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 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 was 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 six months ended July 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 included two elements of contingent purchase consideration (“earnout”). 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 $11.3 million. The Company recorded the gain and received the payment in the first quarter of 2022. 20 Table of Contents CONSOLIDATED RESULTS OF OPERATIONS AND OUTLOOK Six Months Ended Three Months Ended ($ in thousands) July 2, 2022 July 3, 2021 July 2, 2022 July 3, 2021 Sales $ 245,303 $ 217,015 $ 129,127 $ 111,158 Gross Profit (sales less cost of products sold) $ 35,642 $ 29,668 $ 15,709 $ 15,395 Gross Margin 14.5 % 13.7 % 12.2 % 13.8 % Selling, General and Administrative Expenses $ 48,205 $ 45,100 $ 24,105 $ 21,315 SG&A Expenses as a Percentage of Sales 19.7 % 20.8 % 18.7 % 19.2 % Net Gain on Sale of Businesses $ (11,284) $ — $ — $ — Interest Expense, Net of Interest Income $ 3,293 $ 3,457 $ 1,662 $ 1,699 Effective Tax Rate (165.0) % (0.2) % (6.4) % 0.8 % Net Loss $ (14,111) $ (20,008) $ (11,010) $ (8,099) A discussion by segment can be found at “Segment Results of Operations and Outlook” in this MD&A. CONSOLIDATED SECOND QUARTER RESULTS Consolidated sales were up $18.0 million from the second quarter of 2021. Aerospace sales were up $20.1 million, or 22.5%, and Test System sales decreased $2.1 million. Consolidated cost of products sold in the second quarter of 2022 was $113.4 million, compared with $95.8 million in the prior-year period. The increase was primarily due to higher volume combined with the impact of material and labor inflation, addressing supply chain disruptions and labor constraints. Research and development expenses increased $2.3 million due to higher innovation spend. The prior-year period benefited from $0.9 million in COVID-19 subsidies offsetting costs of products sold. Selling, general and administrative (“SG&A”) expenses were $24.1 million in the second quarter of 2022 compared with $21.3 million in the prior-year period. The prior-year period benefited from a $2.2 million non-cash reduction of the fair value of a contingent consideration liability. The effective tax rate for the quarter was (6.4)%, compared with 0.8% in the second quarter of 2021. The tax rate for the quarter was impacted by changes in the year-to-date and forecasted income (loss) before income taxes. Consolidated net loss was $11.0 million, or $0.34 per diluted share, compared with net loss of $8.1 million, or $0.26 per diluted share, in the prior year. Bookings were $148.4 million, for a book-to-bill ratio of 1.15:1. Backlog at the end of the quarter was $494.4 million. Approximately $278.0 million, or 56%, of backlog is expected to be recognized as revenue in 2022. CONSOLIDATED YEAR-TO-DATE RESULTS Consolidated sales were up $28.3 million. Aerospace sales were up $40.0 million from the first half of 2021. Test System sales decreased $11.8 million. Consolidated cost of products sold in the first half of 2022 was $209.7 million, compared with $187.3 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 $4.2 million due to higher innovation spend. SG&A expenses were $48.2 million in the first half of 2022 compared with $45.1 million the prior-year period. The prior-year period benefited from a $2.2 million non-cash reduction of the fair value of a contingent consideration liability. The effective tax rate for the first half of 2022 was (165.0)%, compared with (0.2)% in the first half 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 2022 tax rate was 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. This was partially offset by the removal of valuation allowances related to net operating losses, tax credit carryovers, and certain timing differences that are expected to reverse during 2022 as well as a Federal research and development credit expected for 2022. 21 Table of Contents Consolidated net loss was $14.1 million, or $(0.44) per diluted share, compared with net loss of $20.0 million, or $(0.65) per diluted share, in the prior year. 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 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. Outlook We are revising our expected 2022 revenue to be in the range of $550 million to $580 million, which incorporates a reduction at the high end of the range from previous guidance. The midpoint of this range would mean growth for the year of 27% over 2021 and implies average quarterly revenue of $160 million in the second half, a significant step up from recent levels. This ramp is expected to be weighted more toward the fourth quarter, however, and while we continue to be challenged by ongoing supply chain challenges, we believe today that this expansion in revenue is necessary and achievable. Higher volume will help satisfy customer demand, along with improved profitability and momentum as we close out 2022. Consolidated backlog at July 2, 2022 was $494.4 million. Approximately 56% of the backlog is expected to be recog nized as revenue in 2022. Planned capital expenditures for 2022 are expected to be approximately $9 million to $10 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 Six Months Ended Three Months Ended (In thousands) July 2, 2022 July 3, 2021 July 2, 2022 July 3, 2021 Sales $ 210,694 $ 170,650 $ 109,300 $ 89,220 Less Inter-segment Sales (10) (14) (10) — Total Aerospace Sales $ 210,684 $ 170,636 $ 109,290 $ 89,220 Operating Loss $ (226) $ (8,269) $ (3,276) $ (2,706) Operating Margin (0.1) % (4.8) % (3.0) % (3.0) % Aerospace Sales by Market (In thousands) Commercial Transport $ 133,332 $ 86,001 $ 69,243 $ 47,793 Military 28,873 37,783 13,897 16,801 General Aviation 33,997 29,022 18,130 14,994 Other 14,482 17,830 8,020 9,632 $ 210,684 $ 170,636 $ 109,290 $ 89,220 Aerospace Sales by Product Line (In thousands) Electrical Power & Motion $ 86,602 $ 64,092 $ 42,135 $ 34,748 Lighting & Safety 60,599 51,468 31,388 24,368 Avionics 43,281 32,864 24,406 18,021 Systems Certification 2,671 1,838 1,669 960 Structures 3,049 2,544 1,672 1,491 Other 14,482 17,830 8,020 9,632 $ 210,684 $ 170,636 $ 109,290 $ 89,220 (In thousands) July 2, 2022 December 31, 2021 Total Assets $ 463,715 $ 458,334 Backlog $ 410,765 $ 334,659 AEROSPACE SECOND QUARTER RESULTS Aerospace segment sales increased $20.1 million, or 22.5%, to $109.3 million. Commercial aerospace sales increased 44.9%, or $21.5 million, and drove the improvement. Sales to this market were $69.2 million compared with $47.8 million in the second quarter of 2021. Improving domestic airline travel that is driving higher fleet utilization and increased narrowbody production rates, including the 737 MAX, resulted in higher demand for Astronics’ products. General Aviation sales increased $3.1 million, or 20.9%, to $18.1 million as higher demand in the business jet market for antenna products. The Company expects the strong end-user demand in the business jet industry to drive higher OEM production rates in the near future, resulting in increased demand for its products. Military Aircraft sales decreased $2.9 million, or 17.3%, to $13.9 million. The prior-year period benefited from incremental non-recurring engineering revenue associated with development of programs and higher sales of avionics products. Aerospace segment operating loss was $3.3 million compared with operating loss of $2.7 million for the same period last year. Higher operating losses were driven by inflationary impacts on input costs and inefficiencies associated with production execution due to supply chain constraints that restricted shipment volume. AEROSPACE YEAR-TO-DATE RESULTS Aerospace segment sales increased $40.0 million, or 23.5%, to $210.7 million. Sales continued to be positively affected by reasons discussed above. Aerospace segment operating loss was $0.2 million compared with operating loss of $8.3 million for the same period last year. The improvement was driven by increased sales and the $6.0 million AMJP benefit in the 2022 period, partially offset by a $1.7 23 Table of Contents million increase of expense associated with the reinstated 401K contribution. Aerospace operating loss in the prior-year period was significantly impacted by leverage lost on reduced sales. AEROSPACE OUTLOOK Aerospace bookings in the second quarter of 2022 were $126.0 million, for a book-to-bill ratio of 1.15:1. The Aerospace segment’s backlog at the end of the second quarter of 2022 was $410.8 million with approximately $246.6 million expected to be recognized as revenue over the remaining part of 2022 and $360.2 million scheduled over the next 12 months. During the quarter, we announced some significant program wins. These included the award by Southwest Airlines to provide in-seat power systems, selection by Safran to provide satellite communication hardware for Airbus aircraft and being named the designer and developer of the electrical power distribution system for the Lilium eVTOL aircraft, our first announced eVTOL program. While these wins did not contribute meaningfully to bookings in the quarter, we expect they will be major drivers for our business going forward. TEST SYSTEMS SEGMENT Six Months Ended Three Months Ended (In thousands) July 2, 2022 July 3, 2021 July 2, 2022 July 3, 2021 Sales $ 34,638 $ 46,683 $ 19,840 $ 21,938 Less Inter-segment Sales (19) (304) (3) — Total Test Systems Sales $ 34,619 $ 46,379 $ 19,837 $ 21,938 Operating (Loss) Profit $ (1,813) $ 243 $ (26) $ (946) Operating Margin (5.2) % 0.5 % (0.1) % (4.3) % All Test Systems sales are to the Aerospace and Defense Market. (In thousands) July 2, 2022 December 31, 2021 Total Assets $ 100,224 $ 105,335 Backlog $ 83,635 $ 81,033 TEST SYSTEMS SECOND QUARTER RESULTS Test Systems segment sales were $19.8 million, down $2.1 million compared with the prior-year period driven by lower defense revenue. Test Systems was nearly break-even compared with operating loss of $0.9 million, or (4.3)% of sales, in the second quarter of 2021. Continued lower volume has driven operating losses in the second quarters of 2022 and 2021. TEST SYSTEMS YEAR-TO-DATE RESULTS Test Systems segment sales were $34.6 million, down $11.8 million compared with the prior-year period driven by lower revenue on defense and mass transit programs. Test Systems operating loss was $1.8 million, or (5.2)% of sales, compared with operating profit of $0.2 million, or 0.5% of sales, in the first half of 2021. Operating loss in the first half of 2022 was negatively affected primarily by lower volume. Operating profit in the first half of 2021 was negatively affected by $1.9 million in legal fees related to infringement claims. TEST SYSTEMS OUTLOOK Bookings for the Test Systems segment in the quarter were $22.4 million, for a book-to-bill ratio of 1.13:1 for the quarter. The Test Systems segment’s backlog at the end of the second quarter of 2022 was $83.6 million, with approximately $31.4 million expected to be recognized as revenue over the remainder of 2022 and approximately $51.5 million scheduled over the next 12 months. Our Test business has been pursuing some significant awards which have been delayed to the second half of the year. Our go-forward plan assumes that these awards will be made in the near future, supporting our plans for 2023 and beyond. 24 Table of Contents LIQUIDITY AND CAPITAL RESOURCES Operating Activities: Cash used for operating activities totaled $10.3 million for the first six months of 2022, as compared with $2.3 million cash used for operating activities during the same period in 2021. Cash flow from operating activities decreased compared with the same period of 2021 primarily related to increases in net operating assets, primarily accounts receivable and inventory, more than offsetting cash received from income tax refunds and the AMJP program. Investing Activities: Cash provided by investing activities was $19.5 million for the first six months of 2022 compared with $3.6 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 $9 million and $10 million. Financing Activities: Cash used for financing activities totaled $27.7 million for the first six months of 2022, as compared with $0.9 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 $27.0 million in the first six months of 2022, coupled with $0.8 million in costs associated with the March 1, 2022 amendment of our credit facility. The Company's long-term debt consists of borrowings under its Fifth Amended and Restated Credit Agreement (the “Agreement”). On March 1, 2022, the Company executed an amendment to the Agreement, 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. The definition of Adjusted EBITDA was modified to exclude income from earnout payments and asset sales. On August 9, 2022, the Company executed a further amendment to the Agreement (the “Amended Facility”), which reduced the revolving credit line from $225 million to $190 million until September 12, 2022 with further reductions to $180 million effective September 12, 2022 and $170 million effective October 11, 2022. The Amended Facility extended the maturity date of the loans under the facility from May 30, 2023 to August 31, 2023. Interest is 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 4.75% based upon the Company’s leverage ratio. The Company also pays 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. Both amendments provided for the payment of a consent fee of 10 basis points of the commitment for each consenting lender. At July 2, 2022, there was $136.0 million outstanding on the revolving credit facility and there remained $87.9 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 July 2, 2022, outstanding letters of credit totaled $1.1 million. The Company is required 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 0.00 to 1 for the first and second quarters of 2022 under the previous facility. The Amended Facility includes a maximum net leverage ratio of 4.25 to 1 for the third quarter of 2022 and 0.00375 to 1 thereafter. The Company was in compliance with its financial covenants at July 2, 2022 . The Amended Facility temporarily restricts acquisitions through the third quarter of 2022, as well as dividend payments and share repurchases through the maturity date of the Amended Facility. 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 are currently in the process of evaluating terms and conditions for a new long-term financing arrangement, which includes an asset-based lending agreement and separate agreement that would monetize our real estate as collateral. The extent to which we will be able to effect such refinancing, replacement or maturity extension on terms that are favorable to us or at all is dependent on a number of uncertain factors, including then-prevailing credit and other market conditions, economic conditions, particularly in the aerospace and defense markets, disruptions or volatility caused by factors such as COVID-19, regional conflicts, inflation, and supply chain disruptions. In addition, rising interest rates could limit our ability to refinance our existing 25 Table of Contents credit facility when it matures or cause us to pay higher interest rates upon refinancing. As the Company’s long-term debt approaches maturity, if the Company is unable to refinance, replace or extend the maturity on its credit facility, the Company’s liquidity, results of operations, and financial condition could be materially adversely impacted. If we are unable to obtain a new long-term financing facility before we file our third quarter 2022 Form 10-Q to replace our existing debt facility, borrowings outstanding under our existing credit 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. 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 July 2, 2022 was $494.4 million compared with $415.7 million at December 31, 2021 and $312.7 million at July 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 $9 million to $10 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. 26 Table of Contents