Greetings and welcome to Astronics Corporation Second Quarter 2018 Financial Results Conference. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Debbie Pawlowski, Investor Relations for Astronics. Thank you. You may begin.

Thanks, Sherri, and good evening everyone. We certainly appreciate your time today and your interest in Astronics. Joining me here today are Pete Gundermann, our President and CEO; and Dave Burney, our Chief Financial Officer. You should have in hand the news release that crossed the wires this morning before the market, and if you don’t, it is available on our website at astronics.com. As you are aware, we may make some forward-looking statements during the formal presentation as well as during the Q&A portion of this teleconference. 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 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. You can find these documents both at our website and at sec.gov. So, with that, let me turn it over to Pete to begin. Pete?

Thanks, Debbie, and good morning, everybody. We’re going to do the normal routine of talking through our second quarter results and including the review of our expectations for the rest of the year and then do questions and answer as usual. So, the highlights for the second quarter. You saw the numbers this morning. It was a strong topline performance for our Company. We had record consolidated revenues. Our Aerospace segment turned in another record performance on the top line, and our Test segment had its best quarter in three years or so, almost tripling sequentially what it did in the first quarter. With the strong topline performance, our margins recovered well from our first quarter, again largely driven by the volume improvement. And finally, we remain on target for our 2018 forecast, which at the midpoint calls for consolidated sales of about $790 million, up about 25% from where we ended last year. So, diving into the details of the second quarter. Specifically, revenue was strong at $208 million. That is a new all-time high, as I said, about 38% higher than our comparative period of a year ago and up about 16% from our first quarter of 2018. Acquisitions, specifically Telefonix contributed about $27 million of the $58 million in growth. So, if you’re inclined to back out the acquisition growth, you will find organic growth in the quarter was about 20%. As I mentioned, Aerospace set another record at $166 million in revenue, up about 28% over the comparator period but up marginally over the first quarter. Test is -- gets a lot of credit for our second quarter results with revenue of $42 million, doubling the comparator quarter of a year ago and tripling the first quarter of 2018. Margins responded nicely with the increased volume.…

Thank you. We will be conducting a question-and-answer session. [Operator Instructions] Our first question is from Jon Tanwanteng with CJS Securities. Please proceed.

First one, you spent a lot of time going through the margin expectations last quarter. Where do you expect that kind of $8 million operating loss to trend, for those problems [ph] versus Q3 and Q4, and can you break it down by either product or business line?

It’s a little bit of a moving target. I would tell you that I would like to see that towards the end of year cut in half. I thought we’re going to do a little bit better than that if -- due to the timing of some business -- there’re really two aspects to margin improvement in those three companies, one aspect is just being more efficient, lowering costs, and we’re doing that. But the other one is generating more demand. And I think it’s safe to say that in all three locations, we’re seeing greater demand. It’s a question of when that demand comes through sales. So, I don’t know exactly where we’re going to end up as 2018 comes to a close. I can tell you very competently that when I think about 2019 across all three, it should be a much different picture. I think, we see strong demand or increasing -- improving demand opportunities in all three locations. And I’ll be happy to report that when the time comes. The question is, we don’t know exactly when that time is going to come.

And then, just on the Test side, any further orders in the near future, will they impact 2018 at all or is that slated for ‘19 at this point?

It’s possible but time is kind of running out. So, we’re now in kind of the mode of understanding where 2019 is going to be. I will tell you that we continue to pursue various opportunities, both on the semiconductor side and on A&D side. And I would expect over the next three months to have pretty good insight over where we expect 2019 to be. And most of the indications we have are up to -- middle to up, based on where we are this year. So, we don’t expect to go back to the kind of 2017 results. We expect, if anything, we’re going to build from 2018.

And then, just finally on the Test margins themselves. I think the last time you did this level of revenue, maybe exactly three years ago, you had 24% operating margins in the business; this time around, let’s call it 15%. What’s different this time around and kind of how do we expect that to trend going forward?

Well, part of it is -- let me talk about two different sides of it. The A&D is running at a -- not at a breakeven level right now. So, that’s one of the problems we have going. But we have been investing pretty heavily in these new programs that I keep kind of alluding to which we have not -- which we have not won yet, which we are hoping will have material ramifications next year. So, that’s kind of an investment area. On a semiconductor side, we are -- in the second quarter were basically shipping on two programs in quantity, one new one, one old one. The old one is the one that was pretty much exclusively making up our sales back in 2015 period you’re talking about. And as happens often in these kinds of businesses over time, there is -- their price drops. So, we’ve seen some of that. And with price drops come margin drops. And with the new program, there’s a significant amount of learning curve effects going on in the initial shipments. And so, we’re incurring a little bit of that too. But, we’re pretty optimistic that both programs are going well, both have long legs. And it’s a question of how they’re going to play out next year. And then, finally, when you compare the business today versus the business three years ago, we have a much more filled out infrastructure, especially on the semiconductor side. So, we have a more competent and larger engineering, technical group; we have the sales group that spends a lot of time spanning the world. So, it’s a little bit of a different cost structure. But, we think the prize is worth it. The programs when they hit production, make up for that investment.

Our next question is from Ken Herbert with Canaccord Genuity. Please proceed.

I just wanted to, revisit first the Aerospace margins. I mean, if you’re able to get $4 million in savings or $4 million less of a loss in the three troubled businesses, in the fourth quarter that should help with maybe over 200 basis points of margin. How -- in the second half of ‘18, what’s a fair assumption for the kind of margin improvement we should see within the Aerospace business? Or how do you -- to maybe quantify some of your earlier comments on sort of a steady ramp through the year, can you put any more numbers around that?

Well, let me rely on our age old pattern of not giving bottom line guidance, first, you realize that. Certain amount of it is predictable. I’d like to think that we can, on the Aerospace side, get up easily up over 11% to 12%, somewhere in that range. Our goal is to be in the mid teens. That’s where we want to be. And we have a majority of our businesses that are there. It’s really a question of getting some of the troubled ones to stop hurting us and maybe even helping us. And part of what’s difficult to predict, Ken, as I was tell Jon earlier, I think there is a flip coming where these three collectively are going to stop hurting and actually start helping. And it’s hard to say when that flip is going to come. But, in each case, I can make a compelling reason why our revenue prospects in 2019 are going to be much more positive than 2018. So, to a certain extent, the challenge is not just managing the cost, but developing the opportunities such that we can actually execute on them when they mature. So, we don’t like having the drags and we don’t like looking at the red ink on those businesses. But, it’s not a situation where we see nothing but red ink in the future. So, we feel pretty good about it.

Okay. So, I guess maybe to interpret that, I know you don’t give guidance, but a steady improvement for Aerospace but really maybe a step-up in ‘19 obviously from these businesses, but then it also sounds like from sort of incremental volume improvement in ‘19 as well?

Yes. Well, especially from those three, I’d be disappointed if we’re talking about the same topic in ‘19. I think this will drop up the radar screen. We won’t be talking about it anymore. There are some challenging questions overall -- or not challenging but question marks in the whole business, and the IFE space in particular, about how 2019 is going to shape out. There’s a fair amount of turmoil going on in the industry with certain airline switching models from one supplier to another or even going in a different direction, a different path. And we feel like we’re really well-positioned because we’re suppliers to pretty much all the contenders, but it’s a little nerve-racking watching. So, it’s a little early to put real firm numbers on 2019. As you know, we come out with that guidance towards the end of the year. But we feel well-positioned for whatever’s coming down the road.

And if I look just top line on Aerospace, the guidance implies sort of call a 7% organic growth, 7 to 8% in the second half of this year, which clearly was the pace you were at this quarter. It sounds like maybe with some your comments that could be a little conservative in the second half of this year. Maybe just -- can you talk about a few of the puts and takes within that? And it sounds certainly like your Electrical Power & Motion side of the business could be a swing factor. But, maybe a little more detail on the have to outlook at least for the Aerospace topline?

Yes. There’re puts and takes. And the way I’d describe it is this, and maybe Dave has a different perspective because he spends a lot of time studying these numbers also. But, we have some significant programs scheduled for execution towards the end of the year, which if they slide, obviously could hurt revenues in this period, but look that from another perspective. We always look at the backlog we have and how it’s scheduled and what we have to book to fill in the shipping holes to make our -- to make our plan, to make our forecast. And we don’t have far to go. So, with any kind of optimism on the book and ship kind of business through the end of the year, and if the big programs stay in -- on schedule, we actually I think have quite a bit of upside potential to our -- to the median point of that range. And those two dynamics are kind of why we ended up leaving the range as wide as it is. I would expect by the end of the third quarter, we’ll tighten it. But, there is upside potential. And as usual, there is the possibility that big things flip or couple of big things flip, and that can throw us towards the bottom end of that range.

And if I could, just finally, sequentially, you had a nice improvement in free cash flow. It seems like working capital is still a pretty significant use of cash. Seasonally, you tend to have a really nice strong end of the year from a free cash standpoint. Are we -- considering all your other comments, should we expect something similar this year or is there maybe any unique opportunities to do a little bit better on cash flow and specifically on working capital in the back half of the year?

Ken, this is Dave. You are right. We expect the last half of the year to be really strong in terms of cash flow. We saw the ramp up of our working capital, particularly in inventory in the first half of this year. I expect that ramp to level out or stop. As Pet mentioned earlier, the only thing that could impact that is if we get some test orders that are scheduled to be delivered in the first quarter of next year. That could impact us buying inventory in the last half of this year. But, our expectation is that our working capital will remain relatively flat over the next six months. And we should see significant free cash flow improvement. Receivables went up quite a bit in the quarter too. We had a heavy load of our revenue hit in the last six weeks of the quarter. So, I don’t expect receivables to increase significantly as they did in the past two quarters either. So, it’s a sort of a long way to say yes, we expect our free cash flow to impact -- increase significantly in the next six months, particularly in the fourth quarter.

Our next question is from George Godfrey with C.L. King and Associates. Please proceed.

I’ll add my congratulations. Nice quarter. The $8 million drag in the Aerospace segment, Peter, what is the revenue approximately associated with that -- those businesses that are making the million dollar drag?

I’m doing it in my head. I’d tell you, it’s probably about $12 million.

Okay. So, if I add back the $8 million drag and take out that $12 million from the revenue just reported and ex those businesses, Aerospace segment margin is more like 17%. So, the rest of the businesses look like they’re going really well.

That’s a good point and that’s kind of what we were talking about, I think, a little bit in our last call. We could just fix those businesses, even without getting a big contribution on margin improvement would be dramatic.

So, that’s exact -- that’s the math that I was doing is just 3% margin on that business know, you’re hovering near 20 segment margin if everything is going well.

Yes. Agree.

Okay. And then, back on the Test business. And I heard I listened to those promise very carefully. And this was my interpretation that based on the current product set and customer set that exist today, then margins are structurally lower three years later than they were three years ago. But with new products and a new customer or platform set, then that 24% margin is achievable, or 24% incremental margin on new products and new customers. But because of the pricing discounts from where we were three years ago, yes, that revenue is going to be a lower margin than what it was three years ago.

Yes. To the extent that -- I got to think about this. But, basically the summarized sales that we had in the second quarter was half -- think about as the old program and half the new program. So, the old program is a little bit lower margin than it used to be, and the new program is lower margin, primarily because of startup costs. So, we expect the newer program will continue in force and get better. And the older program is always a little bit of a question mark. But, we’re given indications that there is more demand coming in the future for that than if that’s going [ph] to go away at this point.

And then, my last question is and I feel like I ask this every quarter is the ability to get more customers on this business, how has that incrementally changed today versus the year ago or six months ago? And I’ll leave it there.

Sure. Well, I’ll give you the same answer I probably gave you last quarter or a year ago. We’re working on it. And we’re closer. And we have realized bids outstanding and we’ve got realized discussions ongoing. So, nothing to report at this point. But we are kind of building out the team and developing the expertise to more effectively execute on those opportunities. So, we certainly haven’t given up. And hopefully next quarter, we’ll be able to talk about some success.

Our next question is from Michael Ciarmoli with SunTrust. Please proceed.

Just looking at the quarter on a sequential basis, the trends Aero revenues down sequentially, specifically in the core power and motion was down 7% year-over-year on a pretty weak compare. You kind of said demand remained strong. I would’ve expected that we would have seen a pick up there. I mean, you kind of mentioned turmoil in the marketplace. Was that a factor or any color you could provide in terms of why the core electrical power products took a little bit of a dip?

I would tell you, it’s just program scheduling. I also tried to address that in my comments telling you that our plan is by the end of the year, we are going to see strong double-digit growth there. So, it’s going to be a little bit back half weighted, obviously. But overall, we think we’re doing pretty well and demand has remained really strong. I understand -- your observation is correct obviously, looking at the numbers. But, we’re expecting double-digit growth when all said and done, you look at 2018 compared to 2017.

In that Electrical Power & Motion product line?

Yes, specifically there. Yes.

What -- on the margins, and I now you might be -- you kind of gave the color on 3Q to 4Q. If Test has a similar run rate in the third quarter, presumably it falls off a little bit in the fourth quarter. It sounds like the power motion and products could be up double digits. Can we expect the margins to kind of grow sequentially or will they -- I am just trying to get -- just given sort of the mix and then the movement with Test and obviously you guys still have a wide range of guidance. So, it sounds like there’s some room for things to move around, plus or minus. But is there going to be any material -- I guess, what I am trying to get at it, is there a material change in the Test margins if you kind of do another $42 million quarter and then we drop down sequentially. You kind of mentioned you were sized with a lot more infrastructure. So, just trying to get a sense of the margin mix profile.

Well, I guess, I think, the biggest driver will probably be volume related in Test and for the overall business. There will be a mix change away from Test and towards Aerospace as we move from Q3 to Q4. I think, it’s reasonable to think that Q3 will be a very strong quarter, both top line and bottom line. There are more question marks over Q4 in part because of the mix change, but in part because it’s just a little further out there. But, if you’re going to be careful, then I would probably at this point model a little bit of reduction in Q4.

Okay. And then, last one for me, can you just give you some color? The amount of E&D expense, can you sort break out how that’s being allocated between maybe just Aerospace and Test at the high level? And then, maybe within Aero, are these still -- is the spending for large commercial transport, is this more on the business jet side, just maybe some color on the where the R&D dollars are going?

Sure. This gets to some of our basic operating philosophies as a Company, and the it’s a big number and we’ve talked about it for years. But, it’s one of those things that we think drives the business forward in terms of coming up with the innovations and the technologies that our customers want. Sometimes they are clearly directed at demand that customers are presenting to us. We have a handful of big customers. They ask us to do something. Even if we think it’s crazy, we will do it. Because we want them coming to us with their requests. There are other situations where we will develop technologies, even in a very secretive kind of climate that nobody things or nobody expects from us, nobody even really anticipates from us. And it’s kind of self-directed, self-funded R&D kind of effort. And over time, we believe that that’s an incredible way to create value for our Company. And a lot of those initiatives over the years have been very successful. Certainly true that some of them are absolutely unsuccessful and it just doesn’t work for whatever reason. Technology doesn’t work or the customer changes their mind or whatever. But, basically, what we do is keep the initiative for the marketing and for the product development out in our operating units. We are not a centralized command and control kind of company where those decisions are made at corporate. We look at them in the context of the operating units, finances, and also on a consolidated basis to make sure we can cover the expense of course. But, what we do and how we do it, and staffing to make sure we can be effective is really an operating unit responsibility. So, it’s a decentralized decision-making process, if that makes any sense. In our past, there have been times when our spend has been incredibly outsized relative to the resources that we had on hand because the opportunities that we were seeking were that important, we felt. We had to do it. Today, even though it’s still a big number as a percentage of sales, we feel it’s a manageable and responsible number. And we’ve been floating in that 13%, 14% range. And I would expect as our revenues increase, if anything, it’s going to come down a little bit. So, that’s kind of a long-winded answer as to how we think about it and how we allocate it and how we manage it.

Our next question is from Dick Ryan with Dougherty and Company. Please proceed.

So, Pete, back on Test, delivering you said volumes for the old program and then new program, and it was roughly 50-50. Those are both with the same customer, correct?

We can’t -- our customers get very sensitive about it, any kind of identification. So, we prefer to just think of it as programs.

Okay. How does the backlog -- if the revenues coming out of 50-50, is the backlog 50-50 old and new program make up there as well?

I think it’s -- at the moment, it’s probably weighted more towards the older program, the semiconductor side. But, I don’t have them in front of me, Dick. That’s just kind of out of my head.

Looking at the three challenges you had, certification sales look like they came up nicely. So, I’m moving that under Telefonix. Looks like it’s a good move. CCC, if I recall was kind of more of a demand issue of big jets in certain regions, again higher net worth individuals, but AeroSat, the tail-mount satellite trying to get Panasonic and Satcom Direct. Can you give us an update there? And am I kind of correct in the characterization of the certification business?

Sure. Let me go around the horn. I gave Telefonix some compliments earlier, I’ll repeat them here, right? We basically merged Armstrong with Telefonix, under Telefonix leadership, and that the process is going very well. The combined business is now referred to as Astronics CSC. And the revenues are split between the certification numbers that you quoted and the avionics product line. And we think, there’s a lot of opportunity there. And I think we’re turning the corners. I think, the leadership at Telefonix has been really good at bringing in opportunities. The challenge now for that operation is execution, frankly. It’s having the capacity and the competence to turning on these programs, effectively. And I think they’re doing a good job and they’re making a lot of progress. There’s a ways to go. But, so far so good. So, if we can just extrapolate current trends and assume some kind of execution success, I think that operation is going to be doing just fine. Moving to CCC and your characterization of their business is correct, VVIP. There are two aspects to their improvement. One is executing on a big development job, which has been a nightmare, frankly, from a cost management perspective. It’s costing a lot more than what they anticipated. And we took another $1 million estimate to complete charge in the second quarter. So, we think we’re getting our handle around it. And so, we think long-term going be a very worthwhile program in time that will be I think quite evident. But even beyond that one program, there what we call VVIP, big commercial transports converted to private or aircraft A330s, 777s, 737s, A320s things like that. That market is turning around also from a demand standpoint, in part based on some quieting of the geopolitical…

Our next question is from Doug Thomas with Gabelli and Company. Please proceed.

Just a question for Dave. I didn’t -- will you for a moment talk about the share repurchase where you -- if you executed on any buyback this quarter? And what’s your -- given the discussion about cash flows, what’s your thoughts are about share repurchases over the next, whatever, couple of quarters, next year?

Well, nothing has changed in our philosophy on capital deployment. The kind of the ranking of what we will do with our free cash flow, the share repurchase tends to be at the bottom of the pecking order there. We continue to be interested in acquisitions and reinvesting in the business. We have historically utilized the share repurchase plan opportunistically when we feel the share price is ridiculously undervalued. We have a $50 million authorization available to us and we will disclose in our Q filed next week if we had any activity under that. So, I would suggest that as my comments -- our view is that it’s a tool we can use when we need to, but the focus is on growing the Company.

And then, Pete, the discussion about where we are in the cycle and obviously it’s a fairly strong environment with lots of potential new orders out there. One thing -- I am assuming that you could take a lot of business to make the top line look better, albeit obviously at lower margins. And you don’t talk much about the business that choose either not to take or not to competitively bid for or that -- you’re flat out, not interested in. But I was kind of hoping you would maybe chat for a minute about in terms of the bidding process at this point in time. You talked about price pressure across certain areas. What is you’re -- the discipline that you guys employ when it comes to bidding for work, particularly in an environment like this where demand appears to be growing?

Well, I just -- I don’t get this question very often, Doug. Let me think about it for a second. But, my initial reaction is that we tend to view ourselves as a technical, innovation leader. And our interest is to be leading kind of new markets. And when you do that, you tend to have some -- little bit of pricing flexibility. And we tend to be very close to our customers. We tend to provide value that we think is self-evident. And they, for the most part, we feel generally appreciate it and agree. There are situations where we end up having to negotiate maybe a little bit lower than we’d like to especially on older programs that are little bit more mature or things that start small and grow really big. A lot of times, the price you can get for a new product and low volumes is a little bit different than the pricing you get, once proven itself and everybody wants to buy it. And to some extent, we even leave that charge because we want to protect our markets and not invite in competitors who want to copy us. So, it’s a little bit of a process like that. But, I would tell you that we are by no means kind of a bottom feeder kind of company where we’re looking for volume at the expense of margin in general. That’s not the way we kind of go about our business.

We have reached the end of the question-and-answer session. I would like to turn the call back over to management for closing remarks.

Well, we liked this call better than the last call. And we’re hoping that the third quarter is even better yet. So, thanks for your interest. We will talk to you soon.

This concludes today’s conference. You may disconnect your lines at this time. And thank you for your participation.