Greetings and welcome to the Astronics Corporation Third Quarter 2019 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. Thank you, you may begin.

Thanks, Christine, and good morning, everyone. We appreciate your time today and your interest in Astronics. Joining me on the call are Pete Gundermann, our Chairman, President and CEO; and Dave Burney, our Chief Financial Officer. You should have a copy of the third quarter of 2019 financial results, which we released earlier this morning. And if not, you can find them on our website, at www.astronics.com. Let me mention first as you’re likely aware, that we may make some forward-looking statements during this formal discussion as well as during the Q&A session. These statements apply to future events that are subject to risks and uncertainties as well as other factors that could cause actual results to differ materially from what is stated here today. These risks and uncertainties and other factors are provided in the earnings release as well as with other documents filed with the Securities and Exchange Commission. These documents can be found on our website or at sec.gov. During today’s call, we will also discuss some non-GAAP financial measures. We believe these will be useful in evaluating our performance. You should not consider the presentation of this additional information in isolation or the substitute for results prepared in accordance with GAAP. We have provided reconciliations of non-GAAP measures to comparable GAAP measures in the tables that accompany today’s release. With that, let me turn it over to Pete to begin. Peter?

Thank you, Debbie and good morning everybody. Thanks for tuning into our call. Our agenda this morning, I’ll make some comments on kind of the major themes and thrust affecting our quarter and affecting our business. Dave will – Dave Burney will plow through some of the specifics on our income statement and balance sheet. And then we’re going to turn attention to the future, both the wrap up to 2019 and the fourth quarter that we’re currently in and an early look at what our expectations are for 2020. And as Debbie, kind of hinted at, we’re going to often refer to adjusted numbers when we’re talking about comparisons to last year. For those not as familiar with the story, we sold a semiconductor test business in February of this year, which was a pretty major contributor to our revenue and income in the middle of last year, the second and third quarter in particular. So comparisons backwards one needs to be careful if they’re looking at adjusted numbers or as reported numbers. Those year-over-year comparisons will get simpler going forward in the fourth quarter and certainly in 2020. Summary of our third quarter, top line was about where we expected at $175 million. It was actually our lightest quarter in over two years, since 2017 down sequentially from our second quarter of $187 million. As we hinted that done and feel more convicted about now, we are being affected pretty significantly by the 737 MAX grounding specifically. We put a certain amount of product on the airplane line fit and that revenue obviously is not too much affected because Boeing is continuing to build 42 ships a month. But a lot of our sales thrust goes to the aftermarket, to the airlines and the airlines essentially worldwide are…

Okay. Thanks, Pete. I’m going to go right to the segment discussion. Pete covered a lot on the consolidated side of things. In the third quarter, our operating – in the aerospace segment, we’ll start with. In the third quarter, operating margins contracted in the quarter from lower sales volume as Pete discussed earlier. We had $3.2 million of tariffs, which was $2.4 million increase from last year. And we also had a $1.7 million increase to the litigation reserve, as Pete just discussed. Losses from the three challenged businesses, all in the aerospace segment were reduced by $2 million to $9.2 million, including a program reserve of $2.2 million for the VVIP program that Pete mentioned. Tariffs impacted the segment by $3.2 million. The vast majority, if not all our tariff exposure is in the aerospace segment. Year-to-date, aerospace operating profit increased slightly to $48.9 million. As a percent of sales, operating profit was down 10 basis points to 9.4%. Aerospace operating profit in the first nine months of 2019 benefited from higher volume. Amortization expense related to acquired intangible assets was $2.3 million lower than the year before. And we had slightly reduced operating losses from the challenged business compared to the prior year. These benefits were offset by higher tariffs. If you remember last year, the tariffs began in the third quarter, so we really hadn’t seen much in the way of tariff costs last year, until we hit the fourth quarter. Moving over to the Test segment third quarter, in February, this year, we divested our semiconductor test business. So for comparative purposes, it’s important to keep that in mind. On adjusted Test Systems sales were $19.3 million as reported, down $23.8 million. The divested Test business had sales of $2.2 million and $33.6 million in…

Okay. Turning to the future. Future being the fourth quarter of 2019. First, we are expecting fourth quarter sales to be in the range of $175 million to $195 million. That’s a wide range you might think, given that we’re well into November already and the year ends at the end of next month. But as always, there are a bunch of things that kind of are stacked up in the second half of December to ship. And there’s the possibility that some of those slide out in the January, but the reasonable range is $175 million to $195 million. That means we should see a little bit of a step up from third quarter volume. It gives us some confidence to think that the third volume – third quarter is the low point here. This will tighten our 2019 forecast to be in the range of $750 million to $770 million. Our 2018 adjusted revenue by comparison was $719 million. So the midpoint would suggest 5.7% growth. We would expect aero to end up $680 million to $690 million, last year was $676 million. And Test, we now predict to be $70 million to $80 million for 2019, and 2018 was $48 million after removing semiconductors, so a pretty significant increase there. Freedom, obviously helping out in the second half, Diagnosys is helping out to some extent in the fourth quarter. Again, in the fourth quarter, we expect reserves for the AeroSat consolidation and reorganization and perhaps an increased reserve on the litigation side of funds. 2020, the big assumption we’re making as we initiate revenue guidance for next year is that the 737 MAX return to service happens sometime around year end here or shortly thereafter. We don’t pretend to have information that’s not generally available out there…

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question comes from the line of Ken Herbert with Canaccord Genuity. Please proceed with your question.

Hi, good morning, Pete and Dave. Hey, Pete, good news on the restructuring effort, it has certainly been a busy year. I wanted to first ask for the revenue guidance in aerospace in 2020 implies. You said just under 5% growth or about $25 million of an increase assuming the midpoint this year to end the year. Can you parse that out a bit by maybe how much growth you’re assuming from the three businesses versus what – how much of a tailwind the MAX is next year versus just maybe what you’re seeing organically across some of the parts of the business?

Yes, there are a lot of moving parts as you’re getting at. Let me talk about MAX. First of all, our – the party line that most people seem to be working towards is continued production rates of 42% a month. We expect that to jump up to the high-40s upon return to service and we expect it to trend up towards the end of the year to the high-50s kind of as the year wraps up, that all assumes January return to service. And we’re making some assumptions that there’s a resumption of normal sales sequences to the aftermarket. The way our aftermarket sales typically work is something like this. We come up with new products or we respond to the demands of airline customers. There’s a series of bidding exercises and proposal exercises. And then there’s usually a flight test or some period of time when an airline will take some hardware and they’ll actually put it on a number of their aircraft and they’ll observe it and they’ll test it and they’ll fly it and they’ll see what they think. And then they go forward and we’re getting a little bit sideways here in our aftermarket pursuits to that those trials, those flight trials are being pushed out. So we’re making some assumptions that those flight trials resume shortly after the 37 is lifted and it will result in sales, particularly in the second half of the year. We are not being very aggressive, frankly, in that range with the three struggling businesses. So I would dare to say that from today’s perspective, there’s upside potential to our forecasts there. We had pretty big revenue increase expectations from the three. We were pretty disappointed with the AeroSat results. Just we talked earlier about a launch of a…

Okay. That’s helpful. I appreciate all the detail. And if I could then just to jump down to the margins if and who knows exactly, how the fourth quarter shakes out, but pretty any incremental sort of restructuring charge that looks like on the three businesses, if you run a loss of $30 million to $35 million for the full year and call it, $8 million to $8.5 million or so with tariffs you’ve got – if you get breakeven next year on the three businesses and tariffs, you’ve got $35-ish million or so give or take of margin tailwind heading into 2020. Did I just want to make sure I got that correctly? And second, if there’s any other sort of moving pieces specific around margin next year we should be thinking about it.

Yes, Ken. I think on an annualized basis, your number makes sense. But keep in mind the – it’s not like a water faucet that you just turn it off on 12/31 and everything is restructured and the losses disappears starting on January 1. So as Pete mentioned, the AeroSat restructuring will be occurring as we move through the first and end of the second quarter. Certainly, we expect by the time we get to the second half of the year that those – kind of those annualized numbers that you talked about should be realized as we go into the second part of the year. But probably it won’t start out in the first quarter that way.

But fundamentally – fundamentally, you’re numbers are on target.

Yes. Okay. No, I can appreciate it. It’s clearly going to be a steady gradual improvement with second half really when you see the benefit of the restructuring. And then, of course, you’ll start to anniversary that in obviously, 2021 as well. Okay, I’ll pass it back there. Thank you very much.

Our next question comes from line of Jon Tanwanteng with CJS Securities. Please proceed with your question.

Good morning and thank you for taking the questions. Pete, can you just talk about the program reserve in CCC? What was that all about?

It’s the continual effort where we – essentially the company, a long time ago about the time when we bought it bid off a program, which it was not set up to execute well on. So it eventually that became pretty clear and we’ve been in a struggle basically to get this program executed. And the reason we’re pursuing it and the reason we didn’t abandon it upfront is we actually think the technology will prove to be quite valuable over time on a competitive basis. It’s something the market seems to warn in certain classes of aircraft and it’s a pretty high profile program with a high profile customer. And of course, in the aerospace industry, when you run into trouble on a program, you can decide to fight it out and execute it and keep the customer happy or you can turn and walk away. If you turn and walk away, chances are you never – you might as well never show up at that customer again, ever. So we decided to stick with it. And the program charges are basically realizations at certain points in time that were not quite as far along as we thought we would be. And the estimate to complete the program is higher than we thought it would be and the accounting rules say, that you got to take those charges as you recognize them, not as you – not as you incur them. Dave, you want to clarify that all?

No, that’s right. It’s – this program was crossed into the loss contract program by year and a half or two years ago. So you continue every quarter to revise your estimated cost to complete. And there was a lot on this project that was kind of unknown. And we’ve got into this year, every quarter, we expected that we had adequately accrued for the cost estimate and we continue to run into some stumbling blocks there. Now we estimate that the program is about 90% complete with the finish line in sight here. And the additional cost really was related to the additional time it took. If you remember a couple quarters ago, we thought we’d be done in September, I think it was three, four months adding on to this, it adds cost to the program.

Okay. Got it. But that’s scheduled complete mid-December. You don’t see any barriers at this point to getting over the line?

We sure hope not. That’s the plan. The customer review process in mid-December and we’re working hard to meet our requirements for that review and if we’re successful than kind of the engineering phase of this program will be concluded. There’ll be ongoing support requirements and refinements, because the hardware is not actually going to fly for a little while, but it’ll be relatively low level. At the moment, we’ve got a lot of external costs. We have a lot of external consultants helping us with this development program and it’s a major push and that’s part of why it’s so expensive. We expect a lot of those related expenses both in terms of outside companies doing work for us and the qualifications certification costs to drop significantly as the year end comes.

I would add to that. The other piece to this that kind of falls through the cracks or gets hidden is the distraction from other programs that organization is so focused on getting this to the finish line. That there are number of other programs that that will benefit by having the attention of these engineers on them when they can move off of this program.

Okay, great. Thank you for that color. Dave, what are your total – I guess, projections for problem unit losses, legal reserves, program charges and restructuring costs in Q4 and maybe in the 2020, if you can get that far out?

Well. As Pete mentioned, there’s a range of potential possibilities with regard to the restructuring and – at the low end, probably $5 million each. But there’s a lot of moving parts to this yet. We’re going to get a lot of – we’re going to learn a lot over the next month or so and to finalize that plan. So at the low end, as Pete mentioned, we think it would be about $5 million for restructuring there. We actually think the CCC business, as Pete mentioned, it will not generate a loss in the fourth quarter.

That’s dependent on sales, which are going to butt upright against the end of the year. But there’s a good chance CCC is actually positive in the quarter.

And I’m sorry, what were the other ones?

The legal reserve, I think Pete bracketed it, $2.7 million to $6 million, increasing potentially $6.3 million, right? Is that kind of what you’re getting at?

Yes.

Okay.

I mean, that’s an unknown number. The number for the AeroSat transition is unknown at this point. We’re actively reviewing the various business pursuits that the company’s been involved with and what we decided to go forward with and what we don’t, more importantly maybe don’t decide to go forward with will result in various charges from specifically inventory and maybe some goodwill impairment kind of charges. So we’re looking at a program by program.

Yes. Included in those, there would be a lot of non-cash tech charges. Again, depending on if there’s inventory relating to a program that we decide we do not want to pursue, there could be – included in Pete’s numbers, where non-cash charges as well as severance and reorganization costs.

Okay. Got it. Pete, I’m surprised, you didn’t talk about the one with Rockwell and SES and Vista Global for AeroSat. How do you see those ramping through the years, in terms of install rate and incremental profit from each one?

Yes. Thanks for that, Jon. I did not mention it. We are – that’s one of the things that we’re investigating and trying to get better insight into. But yes, Rockwell Collins or Collins Aerospace has decided to enter the business-jet connectivity, satellite connectivity market using derivative product of ours that we are developing at AeroSat. And yes, we think it’s a confirmation that there’s a lot of potential demand there to draw a company like Collins into it and we’re pleased that they’ve picked our antenna to work with. There’s not been a hard launch on that. I mean, there’s the launch on the program, but they’re not actually doing sales at this point. It’s more tying up the loose ends of the technology and improving the network and doing those kinds of things. So it’s a little premature to know for sure what the expected volume is going to be both for 2020 and 2021, but we’re expecting purchase orders shortly and we’re expecting kind of the hard launch of the – actually putting hardware on airplanes and initiating the sale process in first quarter 2020 or so.

Okay, great. Last one from me. How should we think of the core Aerospace margins, outside of the three plum businesses in 2020?

I think they’re healthy.

Yes. I think we can get the headwinds behind this year going into 2020 and I think we should be able to see the segment operating margins for the Aerospace business start to push back into that mid-teen range. We’ve been there before and the last couple of quarters have been disappointing. But I think we should be able to push back up into that mid-teen range and I think it’s – next year to add a little bit more color on the way we expect the year to progress partly due to this 737 situation and partly due to some other programs that we expect the rollout. We expect the year to build in terms of the top line growth with the second half being a much heavier than the first half. And actually the first quarter probably being our weakest quarter.

Okay, great. Thank you so much guys.

Our next question comes from the line of Josh Sullivan with Seaport Global. Please proceed with your question.

Hey, good afternoon. Just on the Test growth. Can you outline some of the contracts or opportunities, what you’re looking at for 2020?

Well. We sense that there is a better funding environment in general in military tests. That’s a turnaround that we’ve been waiting for some time dating back to before the Trump administration took office. So part of it is better funding along those lines. And part of it is some of the recent thrusts that we’ve had both with our acquisition of Freedom, which takes some of our radio test capabilities and expands it into the governmental market I guess I would call it. As well as our expectations for Diagnosys – maybe we’ll talk about diagnosis a little bit. Earlier this year, we won a program with the New York City mass transit organization to provide a test architecture for one of their rail lines, one of their new programs. And our main competitor there, it turns out was this company called Diagnosys. And on the heels of that win, we ended up in discussion with Diagnosys and one of the mutual observations was that, what they have compliments well what we need. So, one thing led to another and we explored teaming arrangements and we explored sub-contracting arrangements and we ended up deciding with the owners of Diagnosys. It was a privately owned company that the best path forward was an acquisition. So, we feel that together we’re a pretty strong force in this kind of mass transit train test market, which we think is a growing market. And the logic here is, if you think of trains – modern trains, they’re increasingly digitized, they’re increasingly connected, they’re increasingly complex, mission critical type systems compared to trains of yesteryear. And the operators, which are generally municipalities and government agencies are realizing that they have the basic decision that maybe the army might have to make or the marines…

Got it. That’s helpful. And then, I mean, I just dovetailing into that, has there been any change in the M&A perspective. You went through some of the dynamics behind Diagnosys. But just how has the strategy evolved, call it over the last 12 to 18 months?

Well, we’ve looked at a lot of things. I can’t tell you that we’ve seen a whole bunch of things that are kind of right down the aisle for us. And it seems like there’s a lot of money chasing a few items. So the prices have been really high. So, those are observations, things we’ve experienced. I think, we’ve certainly learned a little bit from our experience. We’ve stumbled here on a couple of things. And you learn every time you stumble for sure. The CCC experience taught us something. The AeroSat experience certainly taught us something. They had some common elements to them. But overall, acquisitions have been an important part of how our company’s evolved. And in the midst of all that, there are other acquisitions that have gone very, very well for us. And I would say that it’s too early to tell for sure how Freedom and Diagnosys are going to work out. But, Telephonics was certainly one that we enjoyed. PECO has been a really big plus for us. The test business that we bought from EADS has been a mainstay of our test business, including the semiconductor capabilities that have brought with it. So, I don’t think we’re a company that’s ever going to buy everything that moves or bid on everything that moves. And as we get older and as we collect battle scars, we’re getting a little wiser and we look for certain things. But, all that said, acquisitions will continue to be part of what we do in the future for sure.

Got it. And then is there any update on your position – the free Wi-Fi trend, in particularly with Delta or any other customers?

I don’t think we have anything new to say other than I guess, personally speaking, my observation is that it’s becoming more and more of the discussion in the industry. And the industry is again, distracted by the whole 737 thing that’s really cast a shadow over the entire world. Even airlines that don’t fly, the 737 are dealing with increased levels of demand. But I guess, our assumption, our observation is that that’s where the world’s trending. I mean, more and more people expect free Wi-Fi and expected continuously and nobody expects to pay for it anymore. Maybe in really expensive hotels, but, even that’s getting less and less common and it’s usually something they give away when asked. So, we’re fans. That’s a big thing for us. I mean, our conviction is that people are increasingly committed to their personal electronic devices. They want to use them, they carry them everywhere and they expect it for free. And the aircraft world is a world that’s ripe for continued development and better service and that’s kind of our sweet spot. So, we think free Wi-Fi is a big deal.

Got it. Appreciate the time.

Thank you.

Our next question comes from the line of Michael Ciarmoli with SunTrust. Please proceed with your question.

Good morning, guys. Thanks for taking the questions here.

Good morning.

Just to stay on test for a second. I mean, as we look into 2020 organically, you’ve got tests going at $85 million at the mid point from $75 million. Is that just a function of Freedom and Diagnosys? Or do you expect any organic revenue growth in there?

Well, it’s a little tricky to measure organic just because Freedom and Diagnosys are largely – it’s a poor term maybe. But they’re kind of bolt-on acquisitions and that they’re augmenting initiatives that we already have underway. So it’s one of those situations where we’re hoping that – in both cases, one plus one can equal a little bit more than two. So, it’s hard to answer your question because some of the work that we might otherwise plan to do in our other tests locations, Orlando and Irvine in particular, we might transfer to some of those other businesses. Some of our R211 business for example, we’d probably move out of Orlando or Orlando will subcontract to Diagnosys, which is in Boston. So I don’t view them as – it’s not going to be easy to really measure how much of it’s acquisition growth and how much of it’s organic growth. But I would view it more as organic.

Okay. And then just on aero arrow in 2020, 787 rate cut, 777X getting delayed. Does that enter into the forecast next year? It sounds like you’re going to have a little bit more strength in the second half, which might be when you start feeling some of those – especially the rate cut on the 787. How is that contemplated in the 2020 outlook?

Yes, that’s baked into the numbers. The 777 is something that we have quite a bit of line fit content, 787 much less so directly to Boeing. But yes, we’ve got those kind of baked into the numbers, assuming that the cuts and the extensions, the delays don’t turn out to be greater than way expect.

Okay. And then just the last one for me, the bookings trajectory and kind of backlog. Any kind of real time update in terms of how the bookings are tracking now or maybe how you expect to end the year in terms of backlog. I think you called 3Q sort of the bottom here. Can we assume that that’s maybe the bottom for bookings to in aerospace?

We’d hope so. We don’t have an update for the fourth quarter, but obviously we expect the bookings to rebound here in order to support those revenue levels for next year. I think we’re seeing it on test, it’s not quite as evident on aerospace at this point. But based on scheduled programs that are in backlog, we’re reasonably confident on a step up in revenue in the fourth quarter and the first quarter we would expect to be kind of at that increased level also and then expand from there. Again, assuming that 737 gets back in the year at or near year end.

Got it. Perfect. Thanks a lot guys.

Thank you.

Our next question comes from line of George Godfrey with CL King. Please proceed with your question.

Thank you, and good morning. Thank you for taking my questions. Two questions. Pete, the first one is you stated very clearly, you don’t really have any other information on the Boeing 737 getting certified and coming back into service before the end of this year or January. And you’re making your best estimates. If we take a more pessimistic outlook and that continually gets pushed out, what can you do at Astronics specifically to try to mitigate that downside? And do you just have to sit there and kind of just take the punches as they come in? Thanks.

Yes. I think we’re kind of in that position, unfortunately. I mean, if it gets extended significantly at all, the odds increase of a production slowdown or even a suspension, which would have a significant effect on our company. Of course, we put 95,000 or so plus or minus on each new airplane and that assumes – that does not assume any passenger power for example. So if you add passenger power to it, it can easily double. So that would have – if they go from 42 airplanes, which is where we are today to zero, that would obviously hurt us and we’d have to scramble around and look at what we can do. But it would be a uncomfortable development for sure. Because, a big part of our cost structure isn’t necessarily production related. It’s all the support and engineering that goes into our products. And we would be – if I kind of flash forward to that potential reality, I guess, I would say that we would be really reluctant to cut costs in that way because, those technical skills are our lifeblood really. So, we would be reluctant to cut that. So it would be a bad development if that were to happen, no doubt.

Understood. And then my second question is, you talked about the media right, hitting the satellite and changing some of the program outlooks for AeroSat. And when I think about those three businesses, I always thought the greatest variability in revenue was on the AeroSat piece. Are there other programs for other reasons that may or may not look as attractive today due to competition, product development costs that are also causing you to want to consolidate that facility beyond the platform of program issue with the media right? Thanks.

That’s a good question. I think the best way to look at it isn’t a program by program review, but rather the overall review, kind of a top level observation. And I guess from my perspective, we think that the technology’s important and the technology’s good and the technology’s valuable. We have had a lot of trouble cracking the code. Frankly, I mean, we’ve missed badly on what our revenue expectations were. And in some cases they were clearly things that we could not control. I mean, some people might think we should control or be able to control media rights. I don’t think we can. That’s something that was just an external factor that affected a program that we were kind of counting on at that point in time. But there are other issues where soon or later when it happens kind of over and over and over again, we have to sit back and look at. So is it smart for us to continue to spend money like we’ve been spending money to pursue things that we – like I said, not been able to crack the code. So the collection of thinking is that – again, the technology is good, there are valuable programs to apply it to and there are markets that we want to pursue. And certainly that business jet market is one of the ones that we want to continue to pursue. But we want to do it in such a way that, we don’t risk the kind of all or nothing financial impact of executing on the programs in the short-term. And by doing the consolidation or the reorganization, whatever you want to call it, we can leverage assets that are otherwise kind of free and clear, already paid for. And the incremental return on the satellite program or the antenna programs when we find success will be greater. And the downside risk of another media right hit for example, are greatly reduced.

Understood. Thank you.

Thank you.

We have no further questions at this time. I would now like to turn the floor back over to management for closing comments.

Well, thanks everybody for tuning in. We appreciate your time. We look forward to talking with you again soon. Have a good day.

Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.