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, 2021.) 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 (“USDOD”). 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), supply chain pressures, 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 Systems 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 USDOD, prime contractors to the USDOD, mass transit operators and prime contractors to mass transit operators. In September 2021 the Company also entered into an agreement with the U.S. Department of Transportation (“USDOT”) under the Aviation Manufacturing Jobs Protection Program (“AMJP”) for a grant of up to $14.7 million. The Company received $7.4 million under the grant in 2021 and $5.2 million in the first quarter of 2022. The Company expects to receive the remainder in the second or third quarter of 2022 upon final confirmation from the USDOT of the Company meeting its grant commitments. The receipt of the full award is primarily conditioned upon the Company committing to not furlough, lay off or reduce the compensation levels of a defined group of employees during the six-month period of performance between September 2021 and March 2022. The grant benefit will be recognized over the six-month performance period as a reduction to cost of products sold in proportion to the compensation expense that the award is intended to defray. The Company recognized the remaining $6.0 million of the award during the quarter ended April 2, 2022. 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. In the fourth quarter of 2021, the Company agreed to an earnout payment of $10.7 million for the calendar 2020 earnout, which was recorded in 2021 as a separate line item below operating loss and was received by the Company in early January 2022. In March 2022, the Company agreed with the earnout calculation for the calendar 2021 earnout in the amount of $11.3 million. The Company recorded the gain and received the payment in the first quarter of 2022. 20 Table of Contents CONSOLIDATED RESULTS OF OPERATIONS AND OUTLOOK Three Months Ended ($ in thousands) April 2, 2022 April 3, 2021 Sales $ 116,176 $ 105,857 Gross Profit (sales less cost of products sold) $ 19,933 $ 14,273 Gross Margin 17.2 % 13.5 % Selling, General and Administrative Expenses $ 24,100 $ 23,785 SG&A Expenses as a Percentage of Sales 20.7 % 22.5 % Net Gain on Sale of Businesses $ (11,284) $ — Interest Expense, Net of Interest Income $ 1,631 $ 1,758 Effective Tax Rate 161.7 % (0.9) % Net Loss $ (3,101) $ (11,909) 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 up $10.3 million from the first quarter of 2021. Aerospace sales were up $20.0 million, or 24.5%, and Test System sales decreased $9.7 million. While demonstrating some improvement, sales continued to reflect the ongoing impacts of the COVID-19 pandemic on the global aerospace industry. Supply chain pressures continue to impact delivery schedules and costs, limiting the Company’s ability to respond to desired requests from customers and delaying shipments. Supply chain challenges caused about $15 million in revenue to slide out of the quarter. These orders were not lost and will remain in backlog until the required raw materials arrive. Consolidated cost of products sold in the first quarter of 2022 was $96.2 million, compared with $91.6 million in the prior-year period. The increase was primarily due to higher volume as the global aerospace industry continues its recovery from the COVID-19 pandemic. The current year period benefited from $6.0 million recognized as an offset to cost of products sold related to the AMJP award. Research and development expenses increased $1.9 million due to higher innovation spend. Selling, general and administrative (“SG&A”) expenses were $24.1 million in the first quarter of 2022 compared with $23.8 million in the prior-year period. In March 2022, the Company agreed with the earnout calculation from the buyer of its former semiconductor test business for an earnout in the amount of $11.3 million related to performance in calendar 2021. The Company recorded the gain and received the payment in the first quarter of 2022. The semiconductor test business was sold in 2019. The effective tax rate for the quarter was 161.7%, compared with (0.9)% in the first quarter of 2021. In the past, research and development costs were deducted as incurred. However, beginning with the 2022 tax year, these costs are required to be capitalized for tax purposes and amortized over 5 years. The tax rate was also impacted by a valuation allowance applied against the associated deferred tax asset created by the new treatment, due to the Company’s cumulative losses over the last three years. Consolidated net loss was $3.1 million, or $0.10 per diluted share, compared with net loss of $11.9 million, or $0.39 per diluted share, in the prior year. Bookings were $175.6 million, for a book-to-bill ratio of 1.51:1. Backlog at the end of the quarter was $475.1 million. Approximately $364.3 million, or 77%, of backlog is expected to ship in the remainder of 2022. COVID-19 Impacts on Our Business On March 11, 2020, the World Health Organization classified the COVID-19 outbreak as a pandemic. The spread of the COVID-19 pandemic disrupted businesses on a global scale, led to significant volatility in financial markets and affected the aviation and industrial industries. Substantially all of our operations and production activities have, to-date, remained operational. However, the impacts of the pandemic have placed labor and supply chain pressures on our business and we have been impacted by customer demand variability. Although we saw stable and growing backlog during the first half of 2022 in our aerospace business, COVID-19 related disruptions are ongoing and continue to adversely challenge our commercial transport market. While we remain bullish about the aerospace business, we believe the recovery to pre-pandemic activity, particularly in the widebody market, will take longer than originally anticipated at the outset of the pandemic. As economic 21 Table of Contents activity continues to recover, we will continue to monitor the situation, assessing further possible implications on our operations, supply chain, liquidity, cash flow and customer orders. See Part II, Item 1A, Risk Factors, for an additional discussion of risk related to supply chain disruptions and the recent government vaccine mandates. Outlook We are maintaining our previous revenue guidance of $550 million to $600 million for the year. We believe this range accommodates the supply chain and labor challenges that we are likely to face, although some unpredictability certainly exists. We expect volume to ramp as we move though the year. We expect revenue in the second quarter will be between $125 million and $135 million, with similar rates of improvement in the third and fourth quarters. Consolidated backlog at April 2, 2022 was $475.1 million. Approximately 77% of the backlog is expected to be recognized as revenue in 2022. Planned capital expenditures for 2022 are expected to be approximately $15 million to $20 million. While core aerospace markets have strengthened as vaccination rates rise and passenger traffic accelerated, 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, virus variants, vaccination rates and efficacy and the related length of impact on the global economy, supply chain and specifically on the markets we are active in, which are 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, other corporate expenses and other non-operating sales and expenses. Cost of products sold and other operating expenses are directly identifiable to the respective segment. Operating loss is reconciled to loss before income taxes in Note 15 of the Notes to Consolidated Condensed Financial Statements included in this report. 22 Table of Contents AEROSPACE SEGMENT Three Months Ended (In thousands) April 2, 2022 April 3, 2021 Sales $ 101,394 $ 81,430 Less Inter-segment Sales — (14) Total Aerospace Sales $ 101,394 $ 81,416 Operating Profit (Loss) $ 3,050 $ (5,563) Operating Margin 3.0 % (6.8) % Aerospace Sales by Market (In thousands) Commercial Transport $ 64,089 $ 38,208 Military 14,976 20,982 Business Jet 15,867 14,028 Other 6,462 8,198 $ 101,394 $ 81,416 Aerospace Sales by Product Line (In thousands) Electrical Power & Motion $ 44,467 $ 29,344 Lighting & Safety 29,211 27,100 Avionics 18,875 14,843 Systems Certification 1,002 878 Structures 1,377 1,053 Other 6,462 8,198 $ 101,394 $ 81,416 (In thousands) April 2, 2022 December 31, 2021 Total Assets $ 465,611 $ 458,334 Backlog $ 394,043 $ 334,659 AEROSPACE FIRST QUARTER RESULTS Aerospace segment sales increased $20.0 million, or 24.5%, to $101.4 million. Commercial aerospace sales increased 67.7%, or $25.9 million, and drove the improvement. Sales to this market were $64.1 million, or 55.1% of consolidated revenue in the quarter, compared with $38.2 million, or 36.1% of consolidated revenue in the first quarter of 2021. Improving domestic travel, increased narrowbody production rates including the 737 MAX and higher fleet utilization are driving increased demand for Astronics products. General Aviation sales increased $1.8 million, or 13.1%, to $15.9 million as higher demand in the business jet market somewhat offset lower VVIP activity. The Company expects the strong demand being realized in the business jet industry to translate into higher demand for its products as OEM production levels increase. Military Aircraft sales decreased $6.0 million, or 28.6%, to $15.0 million. The prior-year period benefited from incremental non-recurring engineering revenue associated with development of new programs and higher sales of lighting and safety products. Aerospace segment operating profit was $3.1 million compared with operating loss of $5.6 million for the same period last year. The improvement was driven by increased sales and the $6.0 million AMJP benefit, partially offset by a $0.8 million increase of expense associated with the reinstated 401K contribution accrual. Sequentially, compared with the fourth quarter of 2021, Aerospace revenue grew 2.6% and operating profit improved $5.3 million to $3.1 million. 23 Table of Contents AEROSPACE OUTLOOK Aerospace bookings in the first quarter of 2022 were $160.8 million, for a book-to-bill ratio of 1.59:1. The Aerospace segment’s backlog at the end of the first quarter of 2022 was $394.0 million with approximately $322.5 million expected to be recognized as revenue over the remaining part of 2022 and $356.0 million scheduled over the next 12 months. Demand has been strong across our aerospace product range, with a book-to-bill of 1.48 over the last twelve months and record high backlog of at the end of the first quarter. Most of this demand has been driven by recovery in the narrowbody market, though in the first quarter we saw signs that the widebody market is picking up also, which is necessary to return to pre-COVID levels in the near future. TEST SYSTEMS SEGMENT Three Months Ended (In thousands) April 2, 2022 April 3, 2021 Sales $ 14,798 $ 24,745 Less Inter-segment Sales (16) (304) Total Test Systems Sales $ 14,782 $ 24,441 Operating (Loss) Profit $ (1,787) $ 1,189 Operating Margin (12.1) % 4.9 % All Test Systems sales are to the Aerospace and Defense Market. (In thousands) April 2, 2022 December 31, 2021 Total Assets $ 96,285 $ 105,335 Backlog $ 81,095 $ 81,033 TEST SYSTEMS FIRST QUARTER RESULTS Test Systems segment sales were $14.8 million, down $9.7 million compared with the prior-year period driven by lower defense revenue. Test Systems operating loss was $1.8 million, or 12.1% of sales, compared with operating profit of $1.2 million, or 4.9% of sales, in the first quarter of 2021. Operating loss in the first quarter of 2022 was negatively affected primarily by lower volume. Operating profit in the first quarter of 2021 was negatively affected by $0.9 million in legal fees related to infringement claims. TEST SYSTEMS OUTLOOK Bookings for the Test Systems segment in the quarter were $14.8 million, for a book-to-bill ratio of 1.00:1 for the quarter. The Test Systems segment’s backlog at the end of the first quarter of 2022 was $81.1 million, with approximately $41.8 million expected to be recognized as revenue over the remainder of 2022 and approximately $51.1 million scheduled over the next 12 months. The first quarter was one of treading water for our Test business, with light shipments and bookings. We are pursuing some significant projects which are scheduled for award mid-year. Those awards will largely determine the trajectory of the business through the end of 2022 and into 2023. LIQUIDITY AND CAPITAL RESOURCES Operating Activities: Cash provided by operating activities totaled $0.3 million for the first three months of 2022, as compared with $6.9 million cash used for operating activities during the same period in 2021. Cash flow from operating activities increased compared with the same period of 2021 primarily related to cash received from income tax refunds and the AMJP program, offset by changes in net operating assets, including increase in accounts receivable and inventory as sales and demand increases. 24 Table of Contents Investing Activities: Cash provided by investing activities was $20.8 million for the first three months of 2022 compared with $1.9 million in cash used for investing activities in the same period of 2021. Investing cash flows in 2022 were positively impacted by the receipt of $10.7 million and $11.3 million related with the calendar 2020 and 2021 earnouts, respectively, from the sale of the semiconductor business. The Company expects capital spending in 2022 to be in the range of $15 million and $20 million. Financing Activities: Cash used for financing activities totaled $26.7 million for the first three months of 2022, as compared with $0.6 million cash used for financing activities during the same period in 2021. Cash used for financing activities increased compared with the same period of 2021 due to net payments on our senior credit facility of $26.0 million in the first three months of 2022, coupled with $0.8 million in costs associated with the March 1, 2022 amendment of our credit facility. At April 2, 2022, there was $137.0 million outstanding on the revolving credit facility and there remained $86.9 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 $225 million revolving credit line for the issuance of letters of credit, including certain existing letters of credit. At April 2, 2022, outstanding letters of credit totaled $1.1 million. On March 1, 2022, the Company executed an amendment to the Amended Facility, which reduced the revolving credit line from $375 million to $225 million and extended the maturity date of the loans under the facility from February 16, 2023 to May 30, 2023. Interest will be payable on the unpaid principal amount of the facility at a rate equal to the Secured Overnight Financing Rate (“SOFR”, which shall be at least 1.00%), plus between 1.50% to 3.25% 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 0.40% on the undrawn portion of the Amended Facility, based upon the Company’s leverage ratio. The amendment provided for the payment of a consent fee of 10 basis points of the commitment for each consenting lender. The amendment requires the Company to maintain minimum liquidity, defined as unrestricted cash plus the unused revolving credit commitments, of $35 million. The maximum net leverage ratio is set at 4.75 to 1 for the first and second quarters of 2022 and 3.75 to 1 thereafter, and the definition of Adjusted EBITDA has been modified to exclude income from earnout payments and asset sales. The Company was in compliance with its financial covenants at April 2, 2022. The Amended Facility continues the temporary restrictions on certain activities, including dividend payments, acquisitions and share repurchases, through the third quarter of 2022. 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. We intend to refinance the amended agreement with a new long-term financing facility in the coming months. We are currently in the process of evaluating terms and conditions for a new long-term financing arrangement. If we are unable to obtain a new long-term financing facility before we file our second quarter 2022 Form 10-Q to replace our existing debt facility, borrowings outstanding under our existing debt facility will come due within 12 months of that filing date and could result in substantial doubt about our ability to continue as a going concern in the event that we are not reasonably assured to have sufficient cash balances to repay the remaining obligations at maturity. Other In 2021, the Company was awarded a grant of up to $14.7 million as part of the Aviation Manufacturing Jobs Protection (“AMJP”) Program. The grant was being recognized ratably over the six-month period of performance. In the first quarter of 2022, $6.0 million was recognized as an offset to cost of products sold. The period of performance concluded in March 2022. 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. 25 Table of Contents BACKLOG The Company’s backlog at April 2, 2022 was $ 475.1 million compared with $415.7 million at December 31, 2021 and $297.5 million at April 3, 2021. CONTRACTUAL OBLIGATIONS AND COMMITMENTS Except as noted below, our contractual obligations and commitments have not changed materially from the disclosures in our 2021 Annual Report on Form 10-K. Absent any legislative changes, the Company expects to pay approximately $10 million to $12 million in income tax payments related to the 2022 tax year. These expected tax payments are largely the result of the requirement to capitalize and amortize certain research and development expenses for U.S. tax purposes beginning in 2022. 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 2022 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, 2021. 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.