Astronics Corporation (ATRO) Q3 2012 Earnings Report, Transcript and Summary

Greetings, and welcome to the Astronics Corporation Third Quarter 2012 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Deborah Pawlowski, Investor Relations for Astronics Corporation. Thank you. Ms. Pawlowski, you may begin.

Thank you, Phil, and good morning, everyone. We certainly appreciate your time and interest in Astronics. On the call today is Peter Gundermann, Astronics' President and CEO; and Dave Burney, Chief Financial Officer. They will be discussing the results of the third quarter fiscal 2012, as well as the company's strategy and outlook. We will conclude the call with a question-and-answer session. If you do not have the release from this morning, it is available on the company website at www.astronics.com. As you are aware, we may make some forward-looking statements during the formal presentation and question-and-answer portion of this teleconference. These statements apply to future events, which 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 our earnings release, as well as in documents filed by the company with the Securities and Exchange Commission, which can be found at our website or at sec.gov. So with that, let me turn the call over to Pete. Peter?

Thanks, Debbie, and good morning, everybody. Thanks for tuning in. We feel our third quarter was another in a series of pretty good quarters for the company, although there were quite a few moving parts that are worthy of some discussion, some mention. Our revenue for the third quarter was $68.9 million, a new quarterly record, that's up 22% over the comparable quarter from last year and up 6% sequentially over the second quarter of 2012. We were, in terms of our segments, split 95.5% Aerospace, 4.5% Test Systems. Our expenses during the quarter were a little bit complicated in some respects. Our E&D expenses were $12.8 million. That's an increase of about $2 million from our run rate over the earlier part of the year, and $3.3 million over the comparable quarter from 2011. The increase is somewhat schedule related. We had some customer pull-ins that caused us to accelerate some things, but there's also an increase -- and the indication of increased workload, and we'll talk more about that in a moment. We also had increased warranty reserve -- or an increase in our warranty reserve for the quarter of about $750,000. That's something we wouldn't expect to repeat and is related to a specific problem on a specific part that we need to address. Compared to last year, our SG&A expenses were up pretty substantially, $9.1 million or 13.2% of sales versus $6.4 million or 11.3% of sales last year. That's an increase of about $2.7 million. About $2 million of it is related to the 2 acquisitions we've done in the last 12 months, Ballard Technology and Max-Viz. The $2 million related to those acquisitions are about $1.1 million in higher compensation cost, particularly in the sales structure. Those 2 companies are structured a little bit differently than the rest of our company, so their impacts on our SG&A line, in terms of compensation, is disproportional. And acquisition-related amortization of intangible accounted for the remaining $900,000 of increased SG&A costs. Those $900,000 of amortization also largely explains the increase in depreciation and amortization, which is spelled out below our income statement of $2.1 million in the recent quarter versus $1.2 million in the third quarter of 2011. We expect, going forward, that the observed depreciation and amortization of $2.1 million will stay roughly the same for the foreseeable future. The intangible expense load will go down as we move through the coming quarters, but it'll be replaced largely by increased facility depreciation as we occupy a new facility in our Seattle location. Finally, when you compare the most recent quarter versus the quarter a year ago, you have to take into account that we had very different tax rates. We had a rather normal tax rate of 33.2% in the third quarter of 2012 versus an abnormally low 11.2% in the third quarter of 2011 and that was due to some R&D tax credits, which we recognized in that quarter. So with all those things taken into account, we still earned in a net profit of $4.9 million, 7.2% of sales and $0.33 per diluted share. $4.9 million is not as good as we might have hoped for on a net volume, but given all the things that happened in the quarter, we were reasonably content. Bookings for the quarter were pretty strong, 66.8 million. That's our second best quarter ever after only the previous quarter, the second quarter of 2012, where we had bookings of 77.2 million. So year-to-date that leaves us with revenue at $199 million up 19% over 2011, net income of $16.2 million or 8.1% of sales, that's pretty comparable to where we were this time in 2011. 2012 earnings per diluted share of $1.07, down from $1.11 last year. And again, hitting those major expense items, our engineering and development expense, so far this year is $33.9 million, up from $26.6 million last year. We now expect our 2012 total to be in the $44 million to $46 million range and with an eye to 2013, we are expecting to be in that same range next year. Common discussion point as to what we're doing with all that money, and I don't have anything major new to announce today, at least in terms of specifics, but I can tell you directionally, that we continue to win new programs and be involved in new programs. We talk a lot about our electronic power distribution systems, our EPDS systems, and the current project that we typically highlight is our work on the Lear 85. At this point, we're actively involved in 2 other EPDS programs, which we're not allowed to name at this point, and we're working towards a finalized contract for a third one. So I expect this time next year or pretty close to the end of next year anyway, we will be able to identify those 3 other programs. And I think, I can safely say at this point, that they pretty much corner the market or the industry in terms of general aviation. I think there'll be a pretty impressive list and we can put them all up. We also are working on a major lighting program that we won, which we also are not ready to announce yet at this point. SG&A expenses, so far this year, are $27.2 million or 13.7% of sales. That's up from $19.8 million or 11.9% of sales. The increase there is $7.4 million, and again, our acquisition alone, in terms of amortization and increased compensation costs, account for about $4.4 million of the $7.4 million. Year-to-date bookings are strong, $204.8 million, that's up from $177 million in 2011, and gives us an optimistic perspective as we close out 2012 here in the fourth quarter. In terms of our segment, our Aerospace segment, again, is the major driver for our results. Year-to-date revenue of $190.2 million, up 22.2% and 95.5% of our total contributing all the margin. Within our Aerospace segment, all of our markets are up. Our Commercial Transport Sales were $133 million, up 30% over last year and 67% of our total. We clearly have benefited from being in the right place at the right time in the commercial transport market these days. But our Military sales are up also, up 7.3%, making up $27.8 million of our total 14%. And our Business Jet sales are up 6.6%, $21.8 million, and 10.9% of our total. In terms of our product, Cabin Electronics is our major driver. About 52% of our total sales, up 28% for the year. Aircraft Lighting is a little more than 1/4 of our sales, 27%, and up marginally, 3.5%. Our Aircraft Lighting products are largely concentrated on the business jet arena and the military market, 2 of the slower moving markets these days that we serve. Aeroframe power, this is where the Lear EPS program comes in and the other programs that I alluded to, at this point are only 7.5% of our total and actually down for the year, but we have high hopes for those products going forward. And a new product line we are spelling out, Avionics, which includes some Max-Viz and Ballard acquisition. Year-to-date, $10 million, 4.5% of total. We've owned -- Ballard has been part of us all year, Max-Viz only since the end of July. Next year, we expect those 2 combined to be somewhere in the $20 million to $25 million range. So they will be, together, significant in our results. And then our Airfield Lighting product line is our smallest product line, 3.6% of our total, up 8% for the year. Our System segment year-to-date revenue is $8.8 million, 4.4% of the total the down 1/3 from where they were in 2011. We continue to struggle in the market with this product line. But we also continue to see some exciting opportunities, and I like to think of this as keeping our line in the water and we are targeting some programs and putting the -- working hard on our budget for next year. Our current look next year shows a substantial increase in revenue. So we'll see how that pans out and we'll talk in more detail about that at the end of our next quarter, when we go into our 2013 expectations in some detail. So as we close out 2012, our 12-month bookings are $261 million. That leaves us with a backlog at the end of the third quarter of $115.6 million, which is another new record. We started the year expecting total revenue of $235 million to $250 million. It subsequently was raised in a couple of steps, up to $260 million to $275 million, and today, we are tightening that slightly to $267 million to $275 million. That obviously suggests a fourth quarter that, on the top line, about as the same or slightly better from what we achieved in the third quarter. And I know everyone is interested in what 2013's going to look like at this point, but we're not quite ready to talk about that specifically. We'll roll out our 2013 numbers when we release our fourth quarter results, which will be sometime in February. So that ends my prepared remarks. Phil, why don't we open it up for questions?

[Operator Instructions] Our first question comes from Tyler Hojo from Sidoti & Company.

Pete, Dave, and Deb, so just, firstly, I was hoping you could give us a little bit of an update on some of the narrow-body opportunities in the NC power market. I don't think you hit those in your prepared remarks, Pete.

Yes. I don't think I have any specific to add on those today, Tyler, other than we continue to see a trend where the narrow-body opportunity is materializing for the company. We, as you know, have introduced and are developing some new products specific towards that market. And those are in kind of the testing, kind of final development stage. I'm hoping we can announce something, in terms of launch customers, right towards the end of this year. But I think it's pretty safe to say that there's a widespread interest and recognition that USB-based power systems will be a strong part of the future, and today, are really taking hold. I just spent 2 days at the NBAA trade show, National Business Aircraft Association (sic) [National Business Aviation Association]. It's kind of the world's trade show -- best trade show for the Business Jet and General Aviation unit. And one of the things that's happening in that community is -- not only passenger amenities are important, obviously, for the gulf streams of the world, but also pilots are increasingly are taking their iPads into the cockpit. They want ready and available power. And we've adapted some systems specifically towards the business jet community. And I walked away from that trade show increasingly convinced that not only are passengers in first [ph] transport, but pilots and passengers and the business jet community also are really interested in this USB capability. And I think we've got the right product at the right time. But at this point, I don't have specific, a word to talk about.

Okay, that's fair. And just in context with kind of the increased E&D guidance that you gave, it sounded like it was more outside of, kind of In-Seat Power. I mean, is that accurate or -- I mean, has the kind of spending budget for kind of, narrow-body and business jet In-Seat Power kind of going up here?

A good question. We don't break out our engineering and development expenses by our product lines. But I can tell you that we do spend money where we see opportunities and those opportunities may or may not line up with where our existing revenues come from. And your observation is correct in that we are spending a disproportionate amount of money today in our business jet endeavors in general, and our Aircraft Power product line specifically. I mean, I think Airframe Power, at this point, is only 7.5% of our total revenues. It's getting a lot more than that in terms of our investment. But again, our vision there is that we think we can bring new technology to a class of airplanes, which really needs it and doesn't otherwise get it. And we think that if we can apply our technology effectively to the new generation of airframes as they're being introduced and developed, that someday, we will have a very strong market position and franchise in that area. And I think that's largely happening. Airframe development efforts don't happen every day and they take a long time to complete. But I'm pretty pleased with the progress we're making there. That's not to say that we don't do whatever we can do to support our more major product lines and certainly, anything that we can do to support our EmPower franchise, our In-Seat Power, which is basically a passenger amenity in commercial transport, we do it, no doubt about that.

Okay, great. And just one last question for me. You mentioned an aircraft lighting award that you won, but you can't really discuss yet. I'm just curious if maybe you can just comment on what end market it addresses. I know you're predominantly focused on kind of the some of the military and business jet markets, within the product line today.

Yes. This is a foreign military venture.

Our next question comes from the line of Kevin Ciabattoni with KeyBanc Capital Markets.

Just going back to the E&D expense. Your outlook for the year has kind of been listed here for 3 quarters in a row. I was wondering if you could give some color on how much of that increase is coming from, not legacy platforms obviously, but stuff that you've been working on versus new wins over the last couple of quarters.

Well, I guess I'd say most of all the increase is driven by new wins. We have some situations where, like any company in aerospace, has developments that you think are going to end up costing at least 1.2 or 1.3. So some of the increase is due to that, and some of the increase -- we also end up in situations where customers tell us they want one thing and we run down that road and we get just about to the end of the road, and then the customers flip around and say, well, actually what we wanted was this other thing. And you have to backtrack a couple miles and start all over again, go in a slightly different direction. So we've seen some of that. And then you end up in a discussion as to whether that's a billable type of change to the requirement. So we have some of those going, too. But I'd say the majority of the cost increase is driven by market wins and new products that we're actively developing, actively working on.

Okay, good. And then Military and Biz Jet were both down sequentially in the quarter. I know, Biz Jet had a pretty strong 2Q. Just wondering if you could give some color on kind of the quarter-to-quarter shift there.

Yes. Well, in the business jet world specifically?

Biz Jet and Military, if you don't mind?

Okay. Well Military is, for us, largely a spares exercise, and tied to some strict development programs. We're on every rotary wing, those are continuing to have -- see pretty stable production. Joint Strike is getting to be more of an important program for us and will continue to do so, and the V-22 also. But a big part of it is spares, and those spares can be a little bit lumpy and a little bit difficult to predict. So we don't -- it can be up one quarter and down another quarter. We try not to get too excited about it. We have seen some program wrap-ups, at least temporarily on some of our missile programs, Tactical Tomahawks, one that we put a lot of time into. So that could explain some of the decline. In the business jet world, I think my read on it is that when the year began most people in the industry thought that this was going to be a rebound year in terms of new airframe production. And our products are primarily used when airplanes are built. So we're tied to the bill cycle there. And I think at this point, being a majority of the way through the year, it's pretty clear that the increase that was envisioned has not materialized, is not going to materialize. So production rates are steady, I think they were -- the OEMs were buying at a quicker rate early in the year, so we shipped them more in expectation of stronger production rates, and then as they whittle them back, obviously, they have to bleed off inventory so they buy less from us. So I think that explains a little bit why we're down. Going back to my NBAA experience, I think it's pretty clear that the boom or -- not the boom, the increase that was expected this year now is perhaps pushed off 1 year or 2. And I think the industry looks at it more as treading in water in the business jet world for the next year or 2. We should do better than that as we continue to put more content on new airplanes. And when we look at the business jet world, what we're primarily concerned about is getting our systems, our higher value-added systems, on new airplanes as they go into development. And one of our frustrations that I alluded to earlier is we can work on a program for 1 year, 1.5 years sometimes, and depending on the OEMs, they just don't formally announce the program themselves so they don't let us formally announce it. And that's, at least, one of the situations that we're in right now, in terms of our engineering and development. So that's a long answer to a short question. Did I get it for you?

Yes, you did. Just staying on that a little bit. What are your thoughts for -- or what are you guys baking in, in terms of Hawker for next year or the rest of this year?

Well, Hawker Beech has been, I think they're formally now going by Beechcraft by the way, but they've been a little bit of a drama for the last 1.5 years. They've been a customer of ours for 25 years. We're on every plane they built. Hawker Beech recently announced its intention, as part of a bankruptcy resurrection, to drop its jet production line. So they've, up till this year, built 4 or 5 different jet models, including the Hawker Aircraft, a couple developed by Beech. They're going to stop that production. They're basically going to be a propeller company. That means they're going to build something called the JPATS airplane, Joint Primary Aircraft Training System, which they have been marketing with a lot of derivative for a number of years. Their big thing will be the King Airs. They've got 3 different versions at this point, and they build 100-plus airplanes a year. And then they've got a couple of piston airplanes, the Baron and Bonanza. We're on all those airplanes. We think that those airplanes actually offer some good growth opportunity for us, to the extent that they're stable and proven airframes and they have a mix of military and commercial customers. And there's reason to believe that the basic systems on those airplanes, including their electrical systems, will need to be updated. And so, we have ambition to work with Hawker Beech, or Beechcraft, in those areas. We also are working on some lighting upgrades. If you follow the trade press. I don't I think we released these in the press release.

Yes. I thought I saw that the other day. Yes.

Okay. So we've got some -- our Max-Viz organization has some work going on, on the King Airs and now it's passed ECs [ph] recently, and we're doing some upgrades in terms of LED lighting on, specifically, I think the Baron and the -- which is a twin-engine piston, and the King Airs have been announced. But we have a lot of friends in Wichita, at Hawker Beech, and we're going to do what we can to help them through this muddle, and we think they've got a pretty strong product franchise in propeller airplanes. So we understand that strategy.

Great. And then, just one housekeeping and I'll jump off. If you guys can give what the Panasonic revenue was in the quarter.

Panasonic in the quarter was $27 million.

Our next question comes from Dick Ryan with Dougherty & Company LLC.

Pete, when you look at the recent quarter, and if you were able to strip out the warranty and the extra E&D, you're looking at maybe an operating margin in that 17-ish percent range. You indicated E&D would be at the same level next year, but if you look out a couple of years down the road, I mean, could operating margins get to the kind of 18% to 20% range or would this -- I mean, is this kind of giving us an indication of the kind of leverage that exists?

I think, I guess, I look at the quarter as being very strong from a revenue and booking quarter. And I look at it as kind of a culmination of a bunch of timing issues that selectively hurt a little bit compared to where you might expect us to be. So your question is a little bit beyond our detailed planning horizon. But I think, there's certainly room for increased revenue and relative efficiency in terms of our cost going forward. But, as always, that cost structure or the E&D expense is at least in part driven by our success in the market. And 2 years out, it's kind of difficult to predict where we're going to be. Again, we think we have a chance to really establish ourselves in certain markets, and as A-list customers bring up their airplane development programs, if we get invited to participate, we're going to go after that pretty aggressively. So if 3 or 4 of those companies, this time next year, have announced plans that include us, that could really drive our E&D expense in 2014 and '15 for example. But if we get to this point next year and the jet market is still depressed, then actually it could go down. I wouldn't rule that out. So I don't mean to duck your question, Dick, it's just a hard one to answer that far out.

Yes, sure. The airframe programs you mentioned, the Lear and then the other 2, are they are contributing in 2014?

To revenue?

Yes.

Not realistically, no.

Okay. And, Dave, maybe one -- how should we look at the tax rate going forward?

31%, 32%, 33%. One thing to be aware of is that if our government decides that they want to reinstate the R&D tax credit after the election, we could have a positive adjustment to our rate to recognize R&D tax credit in the fourth quarter or next year, if it happens next year.

What sort of impact could that have?

Oh gosh. In the initial quarter, we'll have a big catch up, presumably. So it'll have a significant impact on the rate in that quarter, then on an ongoing basis, I would think it would have an impact of somewhere between 2 and 5 percentage points on the rate.

Our next question comes from the line of Michael Callahan with Topeka Capital Markets.

I guess, just first off, and I apologize if you already said this, but for the E&D expense for next year, is that going to be roughly equal across the quarters or is it going to be pretty lumpy? Or just how should we be thinking about that?

I would think of it as pretty equal. We end up at certain crunches where we're doing a lot of testing and things like that, which requires outside services. But for the most part, that level balances out.

So this isn't really related to one or even just a couple of programs, it's just kind of even across the board?

Yes, that's the way I'd model it.

Okay. And then I guess the only thing I want to touch on is we hadn't talked about sequestration at all today. I know your actual Military segment isn't that large, but including FAA and Test Systems, 25-ish percent. Have you guys done any work as to what your plans are there? Is there any specific area that you're more or less concerned about, especially maybe, as it relates to FAA? Is there a chance that really gets kind of, I guess hit disproportionately from what we see in the rest of Defense?

Well, the FAA budget is a valid thing to ask about. It's a little bit of a catfight every year. I guess, we think that we've been operating at a fairly low level anyway, so we wouldn't expect too much harm there. As for our overall defense work, I guess, we think most of it's reasonably locked in on pretty good programs. So, from a risk standpoint, unless like Joint Strike were to be killed, that would certainly affect our outlook for years. But we don't expect that to be the case, and we haven't done a whole lot of testing or conditioning of our expectations accordingly, I mean. We think we are on a pretty good distribution of programs and I'm sure hoping that our government finds its way to a more rational approach to managing its fiscal hell. But we don't expect that we would come up with a sequestration adjustment to our short-term expectation.

Okay, and then maybe just lastly, on the sequential decline on the Military segment this quarter. Is that more -- you had mentioned some programs kind of ended or at least temporarily ended. I guess, were those all planned events or was there just some general slowdown in orders as well that maybe took you by surprise?

I'd say it was more just timing and circumstances. We don't view it as a trend at all.

[Operator Instructions] There are no further questions at this time. I would like to turn the floor over to management for closing comments.

Okay, very good. I'd like to thank everybody, again, for tuning in. We look forward to the fourth quarter. And we'll end the call now. I encourage everybody to go out and exercise their civil duty and to vote. Thanks for your attention.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.