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Astronics (NASDAQ:ATRO)

Q1 2014 Earnings Call

May 07, 2014 11:00 am ET

Executives

Peter J. Gundermann - Chief Executive Officer, President, Director and President of Luminescent Systems Inc

David C. Burney - Chief Financial Officer, Principal Accounting Officer, Executive Vice President of Finance, Treasurer and Secretary

Analysts

Kevin Ciabattoni - KeyBanc Capital Markets Inc., Research Division

Richard A. Ryan - Dougherty & Company LLC, Research Division

Operator

Greetings, and welcome to the Astronics Corporation First Quarter 2014 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Alex Hamilton [ph], Investor Relations for Astronics Corporation. Thank you. You may begin.

Unknown Executive

Thank you, Melissa, and good morning, everyone. We certainly appreciate your time today and your interest in Astronics. On the call is Peter Gundermann, Astronics' President and CEO; Dave Burney, Chief Financial Officer; and Mark Peabody, Executive Vice President. Pete will first go through his planned remarks and then we'll open the call for questions and answers. If you don't have the news release that was sent out this morning, it is available on our website at www.astronics.com.

As you are aware, we may make some forward-looking statements during the formal presentation and the Q&A portion of this teleconference. These statements apply to the future events that are subject to risks and uncertainties, as well as other factors that could cause the actual results to differ materially from where we are today. These factors are outlined in the earnings release, as well as in documents filed by the company with the Securities and Exchange Commission. They can be found at our website or at www.SEC.gov.

With that, let me turn the call over to Pete. Peter?

Peter J. Gundermann

Thanks, Alex. Good morning, everybody, and thanks for tuning in. We're going to talk through our first quarter results and our revised expectations for 2014. Long story short, we think we're off to a really good start for the year, we think we're well positioned for the foreseeable future for the rest of the year and we think that the handful of acquisitions that we did in the second half of last year and even in the first quarter of this year are starting to show through, that the emerging company of what we're going to be when all the dust settles is starting to become apparent. And we think it's a pretty compelling picture. We're pretty pleased with how things are progressing, overall.

Certain of our financial results in the first quarter are obvious and easy to understand. Our sales level was very strong, a new record of $141 million, up some crazy 91% over the comparable period of the first quarter 1 year ago. Of the 91 points, organic growth, excluding acquisitions since the comparator period, was up 11%.

Bookings were strong also, a new record of $146 million, exceeding our shipment level slightly, and our ending backlog at the end of the quarter was a new record at $362 million, benefiting not only from the bookings but also from the backlog that we picked up with the acquisition of our renamed Astronics Test Services in late February, the company in Irvine that we purchased from EADS.

The margin profile from the quarter is a little bit more complicated. It takes a little bit more explanation to put into perspective. As reported per GAAP accounting procedures, our first quarter gross profit was $30 million. That's 21.3% of sales, which is below our 2-year average of 25.5%. So slightly less profitable on the gross margin line.

Net income for the quarter was $7.5 million, that's a net margin of 5.3% of sales, which, again, is below our 2-year average of 7.7%. But the important thing that one has to remember in assessing these results is the purchase accounting treatment of acquired inventory, where the rules say you need to write them up to what is deemed to be fair market value rather than the cost to buy it or manufacture it, which is how companies normally account for their inventory. And this, in turn, essentially means that little or no profit is realized on sales driven by that acquired inventory until that acquired inventory is flushed through.

And for us, in the first quarter, the impact of these purchase accounting rules is estimated to be $8.7 million across the business or 6.2% of sales. And these costs go right into cost of goods and start showing up on our gross margin line.

Taking this into account, a more steady state or long-term expectation would be gross margins in the first quarter would have been more like 27.5%, which is actually above our average of 25.2% for the last 8 quarters and net income would have been about $13.3 million or 9.4% of sales, above our 2-year average of 7.7%, and earnings per share would have been $0.70 a share instead of $0.40 a share. So the expensing of the fair value inventory write-up was about $0.30 per diluted share.

As a sneak preview, we expect a similar range of fair value write-up expense in the second quarter, somewhere in the $8 million to $9 million range relating to the acquisitions. And after that, we should be largely finished. We may have another $1 million or $2 million in the second half of 2014, but the brunt of it has been expensed over the last couple of quarters and will be expensed in the current quarter, the second quarter of our fiscal 2014.

So all that being said, we do not publish EBITDA numbers because that gets complicated, but we recognize that most model makers do their calculations in this way and, accordingly, want to point out interest expense in the current quarter, the first quarter, was about $2.3 million, which is up substantially from $218,000 last year, obviously driven by the debt that we took on for the acquisitions.

Our depreciation and amortization expense in the first quarter was $4.8 million, up from $1.7 million last year, and that's, again, largely driven by the acquisitions and the depreciation of certain intangibles that are front-loaded. So we believe that when you take the firm market, write-up of inventory and the increased interest and depreciation expense into account, our margins overall across the business were pretty strong in the first quarter and should be pretty strong, we believe, for the rest of the year.

Going into segments. On our Aerospace segment, revenues in the first quarter were $122 million. That's 87% of our total and up 71% from the comparator period last year. I'm not going to go into too much detail of the products and the comparisons because the increases are so dramatic that the comparisons don't make a whole lot of sense. But if you look at our current sales by market, you'll see a trend, which I think is going to stay with us for a while. We are 70% Commercial Transports now in our Aerospace segment, and much smaller, 6.5% Military, 7% Business Jet. And we expect, or I expect, those percentages to hold going forward.

In terms of product lines, similar trends are starting to emerge. Our biggest product grouping, by far, is Electrical Power & Motion. That was $66 million for the quarter, 47% of total. That product grouping includes our in-seat power product franchise, which had sales for the quarter of about $53 million, and also our flight-critical electrical distribution for smaller aircraft and also our motion systems for seats, which are largely used in commercial transport airplanes.

Our Lighting & Safety product line is our -- product grouping is our second product grouping and that's 25% of total and about $35 million of revenue for the quarter. Lighting is kind of self-explanatory in the cabin and in the cockpit and the exterior of aircraft. There are all kinds of things that light up and there are certain safety mechanisms that we get involved in, which we are, for our new product classification system, lumping together into one product grouping.

And then our third grouping is an Avionics grouping. We do certain niche avionics work and that's $13 million for the quarter and about 9% of our total. We have a couple of significant customers in the Aerospace segment. Panasonic for the quarter was $27.5 million, about 19.5% of our total revenues and Boeing was about $21.6 million, 15.3% of revenues.

Switching over to our Test Systems segment. This was probably one of the bigger headlines, again largely driven by our acquisition of what we're calling Astronics Test Systems in Irvine in late February. They're with us one month, but yet made a pretty large contribution to our collective results in the first quarter. And these results include our Orlando business, our traditional Test Systems business, so the 2 operations lumped together.

Revenues for the first quarter for our Test Systems segment were $18.6 million. That's up substantially from $2.3 million last year and made up 13% of our total. Again, GAAP accounting shows a loss but if you read the fine points of the press release, you will learn that a substantial portion of the inventory flush that I described just a few minutes ago happened in our Test Systems segment. That total was estimated to be about $6.3 million, again coming right out of cost of goods.

Our bookings in the segment were $22.7 million, which is a 22% increase over shipments, which is always positive. And our backlog at the end of the quarter for the segment is $154 million.

We expect, as kind of a sneak preview, in the second quarter we will be announcing another significant customer as defined by the accounting rules, more than 10% of our collective shipments.

Balance sheet. We're pretty content with where we are at the end of the first quarter. We have $29 million cash on hand and total debt of $268 million, for a net debt of $239 million. We believe that we are comfortably financed and have adequate access to liquidity based on the strength in the business and the growth that we're experiencing.

Looking forward, again, our bookings in the first quarter were strong and our backlog going into the second quarter was at a record high. And based on these facts and our observation of what's happening around our business, we're updating our revenue guidance for 2014, to be in the range of $625 million to $660 million. The midpoint of that range would be about $642 million and would represent about -- an increase of about 90% over last year, over 2013.

Of that total, we expect our Aerospace segment to be $480 million to $505 million and our Test Systems segment to be $145 million to $155 million. That's a little higher than we've talked about before and it's just based on customer demand, wanting to move deliveries forward. We would expect that we will basically be on that shipping rate for the rest of the year. If you subtract first quarter shipments from our midpoint of the range, you've come up with a quarterly average of about $167 million, $168 million in revenues and that's where we expect to be, plus or minus, starting in the current quarter.

Again, as a reminder for those of you building models, we expect another $7 million or $8 million of inventory step-up expense in the second quarter and then maybe $1 million or $2 million residual in the second half of the year. We expect capital expenditures this year to be pretty substantial, in the $33 million to $37 million range. That's a reflection of our larger size but, specifically, largely tied to a building that we have purchased and are outfitting in Portland, largely for our PECO operation.

Engineering and Development expense for the course -- for the rest of the year, we are expecting to be somewhere in the $80 million range but there's a bit of the caveat here, in that, based on the process of integration that we're going through, there's probably a lower level of quality associated with this number than we're typically comfortable with. So that number may be revised. But again, for model makers, at this point, we're thinking $80 million is our best guess. What's interesting about that number is it's about 12.5% of the midpoint of the revenue level that we're predicting for the year, which is down from where we've been. Last year, for example, we were up about 15.5%. So our best guess at this point is $80 million for the year and that represents a reduction in that line item in terms of cost compared to where we've been as a business in the past.

I think that ends my prepared remarks. So Melissa, I think we'll open it up for questions at this point.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Kevin Ciabattoni with KeyBanc Capital Markets.

Kevin Ciabattoni - KeyBanc Capital Markets Inc., Research Division

I just want to talk a little bit about the E&D outlook for the year. It's obviously up pretty substantially. I'm just wondering if, A, you could maybe talk about what's included in that from the Test Systems acquisition, if anything? And then, second, maybe you could talk a little bit more generally about your development programs? We saw the Bell V-280 press out in the last day or 2 here. And maybe talk a little bit about the expense ramp with new programs and kind of what's rolling on or off over the next couple of quarters?

Peter J. Gundermann

Okay. Those are -- that's a long set of questions if I really address it properly. Let me start with the -- I guess I challenge your basic assumption. That total is up in terms of absolute value. I think we're about $55 million last year, $53 million, and we're predicting now about $80 million this year. So that's obviously an increase. But proportionately, the percentage of revenue is a decrease. So depending on how you look at it, it's a ramp-up or actually a scaling back. That's what it feels more like to me. You asked about the Test Systems business and I will say that our biggest element of noise in that $80 million number has to do with Test Systems because we've only been together for a couple of months here and we haven't quite got to that level of detail. We're doing some other things in terms of integration and I think things are going pretty well but, in terms of the accounting of how we traditionally look at a business and value engineering and development, we haven't quite got that synched up yet. So there's maybe a little bit more of an estimate or a guess in that number and when we talk in another quarter, I expect we'll have a higher quality number to present there. But you also asked about the V-280, the -- and I don't want to talk specifically about that program as much as maybe about our flight-critical electrical distribution efforts more broadly. And we have been spending quite a bit of money in this particular area in terms of development and investment in programs that really have not hit the production ratings yet, at all. The one we've been talking about the most was the Lear 85, which has been in development for a number of years and recently flew for the first time, which we're all quite excited about. We have quite a bit of content on that program. And we've subsequently been able to win positions on a number of other programs, too. And just to remind other listeners on the call who may not be as up to speed, what we're really doing here, in my opinion, is building a franchise for state-of-the-art, modern, electrical power distribution, flight critical for smaller aircraft, in a way that the industry hasn't seen before. And while we're investing -- invested quite a bit of money in the Lear program, the incremental cost for subsequent programs have actually come down quite a bit. And we expect that to continue and that's because the basic science or architecture of the system that we provide is getting less and less difficult in terms of effort and challenges, although there always are some with every new platform. And so the incremental costs for customizing the program for a new airplane continues to drop. And we have a couple of unannounced programs, a handful of them, that we need to get out. That V-280 release was not one that we expected but -- and haven't actually announced but Bell did it for us. So that's how it works sometimes. But we think we're making really good progress and we think that'll become apparent, not necessarily this year in our financials, and maybe not even next year. These are long-term investments for long-term programs. But we think we're going to be the standard in that small class of aircraft. And that's going to be a valuable franchise for our company. So short answer, I can [indiscernible], but maybe another time might be more appropriate.

Kevin Ciabattoni - KeyBanc Capital Markets Inc., Research Division

No, that works. And then, the Test Systems margins in the quarter were significantly kind of above where I've been expecting, at least. Just kind of wondering if that was all volume driven? If that -- those types of adjusted margins at least, are something that we can expect to see going forward?

Peter J. Gundermann

I'm not sure how to answer that, either. We're still getting to know each other. They're a little bit more positive than I might have expected, too. But they are what they were and there wasn't any real special effort that went into it. It was only 1 month or 1.5 months, so there is some -- obviously, a lot of things that happen for the first time when you do a closing with a new business. I think we'll know a lot more at the end of the next quarter. But I can say that, just in terms of culture, in terms of fit, I've been pretty impressed with what we've seen out of that organization in Irvine. I mean, certainly it's a business with certain strengths and -- but also certain challenges. But I've been impressed by the willingness of the team there to kind of face up to it and get on with it. And I think, we have a pretty strong business case. It's one of those businesses that, I think I've said this before, it's lumpy in the sense that it's dependent on big awards. And so it's a little bit more like a camel compared to -- that needs long sips of water every once in a while and then can go a long ways, compared to some of the rest of our business, which is more production oriented. So there is room for noise there. But so far, so good. And I think we'll know a lot more after the next quarter.

Kevin Ciabattoni - KeyBanc Capital Markets Inc., Research Division

Okay. And then, last one for me and then I'll jump back in queue here. You mentioned some of the Test Systems revenues kind of pulling through into this year and that was behind some of the guidance lift. Just curious if you could kind of talk a little bit about how much of that was maybe new business versus those revenues that you said kind of pulled it from next year into this year? And does that create more of a significant headwind for you guys looking into next year that you need to fill?

Peter J. Gundermann

Well, you saw pretty good bookings for that segment and those bookings, I would say, collectively were somewhat unexpected for this year. But they came in and they came in for this year. We might have expected them a little bit later and we might have expected them for next year. So yes, there's -- our attitude is, and always has been, when a customer wants it, we ship it. If they want us to ship it now, we ship it now. If they want us to ship it a little later, we ship it later. We don't try to fine tune things or smooth things very much, maybe, compared to some other companies out there. So that's part of what's happening here. Obviously, the more that we pull from next year into this year, it creates risk for next year. But we think that the business case is pretty strong and by the end of the summer, the beginning of the fall, we should have much better insight as to what's going to happen in 2015, for that part of our business.

Operator

[Operator Instructions] Our next question comes from the line of Dick Ryan with Dougherty & Company.

Richard A. Ryan - Dougherty & Company LLC, Research Division

So, Pete, you mentioned the potential of getting another 10%-plus customer and I didn't catch, was that in Test? Or is that in the Aerospace side of the business?

Peter J. Gundermann

Yes, that's in Test. And it wasn't getting one, it's just naming one.

Richard A. Ryan - Dougherty & Company LLC, Research Division

Okay, naming one. And is that in the consumer electronics side, which has kind of been the driver of that business here lately? Or is it kind of in the legacy military defense environment?

Peter J. Gundermann

In the electronics -- the consumer side, commercial side.

Richard A. Ryan - Dougherty & Company LLC, Research Division

Okay. And when will that start driving or contributing?

Peter J. Gundermann

It's already there but it wasn't big enough to require disclosure and, at the request of the customer, we prefer not to until we have to.

Richard A. Ryan - Dougherty & Company LLC, Research Division

Okay. And when you look at the commercial side, organic, you said 11% for the year. You came off of a 21% fourth quarter. Is there kind of a steady-state level we should be kind of considering for organic growth for the business?

Peter J. Gundermann

That's a good question. And Dave, I think I might throw it -- we've got so many moving parts right now, Dick, I'm not sure that we have a number like that off the top of our head. And as time goes on, it gets a little harder to decide what's organic and what's not because some of the businesses we've had, we've now had long enough, even the recent acquisitions, to start to play fairly critical roles. So it feels like organic. But I don't know. Dave, you have a quick answer to that?

David C. Burney

No. I think I'd rather wait until we get into a more formal process to provide our revenue guidance for 2015.

Peter J. Gundermann

No, for this year, I think he's asking. Right?

Richard A. Ryan - Dougherty & Company LLC, Research Division

Yes.

David C. Burney

Oh, I thought you were asking for next year.

Peter J. Gundermann

No, for this year.

David C. Burney

Yes. No, as Pete said, there's a lot of moving parts to this thing that we're digesting here. So we haven't really looked -- I don't have it in my fingertips right now to look at it, in organic versus acquisition. And as Pete said, defining organic versus acquisition is going to get blurry as we get into this year, as we acquired PECO in July, we had a couple more acquisitions in the beginning of the fourth quarter last year. So that organic versus inorganic or acquired business is going to get blurred as the year goes on.

Peter J. Gundermann

We'll try to talk about that again at the end of the second quarter, Dick. I'm sure we'll have a better perspective on it.

Richard A. Ryan - Dougherty & Company LLC, Research Division

Okay, no problem. Dave, staying with you. Anything in the SG&A that's acquisition-related, kind of onetime or was it all in the COGS lines?

David C. Burney

I would say it's all in the COGS line. There was some insignificant legal, acquisition-related costs for -- as we closed EADS, the ATS, that acquisition in February. But Pete talked a little bit about the increase in amortization expense for the intangibles for the acquired businesses. That's in SG&A.

Richard A. Ryan - Dougherty & Company LLC, Research Division

Pete, moving to the AeroSat side. Can you talk a little bit about the progress you're seeing in the antenna space, in the Ku connectivity offering, number of planes you're currently flying and if you're still kind of looking for that $20 million to $40 million sort of contribution from that segment this year?

Peter J. Gundermann

I'll start with the last portion. Yes, we're still expecting to be in that range. I think we're making pretty good progress across the range of projects. I'd say that in at least one case the bird strike issue is resolved. And so, we have a path and kind of a proven way to get that done. The challenge is that there are a number of other players, including different wings of the FAA and different engineering houses or consultants involved in different platforms. So getting everybody to sing from the same sheet of music is taking a little bit of fine tuning. But we feel like we're making pretty good progress. So I don't have anything negative there to report.

Richard A. Ryan - Dougherty & Company LLC, Research Division

Okay. We've heard some new technology introductions being made there. AT&T has said they're looking at kind of an air-to-ground solution. What's your strategy? I mean, you've got the Ku offering now. What's your strategy for that? You've announced the VVIP win. How should we look at AeroSat going forward?

Peter J. Gundermann

Well, as you know, Dick, it's a little bit like the Wild West here. This is the one part of our business that's a little bit more dynamic, shall we say, in terms of the market evolution. It's not an established market, so there are going to be many twists and turns. I guess I would offer you my seasoned advice in this industry, part of which is, a new announcement doesn't necessarily make a new product. Especially announcements for products that are going to be out in a couple of years. So, I would view a lot of those kinds of events with a little bit of caution and not -- tend not to overreact. I think in a couple of years, this market is going to be relatively stable, especially in North America, and so it'll be harder for a new business model to break in, I think, than people might assume. As for our business model, on the -- we're happy to sell antennas to people who need them. And today we're concentrating on Ku, but we feel it's very much in our core competence to develop a Ka, and if we find customers who are willing to source that kind of device from us, we'll be happy to work with them on it. In the Business Jet VVIP side, we do have an effort underway to provide the service and we have announced one win, one airplane, but it's a first step, an important step. We don't have -- we're still kind of testing that market and developing it. And there's some things we need to do technically and product-wise to optimize it and we will be doing those things, also. But I think, for the foreseeable future, right now, we don't tend to overreact to product announcements by new entrants and we are sticking with our forecast and we think we're making good progress on our certification efforts, which are for real, live airplanes right now.

Operator

Thank you. Mr. Gundermann, there are no further questions at this time. I'd like to turn the floor back to you for closing comments.

Peter J. Gundermann

Well, short and sweet. Thanks, everybody, for tuning in and we look forward to talking to you next quarter. Have a good day.

Operator

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.

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Source: Astronics' (ATRO) CEO Peter Gundermann on Q1 2014 Results - Earnings Call Transcript

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