Greetings, and welcome to the Astronics Fourth 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 2019 fourth quarter and full year financial results, which were released early this morning. And if not, you can find them on our website at astronics.com. Let me mention first, as you are 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 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 as a 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?

Thanks, Debbiee and good morning everybody. Our agenda today is as follows. I'm going to start with a discussion of some of the major issues facing the company, not only in the fourth quarter but looking a little bit backward and looking a little bit forward. There are a number of them, three on the aerospace side and two on the test side. Then I'm going to turn it over to Dave and he's going to walk us through the numbers both on the income statement and the balance sheet and we'll talk a little bit about the future to the extent that we can see it and do the normal question and answer at the end. So major events starting with the aerospace segment and probably the elephant in the room the 737 is a challenge for us. When we last talked, when we released third quarter results in the first week of November, we at that time issued preliminary revenue guidance for 2020 and there were some assumptions stated as part of that revenue guidance, specifically, we assumed that the 737 MAX would see a return service to at or near year end. And at that time we would expect a pretty quick production ramp from 42 airplanes amongst the 47 a month, eventually go into 57 probably sometime out in 2021. Those expectations proved way off based instead of 42 aircraft a month have gone to zero and 800 airplanes plus remain grounded. The 42 airplanes a month going to zero effect fast because we put about just shy of $100,000 a product on each airplane as it's built, that's about $4 million a month in revenue. That's good business for us. It's one of our largest production programs, actually its 42 or 52 units a month.…

Thanks, Pete. Pete touched on – there was a lot of noise in the fourth quarter to cut through. So in addition to looking at GAAP results as he mentioned, it makes sense to talk to adjusted results, removing sales and direct costs from our semiconductor test business, which we owned for the full year of 2018 but sold in February of 2019. Also, we moved the impact of the restructuring an impairment charges for an antenna business, and the legal reserve that Pete just spoke to. We believe these non-GAAP measures will help users of the financial statements better understand the core performance of the ongoing business included in our press release from this morning are a few tables on Page 11 and 12 reconciling the GAAP numbers to the non-GAAP information. Also, if you refer to the footnotes at the bottom of the income statement on Page 8 of the release, you can see geographically the income statement lines impacted by these items. Getting to fourth quarter operating results; fourth quarter consolidated sales were down $4.5 million to $198.4 million. This reflects a $10.3 million decline due to the divested semiconductor test business, partially offset by added sales from the diagnosis and freedom communications acquisitions. They were also in our test segment. Those added $9.9 million of sales. Aerospace segment sales decreased by 1.8% to $172.1 million, this is a point where I'd like you to follow with me on Page 11 of the press release where we have the reconciliation of GAAP to non-GAAP information. We had GAAP lost from operations of $36.9 million in the fourth quarter of 2019, which reflects $46.7 million of restructuring and impairment charges and an increased reserve for the ongoing lawsuit. More specifically in our antenna business, we took charges totaling…

Okay. So looking forward for the rest of 2020, again, on February 3rd, we issued a release then. We were pulling our revenue guidance for the year until the situation got clear. Unfortunately, today, the situation is still not clear. We need a little bit of a firmer estimate as to a return to production for the 737 MAX, and we need some estimate or some quality predictions on return to service for the airlines. I'm hoping that when we talk again, reporting first quarter results in early May, that we will have that clarity. If we get it beforehand, we'll issue guidance sooner rather than later. But I think for now, a reasonable expectation is that May press release. However, we are in late February and within shouting distance of the end of the first quarter. We're expecting first quarter revenue to be light; $155 million to $165 million is what we're predicting. 90% of it will be Aerospace. We are expecting that we will strengthen significantly as the year progresses. Again, that depends, obviously, on the return to production and some reasonable return to service. But even apart from 737 MAX activity, we have kind of a schedule that's biased towards the end of the year with the rest of our book of work. So one way or another, we expect the second half to be stronger than the first half. The question is how much, and we will publish more results when we – as soon as we can, but we've been surprised enough, I guess, by issuing expectations and having to pull them back that we are reluctant to do it again at this point. So I think that concludes our prepared remarks. Christine, we can open it up for questions now.

Thank you. [Operator Instructions] Our first question comes from the line of Jon Tanwanteng with CJS Securities. Please proceed with your question.

Good morning gentlemen. Thank you for taking my question.

Good morning.

Pete, maybe to start with, you were down 50 people, I think you referred to in operations related to the 737. I didn't catch if there was a charge related to that. And if those cost savings were evident in Q4, I expect not because they're still producing. How should we think of that expense coming down in Q1 and the operating margin in Aerospace heading forward?

There wasn't much of a restructuring charge associated with those reductions, and they were late Q4, so you wouldn't see it much in Q4. But I think it's probably fair to say that it's a good book of business for us on the 737. So when the volume goes way down, we have a really hard time cutting costs proportionately just because we have too much infrastructure in those operations that we have to maintain and other business we have to execute on. So it's going to compress margins until we get back into some regular production cycle on 737. Dave, you want to add anything to that?

No, I think that's accurate.

Okay. And assuming we get to production, if you're starting by midyear, I don't know what Boeing actually end up doing or the FAA, but 40 planes maybe kind of aggressive in the beginning, but assume we get to 40, somewhere between 40 and 57 by 2021, when does the aftermarket actually come back for your business, particularly given all the planes that are being over – run overcapacity right now?

It's a very good question, Jon. To be honest, we are asking the same question of ourselves. The 737 affects us those two ways. If Boeing announces they're going to restart production at whatever quantity, it's easy for us to kind of plug that into our models and into our factories, assuming that it doesn't stay shut down too long because then you lose some of that capacity permanently or it's much harder to bounce back. But the aftermarket side that you're asking about is a very important question for us. And frankly, we're at a little bit of an unknown situation. We've never been in a situation where the industry has gone through this kind of hiccup. With this many planes on the sidelines, there are wildly varying predictions as to how long it's going to take to get those airlines back in the service, and we don't pretend to be experts in that. We don't know. I mean I've seen predictions for 1.5 years, I've seen much faster predictions, like a quarter. But the question that you're asking is even beyond that, which is when do the airlines start kind of resuming normal behavior, as we would understand it. And I would assume that, that's linked to a return to service, but I don't know how closely. So for example, if it takes 1.5 years to get airplanes into the air, it could be that the airlines resumed their plans and their fleet upgrades immediately, knowing for sure when they're going to get airplanes and they can start in advance with that work. It could also be, on the other hand, that they are – some of them are more conservative and want to wait until they have the airplanes in their hands and in their fleets. We just don't know the answer to that yet. It's a fair question. It's one that I think we need to keep asking, but it's one that I think we need to keep asking, but it's one that I can't honestly sit here and tell you we know the answer.

Okay. That's fair. Maybe a bit more color on the, I guess, 800 planes that are sitting on lots right now. How many of those have your aftermarket products installed on them? And maybe how many are in the queue to get them installed? Because those will be the quickest to come back into service, I would assume.

Very few of them have our aftermarket product on it, very few. Half of them are new builds, so they just got off the production line, so they would have no aftermarket, by definition. The other half are relatively new airplanes, been out there for less than a year or so, 1.5 years maybe. 1.5 years in service I mean.

With them sitting on a lot be an opportunity for them to be upgraded to in-seat power and then connectivity and all while sitting there?

I can tell you, nobody's doing that. Nobody's touching those airplanes.

Dave, one last one. Just how much legal and warranty expense was there outside of the reserve that you took? And does that roll over into 2020?

Well, I don't expect the warranty expense overall into 2020. Combined, it was about $4 million in the quarter.

Got it. And was the legal side bigger than the warranty side or were they about the same?

No, the warranty was about two-thirds of it.

Okay. Got it. Are there any other charges that we should be aware of that may impact you in Q1 or Q2 or anymore going forward?

No. No.

Okay. Great. Thank you.

Thank you.

Our next question comes from the line of Ken Herbert with Canaccord Genuity. Please proceed with your question?

Hi. Good morning Pete and Dave.

Good morning.

I just wanted to ask on the MAX. A lot of suppliers that sell to Boeing directly, like you do, out of – for the PSUs have indicated that they're getting signals that they should start production again in April or around that time frame, obviously, at sort of lower rate. Is there anything else you can comment on or anything else that you can share regarding sort of where your discussions stand and your expectations as to when you might start to ship MAX product again to Boeing directly?

Sure. We do have ongoing discussions, but they're not firm at this point. So we are asking for certain accommodations to keep the production line going, frankly. We've not gotten a positive response to that. But in general, we read and hear and – similar things to what you're describing, Ken, kind of a slower rate stood up at the March, April time frame in that going for quite some period of time, so late in the year. But we don't have firm guidance on that at this point. If we did, that would be enough, I think, for us, to put some kind of guidance out there, but we just don't have it yet.

Okay, that's reasonable. And when – with the cost actions you've taken, when you do start to ramp MAX production, how long will it take? Or what volume do you need to get back to before on the MAX, you're may be at sort of segment margins? Or how do we think about the margin progression on that?

It’s a good question. I think if we can get back in the production at a steady state at even half of what we did last time, we can manage – or up until the shutdown, we're at 42 a month, so if we could get the half back, I think we'd be in pretty good shape, especially given the cost-cutting and the progress we've made with the other three businesses. I mean that's a big margin pickup for us. And for the most part, that pickup has nothing to do with 737, a little bit of CCC because CCC's market for VVIP airplanes is dependent on the MAX a little bit. But for the most part, that margin pickup should happen, kind of regardless of what's happening with the 737, which affects us more in other parts of the business. So I will feel a lot better when we get back into production. But then again, of course, return to service is also important for the reasons I've already discussed.

Okay. That’s helpful. And just finally, you obviously did two small acquisitions on the test side in the second half of 2019. As we think about capital allocation, how should we think about M&A activity this year? And is it still something you're looking at? Or should we – is that maybe getting sidelined a little bit here just until you get better certainty on the business?

Yes. I think it's probably safe to say it's a little bit sidelined. I mean we have our eyes open, you always have to because you can't – it's not up to us when a good acquisition candidate becomes available. But our first priority is to execute on the things that are in front of us and prepare ourselves for the future as best we can read it. And to that extent, that takes some attention away from the possibility of acquisition. I think, also, it's probably safe to say that most sellers in the market right now are probably thinking twice about that and pulling back a little bit. So I think the whole activity level is slowing down a little bit.

Okay. Just one final question. There's obviously a lot of concern with the virus on supply chains, and I know you've been working to maybe move some of the work out of China on your supply chain. Can you just give any high-level comments on to what extent you're maybe seeing, the impact of this yet on your business, either supply chain or customer demand? Or how we should think about that? Obviously, a lot of uncertainty there, but any more color around that would be great.

Yes. Well, a lot of uncertainty, as you said, and it wasn't in our prepared remarks because we don't have anything firm to say about it, but there are three potential impacts for us. One is, obviously, it is hurting airlines right now, and anything that hurts airlines risk hurting us. But we've not seen or had that virus fear used as an explanation for a lack of demand in the market. That's not what we're hearing at this point. So we've got our eyes on it. We obviously have close relationships with airlines. But at this point, that's not a major driver. The second potential impact for us is sources of supply. We are pretty vertically integrated in most of our businesses, but we do some sourcing out of China. For better or for worse, we've been actively trying to move many of those supply chains, in part, because of tariff expense, and we've made a lot of good progress. And so far, we're not aware of major supply wrinkles. But people in China are slowly getting back to where factories are slowly getting back to answering phone calls. So we're not exactly sure if we're going to have much of an issue or not. Most of what we do there is pretty low level assembly, mechanical or electrical, electronic circuit boards or some metal work maybe, but it's not terribly limiting in terms of sources of supply. So we could do most of what we do in China somewhere else. So at this point, that's not a major issue for us. The third area, excuse me, is we actually have quite a bit of sales activity going on in China. And like anywhere else in the world, if you're going to do an aftermarket sale to an airline, they have a process they typically go through and that process typically involves flight trials and fit checks, and some of these things can take two or three months to go and to run the course, and you have to run the course before you get kind of a big production order, and we are seeing those efforts push out. So again, not major things that we necessarily are wringing our hands over, but three areas where we're watching it, kind of airline traffic, our development programs and sources of supply, but nothing major to say today.

Alright, thanks for the color.

Sure.

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

Thank you. Good morning and thank you taking the question. The first one, I wanted to follow-up, Pete, on your comments around acquisitions and thinking about the last five years and the challenges you faced in the semiconductor business and the three businesses we have. Do you think the complexity of the business is such that doing more acquisitions just brings in more volatility or difficulty, and therefore, perhaps the business or the capital should be allocated more towards share buyback. And anticipating you saying no, we can do more acquisitions, but – so I'm thinking about AeroSat, for example, where the issues were not with Astronics but with the partners, so even if you've got your arms around the company you buy, the partners you deal with may not, and therefore, you have these problems that can keep lingering on. That's the first question.

I will grant your charge there. And certainly, acquisitions bring complexities, no doubt about it. So that's something you have to weigh in from a risk analysis, and we've obviously missed a few here recently. So I think we've learned some lessons and we can carry that forward. And like I said, you have to keep your eyes open because you never really know. But at this point, we're not feeling a tremendous amount of pressure to do an acquisition for sure. And your other question about buybacks, with the share price where it is currently, I think that's a compelling use of capital compared to anything else we might do with it right now. We're not buying shares. As Dave said, I think we have a responsibility to be a little bit conservative as managers of the company's assets. Given the questions in the market and the continual, I guess, slide in one of our major programs, the 737 MAX, we want to get that under control. But we're aware of the trade-off of external investment versus internal investment, and I think we will continue to balance our priorities as opportunities permit.

Okay. And then my second question is if I look at the three-month period just ended versus last year, and I'm looking specifically at the Aerospace segment, $172 million this year versus $175 million. And, if I look at the margin and add back the $5.1 million you talked about to the adjusted Aerospace operations, we're still below what the margin was a year ago. And I'm guessing those three problem businesses were contributing to the loss there. So my question is, is the product mix today fundamentally less profitable than it was a year ago? Or is the customer demand for the certain revenue mix changing, such that the revenue might not look different, but the profitability of the revenue mix results in it being less profitable on revenue stream as we move forward? And if I – if that didn't come through clearly you stated.

I think George, we also have the increase in the legal and warranty costs that were primarily in the Aerospace segment. And we also – we had an increase of tariffs compared to the year before, for the year anyways.

Okay. So the estimate, just very simple, so $100 of aerospace revenue today and going forward, even if revenue mix shift with customer demand or specific product changes, the net result is that $100 should be every bit as profitable as it was today or five years ago.

Yes. I mean, we typically talk about the leverage we have on our sales being 40% plus, so I think that's still applicable to the model today.

Okay, thank you for taking my questions.

Thank you.

Our next question comes from the line of Dick Ryan with Dougherty & Company. Please proceed with your question.

Thank you. Say, Pete, at the Q1 guided level, are you guys anticipating profitability?

We are – Dick. It will be close, but we should be profitable at that level.

Okay.

It’s kind of a – it's a low single-digit operating income level at that point. But to be clear, if we expected we were going to continue to operate at that $155 million to $165 million quarterly revenue level, we would make some changes, more changes than what we've seen over the last six months. We don't expect, while we're not providing some detailed guidance, the business is not currently staffed to run at $163 million rate. We're staffed to run up to a $200 million plus quarterly rate, and that's – if we didn't expect that, at some point, we would probably – we would be making some significant adjustments, I think.

Sure. Okay. On the legal side, is there any historical precedent that would suggest the U.K. or France goes more towards a U.S. ruling or towards a German growing?

That's a very good question. The rules, it turns out, vary pretty dramatically from country to country. So there is a set process that you go through, and you kind of started at the beginning over and over in each country. Different lawyers, same material. So from a cost standpoint, one of the good things, I guess, is that we've kind of been over this a couple of times now, so we wouldn't expect to have the same level of cost, repeating the argument in the new countries. But they are different, the period of performance is different, the damages, calculation techniques are different. And the – some other rules, like one of the things – well, the way the product gets to the country, the applicability towards the patent infringement rules there varies too. And I'm talking a little bit in code because I've got to be a little bit careful, but it is basically starting all over. And you can't help but notice that the U.S. company wins in U.S., and the German company wins in Germany, and maybe that's just not the way it always works, but I wonder how many times the U.S. company wins in Germany and the German company wins in the U.S., it'd be interesting to run an experiment. I don't know. But we're moving to a relatively neutral turf in these other two countries. So to the extent that there's a home advantage, and I don't know if there is, but to the extent that there's a home advantage, you'd expect it to be a little bit more even in those other two locations.

Okay, thank you. Say, on – now that AeroSat's more focused on the business connectivity front, can you kind of handicap where do you think the competitive landscape is today, Pete? I mean you've got satellite options, obviously, with your offering, and you've got some air to ground competition as well. How is the progress with the new partners on the business jet offering looking? And what's your sense of that market rolling out?

Well, our main partner there is Collins Aerospace, and they are a very credentialed company. They are very successful, obviously, in a lot of ventures, and they have a lot of fingers in a lot of places. And so far, I'd say we think things are going pretty well. We have made some changes to our product, partly driven by improvements on our side, partly driven by requests on their side, and we think the combination makes a compelling product. It's a little early to put detailed plans out there as to how we're going to succeed, but we're optimistic. And you're right, there are competitive offerings today, if – for a plane that flies primarily domestically over North America and air to ground installation is relatively cheap and effective, it may work better in many circumstances. But for bigger airplanes that go across the water, those options don't work. So that's where our market really is. And I guess we feel we're a little bit cautious, obviously, based on our experience, but we're – giving everything we got to this one program, and we're very focused on that. And as the year progresses, we should be able to start talking about installation rates and STCs. At this point, it's mostly a certification exercise.

Okay, great. Thank you.

Sure, thank you.

Our next question is a follow-up question from George Godfrey with CL King. Please proceed with your question. George, you there? Mr. Godfrey, your line is alive.

Sorry, thank you. I'm just kicking this thing around in my head, and I'm thinking back to my question on complexity. And I want to use the lawsuit you mentioned about winning in the U.S. and winning in Germany that even if you're in the right and fully recognize that, the NPV of victory is just not as great as the time it uses up with management's bandwidth to focus on other issues, and so I'm using that as a data point or an issue in the California plant or Washington where you say, "You know what, we just – I just can't deal with that right now. I've got to focus on other things." Does that thought process come in where you just have to bite the bullet and just say, "Yes, we're right, but we need to move on." Thanks.

Well, in this case, just for a little more background, the history stems from activities that happened way back, like in 2000, 2001, 2002, 2003. The activities are central to our in-seat power product line, which we've owned for, I don't know, 17, 18 years, about that time. And there is not a reasonable – there has not been and is not a reasonable option to walk away based on disagreement of the parties, just not an option, frankly. So this is something that we have to go through. We don't prefer not to spend time or money doing this, but you don't always have your choice. We'd prefer not to deal with 737 guys either, but we don't have a choice. This is one of those things that's kind of central to one of our core technologies. We think it's frivolous to a large extent, but we got to compete it, so not much of an option.

Understood, thanks for taking the follow-up.

Sure. We have reached the end of the question-and-answer session. I would now like to turn the floor back over to management for closing comments.

Thank you for your attention. We'll look forward to talking with you at the end of the first quarter. 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.