141,070 Operating Loss $ (5,563) $ (63,145) Operating Margin (6.8) % (44.8) % Aerospace Sales by Market (In thousands) Commercial Transport $ 38,208 $ 102,775 Military 20,982 18,113 Business Jet 14,028 15,006 Other 8,198 5,176 $ 81,416 $ 141,070 Aerospace Sales by Product Line (In thousands) Electrical Power & Motion $ 29,344 $ 69,456 Lighting & Safety 27,100 37,922 Avionics 14,843 22,143 Systems Certification 878 3,331 Structures 1,053 3,042 Other 8,198 5,176 $ 81,416 $ 141,070 (In thousands) April 3, 2021 December 31, 2020 Total Assets $ 481,134 $ 484,885 Backlog $ 210,153 $ 191,081 28 Table of Contents AEROSPACE FIRST QUARTER RESULTS Aerospace segment sales decreased $59.7 million, or 42.3%, to $81.4 million. Sales continued to be negatively affected by low commercial aircraft build rates and a weak commercial aircraft aftermarket as airlines have reduced spending and grounded aircraft due to the global COVID-19 pandemic. Electrical Power and Motion sales were down $40.1 million compared with the prior-year period. Lighting & Safety sales decreased $10.8 million. Additionally, Avionics sales were down $7.3 million compared with the prior-year period. Aerospace segment operating loss was $5.6 million compared with operating loss of $63.1 million for the same period last year. Leverage lost on reduced sales significantly impacted operating results. Aerospace operating profit in the prior-year period was impacted by goodwill and other asset impairment charges of $74.4 million, as previously discussed. AEROSPACE OUTLOOK Aerospace bookings in the first quarter of 2021 were $100.5 million, for a book-to-bill ratio of 1.23:1. The Aerospace segment’s backlog at the end of the first quarter of 2021 was $210.2 million with approximately $178.0 million expected to be recognized as revenue over the remaining part of 2021 and $185.3 million scheduled over the next 12 months. TEST SYSTEMS SEGMENT Three Months Ended (In thousands) April 3, 2021 March 28, 2020 Sales $ 24,745 $ 16,553 Less Inter-segment Sales (304) (39) Total Test Systems Sales $ 24,441 $ 16,514 Operating profit $ 1,189 $ 722 Operating Margin 4.9 % 4.4 % Test Systems Sales by Market (In thousands) Semiconductor $ — $ 1,634 Aerospace & Defense 24,441 14,880 $ 24,441 $ 16,514 (In thousands) April 3, 2021 December 31, 2020 Total Assets $ 102,138 $ 105,079 Backlog $ 87,393 $ 92,337 TEST SYSTEMS FIRST QUARTER RESULTS Test Systems segment sales were $24.4 million, up $7.9 million compared to the prior-year period. Volumes have increased, as defense and government markets have been largely unaffected by the pandemic. Test Systems operating profit was $1.2 million, or 4.9% of sales, compared with $0.7 million, or 4.4% of sales, in the first quarter of 2020. Operating profit in the first quarter of 2021 was negatively affected by $0.9 million in legal fees related to infringement claims. Operating results in 2020 benefited from $1.6 million in semiconductor warranty revenue. TEST SYSTEMS OUTLOOK Bookings for the Test Systems segment in the quarter were $19.5 million, for a book-to-bill ratio of 0.80:1 for the quarter. The Test Systems segment’s backlog at the end of the first quarter of 2021 was $87.4 million, with approximately $39.2 million expected to be recognized as revenue over the remaining part 2021 and approximately $46.8 million scheduled over the next 12 months. 29 Table of Contents LIQUIDITY AND CAPITAL RESOURCES Operating Activities: Cash used for operating activities totaled $6.9 million for the first three months of 2021, as compared with $23.3 million cash provided by operating activities during the same period in 2020. Cash flow from operating activities decreased compared with the same period of 2020 primarily due to lower net income adjusted for non-cash expenses and income in 2021 compared with 2020 due to the impacts of the COVID-19 pandemic on our business, coupled with changes in net operating assets. Investing Activities: Cash used for investing activities was $1.9 million for the first three months of 2021 compared with $2.8 million in cash used for investing activities in the same period of 2020 due to a decrease in capital expenditures. The Company expects capital spending in 2021 to be in the range of $10 million and $11 million. Financing Activities: Cash used for financing activities totaled $0.6 million for the first three months of 2021, as compared with $136.8 million cash provided by financing activities during the same period in 2020. Cash flow from financing activities decreased compared with the same period of 2020 due to net proceeds on our senior credit facility of $145.0 million in the first three months of 2020, partially offset by $7.7 million of share repurchases before the 10b-5 plan associated with the share repurchase program was terminated. The Company's Fifth Amended and Restated Credit Agreement (the “Agreement”) provided for a $500 million revolving credit line with the option to increase the line by up to $150 million. The maturity date of the loans under the Agreement is February 16, 2023. The maximum leverage ratio of funded debt, net of cash to Adjusted EBITDA (as defined in the Agreement) was 3.75 to 1, increasing to 4.50 to 1 for up to four fiscal quarters following the closing of an acquisition permitted under the Agreement, subject to limitations. The Company paid interest on the unpaid principal amount of the facility at a rate equal to one-, three- or six-month LIBOR plus between 1.00% and 1.50% based upon the Company’s leverage ratio. The Company also paid a commitment fee to the lenders in an amount equal to between 0.10% and 0.20% on the undrawn portion of the credit facility, based upon the Company’s leverage ratio. In May 2020, the Company executed an amendment to the Agreement (the “Amended Facility”), which reduced the revolving credit line from $500 million to $375 million. The Amended Facility suspends the application of the leverage ratio up through and including the second quarter of 2021 (the “suspension period”). The maximum net leverage ratio will be 6.00 to 1 for the third quarter of 2021, 5.50 to 1 for the fourth quarter of 2021, 4.50 to 1 for the first quarter of 2022, and return to 3.75 to 1 for each quarter thereafter. At April 3, 2021, there was $173.0 million outstanding on the revolving credit facility and there remained $200.9 million available subject to the minimum liquidity covenant discussed below, net of outstanding letters of credit. The credit facility allocates up to $20 million of the $375 million revolving credit line for the issuance of letters of credit, including certain existing letters of credit. At April 3, 2021, outstanding letters of credit totaled $1.1 million. Through the third quarter of 2021, the Amended Facility requires the Company to maintain minimum liquidity, defined as unrestricted cash plus the unused revolving credit commitments, of $180 million at all times. Through the second quarter of 2021, the Company is required to maintain a minimum interest coverage ratio of 1.75x on a quarterly basis, except for the first quarter of 2021, which was set at 1.50x. The Company was in compliance with its financial covenants at April 3, 2021. During the suspension period, the Company will pay interest on the unpaid principal amount of the Amended Facility at a rate equal to one-, three- or six-month LIBOR (which shall be at least 1.00%) plus 2.25%. The Company will also pay a commitment fee to the lenders in an amount equal to 0.35% on the undrawn portion of the Amended Facility. After the suspension period, the Company will pay interest on the unpaid principal amount of the Amended Facility at a rate equal to one-, three- or six-month LIBOR (which shall be at least 1.00%) plus between 1.00% to 2.25% based upon the Company’s leverage ratio. The Company will also pay a commitment fee to the lenders in an amount equal to 0.10% to 0.35% on the undrawn portion of the Amended Facility, based upon the Company’s leverage ratio. The Amended Facility provided for the payment of a consent fee of 15 basis points of the commitment for each consenting lender. The Amended Facility also temporarily restricts certain activities, including acquisitions and share repurchases, and requires mandatory prepayments during the suspension period when the Company’s cash balance exceeds $100 million. The Company has not made any prepayments during the three months ended April 3, 2021. 30 Table of Contents The Company’s obligations under the Amended Facility are jointly and severally guaranteed by each domestic subsidiary of the Company other than non-material subsidiaries. The obligations are secured by a first priority lien on substantially all of the Company’s and the guarantors’ assets. In the event of voluntary or involuntary bankruptcy of the Company or any subsidiary, all unpaid principal and other amounts owing under the Amended Facility automatically become due and payable. Other events of default, such as failure to make payments as they become due and breach of financial and other covenants, change of control, judgments over a certain amount, and cross default under other agreements give the agent the option to declare all such amounts immediately due and payable. OFF BALANCE SHEET ARRANGEMENTS We do not have any material off balance sheet arrangements that have or are reasonably likely to have a material future effect on our results of operations or financial condition. BACKLOG The Company’s backlog at April 3, 2021 was $297.5 million compared with $283.4 million at December 31, 2020 and $369.4 million at March 28, 2020. CONTRACTUAL OBLIGATIONS AND COMMITMENTS Our contractual obligations and commitments have not changed materially from the disclosures in our 2020 Annual Report on Form 10-K. MARKET RISK The Company believes that there have been no material changes in the current year regarding the market risk information for its exposure to interest rate fluctuations. Although the majority of our sales, expenses and cash flows are transacted in U.S. dollars, we have exposure to changes in foreign currency exchange rates related primarily to the Euro and the Canadian dollar. The Company believes that the impact of changes in foreign currency exchange rates in 2021 have not been significant. CRITICAL ACCOUNTING POLICIES Refer to Note 2 of the Notes to Consolidated Condensed Financial Statements included in this report for the Company’s critical accounting policies with respect to revenue recognition. For a complete discussion of the Company’s other critical accounting policies, refer to the Company’s annual report on Form 10-K for the year ended December 31, 2020. RECENT ACCOUNTING PRONOUNCEMENTS Refer to Note 1 of the Notes to Consolidated Condensed Financial Statements included in this report. FORWARD-LOOKING STATEMENTS Information included in this report that does not consist of historical facts, including statements accompanied by or containing words such as “may,” “will,” “should,” “believes,” “expects,” “expected,” “intends,” “plans,” “projects,” “approximate,” “estimates,” “predicts,” “potential,” “outlook,” “forecast,” “anticipates,” “presume” and “assume,” are forward-looking statements. Such forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance and are subject to several factors, risks and uncertainties, the impact or occurrence of which could cause actual results to differ materially from the expected results described in the forward-looking statements. Certain of these factors, risks and uncertainties are discussed in the sections of this report entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” New factors, risks and uncertainties may emerge from time to time that may affect the forward-looking statements made herein. Given these factors, risks and uncertainties, investors should not place undue reliance on forward-looking statements as predictive of future results. We disclaim any obligation to update the forward-looking statements made in this report. Item 3. Quantitative and Qualitative Disclosures About Market Risk See Market Risk in Item 2, above. 31 Table of Contents