Good day, everyone, and welcome to the Astronics Corporation Second Quarter 2024 Financial Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please also note today's event is being recorded. At this time, I'd like to turn the floor over to Debra Pawlowski. Ma'am, please go ahead.

Thanks, Jamie, and good afternoon, everyone. We certainly 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 our second quarter 2024 financial results, which crossed the wires after the market closed today. If you do not have the release, you can find it on our website at astronics.com. As you are aware, we may make some forward-looking statements during the formal discussion and the Q&A session of this conference call. 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. You can find these documents on our website or at sec.gov. During today's call, we will also discuss some non-GAAP 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 with comparable GAAP measures in the tables that accompany today's release. With that, let me turn the call over to Pete to begin. Peter?

Thank you, Debbie, and good afternoon, everybody. Thanks for tuning into our call. We're going to talk about second quarter results obviously, dig into some specifics of the recent refinance efforts, or refinance process that we went through earlier in July, and close the call by talking through our expectations for the remainder of 2024. So, long story short, we feel that the second quarter was a very good quarter for Astronics. Simply put, strong sales, improving margins and very strong bookings. Our Aerospace segment, which is just shy of 90% of our sales year-to-date had a very good quarter. Our Test segment, approximately 10% of our sales had what I would term as a reset quarter. We'll get into the segment results a little bit later, but as I already mentioned, we also, after the quarter close, accomplished a refinance in early July, which we feel is a very important step forward for the financial health of our company. Running through some overall consolidated numbers, again, sales of $198 million exceeded our guidance for the quarter. That's happened a handful of times recently, has become a little bit of a trend. Up 14% year-over-year in the comparator quarter and up 7% sequentially from the first quarter. The sales level marks a return, frankly, to pre-pandemic levels. The sales level was enabled by positive trends that continue to propel us forward. And these are things that we talked about the last few calls. I'm not going to go into them a whole lot of detail, but we continue to see moderating inflation. We continue to see price increases that we have implemented taking hold and beginning to have an effect on our business. And most importantly, our supply chain, which is very much global in nature, continues to improve. Also,…

All right. Thanks, Pete. As Pete discussed, we continued our strong momentum into the second quarter with consolidated sales growth of 14%, with strength across most product lines and notable increases in demand from the commercial transport and defense markets. Consolidated revenue was $198.1 million, and this is the highest we've seen since the fourth quarter of 2019. It's difficult to make comparisons to 2023 as we're still fighting through the pandemic parts shortages and high inflation and hadn't yet reimplemented bonus plans. I think it's more relevant for the most part to compare performance to the first quarter of this year, sequentially. As we frequently point out, there is inherently strong operating leverage in our business. The double-digit growth in sales compared with the second quarter last year translated into a 21% gross margin, which was up 220 basis points compared with last year, while operating margin improved 240 basis points to 3.8%. While these improvements are nice, our sales and profit were actually dampened by about $3.5 million due to an increase of estimated costs to complete that Pete had mentioned on mass transit test contracts. And this has had the effect of lowering sales and related margins by the same amount as the percentage of completion on those contracts was reduced. Also, $1.3 million of restructuring and severance costs, primarily in the Test segment, were recorded in the quarter. Consolidated operating income was $7.6 million and represents 45% operating leverage on the incremental sales over the first quarter of 2024. Adjusting for the estimated cost to complete revisions and the restructuring and severance costs, our consolidated operating profit would have been $12.4 million or about 6%. Still not where we want to be which is up in the double digits, but on the right track. As we've…

Okay. With respect to the remainder of 2024, in our first quarter call we identified three watch items, which we felt would be important for how 2024 was going to shape up and work out. The first one was whether the demand groundswell that we have been seeing for many quarters up to that point would continue. The second one was whether we would get the 4549T contract award in a timely manner. And the third was, what would Boeing rates do with respect to their demand signals for us? The good news for today is that all three of those things seem to be in pretty good shape. We've talked about demand already. $219 million of bookings in the second quarter very well answered that question and we continue to be pretty optimistic about our prospects in the market. So demand continues to be very strong and is a helpful tailwind as we move into the second half of the year. The 4549T radio test contract with the Army came a little later than we'd hoped, but it still got into the second quarter, which is what the plan was. As we started the quarter, we are thinking again that that will provide $10 million to $12 million of revenue over the course of 2024, and it already did $7.2 million of that in the second quarter. It will be a reduced rate in the third quarter and the fourth quarter, but the important thing here is that the sooner we get through that engineering low-rate production portion of the program, the sooner we will get into full rate production. Again, assuming that that's consistent with the Army's expectations. We think it is. Finally, Boeing rates, I'm not going to tell this crowd on our call anything they don't…

[Operator Instructions] Our first question today comes from Jon Tanwanteng from CJS Securities.

Nice job on the bookings and the recovery here. I was wondering if you were still comfortable with the mid-teens EBITDA margin exiting the year. I think you've talked about that several times or maybe just below that. I know you're trying to get higher than that. But is that still in the picture with the way the backlog is and how your supply and prices are improving through the year?

Yes, I think it's going to be close. I think we've got a very healthy backlog, and we've demonstrated the incremental margins that should get us there if our top line does what we think it might do. The other obvious unknown at this point is how our Test business is going to respond to all the changes that happened in the second quarter. We're hoping that it makes big incremental contribution simply by avoiding the big hits. I would say it's going to be a push, but we think we have a good shot at being there. Dave, what would you say?

Yes, I think I would echo that. You make an assumption that we don't have any of these odd things that we had in the second quarter here with adjustments, significant adjustments to the estimated cost to complete that program and severance. I think getting up into the double digits and mid-teen area is an achievable level of adjusted EBITDA.

Got it. And when do you think cash flow will start to catch up to the earnings? It looks like you built some working capital here. I know you're working on inventory trends, obviously, but is there any thoughts on kind of when that actually converges and how much capital you might see this year?

Yes. I won't give you a quantitative answer here, but qualitatively, definitely the second half of the year is going to be a significant improvement in cash flows.

Okay. And then when do you expect Test revenue to ramp as we go through -- as you start executing on this contract? Is that mid next year? Or do we have to wait until '26 before you get out of this program, this low rate initial production?

Yes. I think we're going to have to wait and see on that one, Jon. As best we -- we just won the program a month ago. We had a kickoff meeting with the Army, so we learned a little bit about what their intentions are. And it seems like this original $15 million delivery order will be followed by another similarly sized delivery order of further engineering development work for TPSs, for test program sets that need to be done and some other ancillary engineering requirements. Your question at its core is, when are we going to get into production? And I don't -- we are thinking that that will be at the earliest the middle of next year, but it could be slower than that. It really depends in how long it takes us to get our part done because we have a lot of things to do. But also, the Army has to do their part. We obviously don't control how they allocate resources internally to these kinds of tasks. But we'll know more about that, and I expect that will be a regular part of the conversation in these calls every quarter going forward.

Okay. Last one, if I could sneak one in there. Just any thoughts on what happened to Delta, if that will flow through to you as one of your customers? Does there an impact on the operations have any effect on their spending?

No. Not significantly, no. Their longer-term plans stay in place. We don't -- we can't really comment on what happened to them or why, but we don't see any ramifications directly for us as a result of that whole issue.

Our next question comes from Michael Ciarmoli from Truist.

Pete, I guess just on the -- you've got the line of sight here, you've got the bookings, the backlog. And yes, it certainly sounds like Boeing wants to protect its suppliers. I mean do you have the visibility of what you're shipping direct to Boeing, what you're shipping direct to Airbus? And I guess simultaneously what's going to the two big seating suppliers and carriers? I mean it just seems like there's so many different cross guards out there on these production rates. You did call out some inventory in the channel presumably. But do you have that line of sight from the bookings?

I would say that the bookings are driven mostly by demand for updating -- a big portion of our bookings are driven by demand for updating in-flight entertainment and connectivity equipment. We ship to channels that aren't always correlated with production rates, right? They generally are two airlines ultimately, and they may go to line-fit installation or they may go to retrofit installation. And I think the simplest thing I can say about our booking trends is that it's robust. I mean, there's a lot of demand for both retrofit and I think preparation for increased line-fit rates. We're not thinking that there's a whole lot of inventory being built up there. Obviously, if Boeing can't get their 87 rate up and can't get their 37 rate up, then sooner or later that becomes an issue and things change. But it seems to us that the world is expecting those rates to go up and they're planning accordingly. I think part of it, I think you and I had this discussion also separately, that for better or for worse, the interior parts of the industry like seats and interiors and some of the other ancillary parts, tend to be problematic for aircraft production in terms of the suppliers getting out and being on time and having all the quality that everybody wants. And so it tends to be one of the last places I think that the industry is going to want to slow down or cut back. I think they're looking at this opportunity as a way to maybe get ahead of the curve a little bit and deliver more product and get on time. Of all the things that we worry about or struggle with, I don't think building inventory in the channel is a major concern at this point.

Got it. Got it. And then any -- are you see anything -- any behavioral or demand changes? I know you talked about airline retrofit. It seems like some of the low-cost carriers are having their struggles, and Southwest, maybe that could be a tailwind given they're going to finally move to the 21st Century here. But any noticeable difference between the majors, the discount carriers?

Not really. I mean, Southwest has become a major customer for us this year. We're going to have revenue approaching the $20 million range, something like that. They are kind of catching up. They're one of our biggest certainly North American airlines that hadn't invested heavily in our product. They are doing so now. There are some fleets on some airlines where decisions are getting pushed out because of the inability for the OEMs to deliver the airplanes that the airlines want. I mean that's definitely happening. And we are seeing that in certain situations. But I mean, you step back and you look at our overall booking trends, we put that chart on the back of our press release, and I think it pretty effectively tells a story for a couple of years now. The booking bars are significantly ahead of the shipping bars, and that's ultimately not just building inventory, that's increasing strong demand kind of across the customer base. We're very much enjoying it and like to see it continue.

Got it. Got it. And then just last one for me, just shifting over to Test. The EAC in the quarter on the transit program, I mean, is there any additional risk on that contract? Did the BAC sort of write down the margin on a go-forward basis? Or do you have some residual kind of tail risk on this program? Just trying to understand if this is the front end of EACs or you think this kind of cleans it all up.

It's a very fair question based on our history here with this particular product line. But the way we've developed so far in terms of consolidating effort and shutting down ancillary operations and the fact that we're at the very tail end of the programs that are in question, leads us to believe that we're in pretty good shape. I mean, certainly, we took the reserve that we took or the adjustment that we took with an idea that that's all there's going to be. There might be more going forward at the smaller marginal end, but we don't see that at this point, and we're hoping for something quite a bit different.

Our next question comes from Scott Lewis from Lewis Capital.

Congrats on the nice quarter. I've got kind of a conceptual question about price increases. I know you guys are probably trying to capture the material cost increase you've seen. But I wonder if you're thinking about the increase in cost of capital with a kind of much higher interest rate environment? And maybe also your increased cost of protecting your IP. Do you think you have the ability to kind of capture those in your price increases going forward?

Yes. I think the whole industry has exercised some muscles that had been kind of dormant for many, many years in terms of how to manage inflation. And we certainly have learned or relearned things that we knew a long time ago in terms of protecting ourselves in contracts and also identifying in our business those areas where we can increase prices on certain spares opportunities and one-off buys or retrofit buys or things like that. I think the whole industry is kind of shaking off the cobwebs and has gotten pretty good at that. And I would say we have too. I think we're doing a pretty good job of it. Our material cost is significantly higher than our direct labor cost. But we're protecting ourselves contractually on both sides with inflation indices and things like that that I think will leave us in a much stronger position. I'll also say that I think it's been such, so severe, not so much today but over the last two years, inflation pressures have been so significant, and they're so pervasive and everybody feels it, so that it was not terribly difficult to raise prices. Our customers were surprisingly accommodating because they were going through the same thing also from all suppliers. There was kind of an accepted understanding that you could change price levels and nobody liked it, we didn't like doing it ourselves, but you kind of had to, and everybody knew that. I do think that's kind of changing. I think it's going to be harder in the future to get those kind of price increases than it has been over the last year. I think everything is going to quiet down, but those long-term programs that are multiyear, when those come up for renegotiation, there will be big increases. And I think everybody involved on both sides of those kind of programs are aware of that. This dynamic will continue for two or three years even if the kind of ambient inflation rate drops back to the Fed's goal of 2% to 3%.

And then just my last question, have you seen anything with EV TOL programs either picking up or slowing down? What have you seen there?

Well, we are actively involved with a number of those EV programs on a fee-for-service or kind of an off-the-shelf architecture that we've developed for certain critical technologies. I would say the general nature of the industry is that in-service dates have slipped a little bit, maybe got a little bit more realistic compared to where they were initially. I think we're also entering a phase or have been in a phase for a while here where funding is going to be more challenging, especially for the startups. And I guess our feeling is that the airplanes are going to fly and the FAA and the ASA are going to figure out a certification path. The question is whether the business cases are going to develop in time to make a real industry out of it. And it will be interesting to watch. We are involved, as I said. We're not betting the farm by any stretch. But for people who are interested in that part of the industry, if it develops anywhere near some of the more optimistic scenarios that are out there, we should benefit pretty substantially from it.

[Operator Instructions] Our next question is a follow-up from Jon Tanwanteng from CJS Securities.

Just wondering if you could give an update on litigation and expected expenses as you go through the year and beyond that.

It's been pretty quiet, actually. We have a couple of -- activity will pick up towards the end of the year depending on a couple of decisions that we're expecting, particularly in France and in the U.S. on the Teradyne manner. We pretty strongly won in both those jurisdictions, but the other side appeals and the court has an obligation or a willingness to hear the appeal. And then depending on how that appeal is handled, will influence where we go from there. I think the exciting thing about it from my perspective is that it's the middle of 2024 already and we are thinking that there's a good chance that both of these things are wrapped up before we get to the end of 2025. And that sounds like a long ways off, but when you look at how long these things have been going on, we're pretty excited about that.

Okay. Great. And then just -- I may be getting ahead of myself here, but as your cash flow starts to improve and accumulate, what are your priorities for the cash flow? Obviously, you have to catch up on some CapEx, maybe get up to a level that's more normalized for you. But beyond that, what is the expectation for capital allocation?

I would say the first thing that we would be wanting to do would be to pay down our debt a little bit. Debt load is a little bit higher than we would like it for kind of a normal run rate situation. I mean in the past, we would lever up to these levels or even a little bit higher on the heels of an acquisition, but not having done an acquisition, this is a debt level that we would like to see reduced. And that's a function of what happens to our income statement and our cash flow over the foreseeable future. We do expect that the acquisition world is going to wake up a little bit. It's been pretty slow from our perspective. Certainly, deals are getting done, but there isn't much of a flow that we would be interested in. And I guess I would say that we feel we have such an opportunity ahead of us just to execute on the backlog that we have in place and the opportunities that we've won frankly, including during the pandemic, that our best way to create value is to execute on what we have on our plate in front of us. Acquisitions will be a secondary pursuit when our balance sheet makes us more capable there. Our first priority is simply to execute and take on debt. Dave, I don't know if you'd describe it any differently?

No, I'd say that that's the priority is to execute. And as we move through the next 12 months, rebuild our dry powder and liquidity and kind of be ready for next year.

And ladies and gentlemen, with that and showing no additional questions, ends today's question and answer session as well as today's conference. We do thank you for attending today's presentation and now disconnect your lines.