ATRO - NASDAQ

Greetings, and welcome to the Astronics Corporation Third Quarter Fiscal Year 2025 Financial Results. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce Craig Mychajluk. Thank you. You may begin.

Yes. Thank you, and good afternoon, everyone. We appreciate your time today and your interest in Astronics. Joining me here are Pete Gundermann, our Chairman, President and CEO; and Nancy Hedges, our Chief Financial Officer. Our third quarter results crossed the wires after the market closed today, and you can find that release on our website at astronics.com. As you are aware, we may make 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 those documents on our website or at sec.gov. During today's call, we'll also discuss some non-GAAP measures, which we believe 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 table that accompany today's release. So with that, I'll turn it over to Pete to begin.

Thanks, Craig. Hello, everybody, and welcome to our third quarter call. We feel it was a very positive quarter, and we are pleased to share the results. As is our practice, I'll start off with a summary of the headlines for the quarter, then Nancy will go through the financial fine points, then we will discuss expectations for the future for both the fourth quarter and also we'll take an early look at 2026. Finally, we'll open up the lines for questions. The first headline for the quarter is that we had solid volume with revenue of $211.4 million. This is our second highest quarterly level ever and just marginally below our record. That sales level is a tick up from the first couple of quarters of 2025 and is the result of broad-based demand across our product lines, markets and customers as well as improved performance in our supply chain and better efficiencies in our production system. Our Aerospace segment led the way with sales of $192.7 million, a level consistent with recent periods. Our Test business had sales of $18.7 million, which is down from the third quarter of 2024, but higher than the earlier 2 quarters of this year. The second headline has to do with margins. As one would expect, higher revenue together with efficiency improvements have led to higher margins. Operating margin of 10.9% in the quarter was higher than last year's 4.1%. Adjusted operating margin, taking into account expenses related to restructuring, litigation and acquisitions was 12.3% for the quarter. Our Aerospace segment specifically had operating margin of 16.2%, generating all of our operating income for the quarter. Test operating margin was essentially breakeven at negative 0.1% while no one is happy with 0% operating margin, this actually represents progress and is a testament to the cost reduction initiatives we have put in place in recent periods. To break even on a modest revenue level of $19 million in the quarter promises good things in the future since we expect test sales to increase. Adjusted EBITDA was at 15.5% of sales, our highest since the pandemic struck in 2020. Our third headline has to do with bookings. Even though third quarter shipments were on the strong side, bookings kept right up. Total bookings of $210 million yielded a book-to-bill of 1.0. We ended the quarter with backlog of $647 million, a very high level by historical norms, which sets us up well for the coming periods. Our fourth headline has to do with acquisitions. We have made a couple of smaller acquisitions recently, one early in the third quarter and one just recently early in the fourth. The first one was Envoy Aerospace, which we previously discussed in our second quarter call in August. Envoy Aerospace is an ODA, which stands for Organizational Designation Authority. ODA is a program in which the FAA grants certification approval authority to outside organizations by which the FAA extends its capacity and reach. We believe having an ODA is a competitive differentiator as we are often involved in aircraft retrofit programs and FAA certification is becoming a more important capability in the eyes of our customers. Having certification authority lessens program and schedule risk, both for us and for our customers. Envoy has external sales of about $4 million annually. Prior to the acquisition, we were consistently one of their largest customers. The second acquisition is that of Bühler Motor Aviation or BMA. Located in Southern Germany, BMA is an established manufacturer of aircraft Seat Actuation Systems with a broad product portfolio that includes actuators, control electronics, pneumatics and lighting. BMA competed with our PGA operation in France in the seat actuation market, and now they will work cooperatively with each other to better serve the needs and opportunities of that market. We expect BMA to have sales of $20 million to $25 million in 2026, and we paid less than onetime sales for the acquisition. Much of the costs related to the acquisition, legal and diligence and the like were included in our third quarter expenses. The acquisition's operating contributions will be captured in the fourth quarter and onward. Finally, our last headline, we completed a couple of important refinancing actions in recent weeks, one in the third quarter and one just after its close. These financings lowered our cost of debt, improved our financial flexibility and importantly, reduced future dilution potential. Nancy will cover the accounting treatment, which is a little bit complex, but basically, in the third quarter, we issued a new $225 million 0% convertible bond to buy back a majority of an earlier convertible bond that was significantly in the money, meaning it was already fairly expensive to settle. And if our stock continued to rise as we expect it to do, it would get even more expensive. Using proceeds of the new convert plus some borrowings under our existing revolver and available cash, we successfully repurchased 80% of the previous 5.5% convertible note, effectively lowering our cost of debt while also eliminating 5.8 million shares of potential dilution. As part of the transaction, we also bought a capped call on the new 0% notes that effectively raises the equity conversion price to $83, meaning that there will be no dilution on the new bond unless and until the market price of our stock exceeds $83. So this transaction significantly reduced the potential dilution we would otherwise be facing. The earlier convert had a face value of $165 million. Since we bought in 80% of it, there is now 20% still outstanding or $33 million. We can pay the smaller bond off when it comes due in about 4 years in either cash or stock. We intend to use cash. But even if we use stock, the dilution will be a maximum of 1.4 million shares or about 4% based on our existing share count. This is a significant reduction in the potential dilution risk that existed before the buyback. We also benefit in terms of interest, obviously. The new bond has a 0% coupon, while the older bond is at 5.5%. So we replaced some more expensive debt with much cheaper debt. Our second refinancing step completed just a couple of weeks ago was a transition from the ABL facility we had in place to a cash flow revolver. The size of the ABL was $220 million and the cash flow revolver is sized at $300 million. The interest expense is comparable, but the new facility offers less administrative burden and increased financial liquidity for the future. The financial implications of the new convertible bond and the repurchase of the majority of the previous bond is fully reflected in our third quarter financials. The ABL to RCF transition will be reflected in our fourth quarter financials. Now I'll turn it over to Nancy.

Thanks Pete. I'll review profitability and various accounting and other events related to our Q3 2025 financials. We had gross profit of $64.5 million, up nearly 17% compared with the prior year period as the benefits of higher volume, pricing actions and productivity improvements helped to offset the $4 million impact of tariffs in the quarter. Last year's third quarter also had a $3.5 million impact from an atypical warranty reserve. Gross margin of 30.5% reflects the 31.4% gross margin realized by the Aerospace business, which was muted somewhat by the Test segment gross profit of 21.6%. R&D expense declined $2.3 million to $10.2 million or 4.8% of sales based on the timing of projects. We believe we're at a more normalized run rate currently at about 5% of sales. Of course, this can vary based on the timing and opportunity of new projects. The $3.1 million decline in SG&A expense was primarily the result of a $4.3 million decline in litigation expense. While it's been quite a while since we can claim any form of normalcy, historically, we've operated the business with SG&A at about 14% to 15% of sales. Operating income was up over 2.5x to $23 million. We recorded a loss on debt settlement of $32.6 million. I'll cover the details of the accounting treatment for the new 0% convertible bond in the cap call here in a bit. We had a $1.2 million tax benefit as we reversed the valuation allowance for R&D expenses that can now be deducted in the current year for tax purposes as a result of recent tax reform. Notably, we generated $34 million of cash in the quarter and had free cash flow of $21 million, driven by strong cash earnings combined with lower working capital requirements. I should point out that $3 million of the cash from operations was from a tenant improvement allowance reimbursement. This is offset by the CapEx investments in the build-out and consolidation for our new Redmond, Washington facility. We expect an additional approximately $5 million in reimbursement for the project in the fourth quarter. This project is what's driving our fourth quarter CapEx to be around $20 million to $30. Year-to-date, we've generated $47 million in cash from operations and have had $20 million in capital expenditures for free cash flow of $27 million. We would expect to be free cash flow positive for the year. Our fourth quarter cash flows will reflect the purchase of BMA, both in terms of the purchase price and the operating activity from the acquisition date forward. Turning to our balance sheet and refinancing actions. Let me talk a bit about the convoluted accounting treatment for the new 0% convertible notes that Pete discussed. First, I'll point the impact to the income statement. We recognized a noncash loss on the settlement of debt of $32.6 million, which represents the inducement charge for bondholders to redeem the $132 million in principal of the 5.5% convertible notes. Second, let me talk to the source and use of funds related to the new convertible note as well as the implications to the balance sheet. Proceeds from the new convertible bond were $217 million after payment of $8 million in fees and expenses. That $217 million, coupled with an $85 million draw on our ABL revolver plus $11 million in cash on hand were used to repurchase 80% of the old convertible note for approximately $286 million and to purchase the capped call for $27 million. Debt increased about $175 million from the end of the second quarter to $334 million. That's a function of 3 factors. First, we incurred new debt of that $217 million related to the new convertible bond, which is the $225 million netted down by $8 million in issuance fees and expenses, which are required under GAAP to be presented as an offset to the debt on the face of the balance sheet. Second, as I mentioned, we borrowed $85 million on our ABL to fund part of the repurchase transaction. And third, debt was reduced by $128 million, representing the $132 million in principal paid off on the previous convertible, net of $4 million in associated issuance fees that also needed to be written off. Shareholders' equity declined as a result of the transaction. The premium paid of $121 million plus the cost of the capped call of $27 million, plus $4 million write-off of the unamortized debt issuance costs related to the repurchased 5.5% notes resulted in a $152 million reduction in shareholders' equity. The net result is, as Pete discussed, lower cost debt, significantly reduced potential dilution and combined with the refinancing of our revolver to being cash flow based, meaningfully greater financial flexibility. I should point out that we currently have $95 million outstanding on the $300 million cash flow revolver and liquidity of $169 million. And let me hand it back to Pete.

Thank you, Nancy. I'll now turn the discussion to the future and what we expect for both the fourth quarter and our initial expectations for 2026. We expect the fourth quarter to be a step change for the company. We have generated average revenue of $207 million over the first 3 quarters of 2025. In the fourth quarter, however, we are expecting revenue to climb to a range of $225 million to $235 million, which is a significant step-up. The increase is due in part to our recent German acquisition, but mostly to the various market forces that are driving our business. The higher volume should mean good things for our income statement as we typically see 40% to 50% marginal contribution on incremental revenue dollars. Further, we think the higher volume expected in the fourth quarter will provide a baseline for 2026. We are not ready yet to issue formal revenue guidance for next year, but we are well along in our budgeting process, and it appears 2026 will be a year of solid growth. Our belief at this point is that we will see 10% growth or better. We are working to refine the range and expect to release initial revenue guidance closer to year-end 2025. You may ask what is driving the growth? Our company has been and continues to benefit from a wide range of industry trends. I'll cover the major ones briefly, and I'll try to be concise. First and most obviously, increasing OEM build rates are a big positive for us. Narrow-body and wide-body production rates are trending up at both Airbus and Boeing and to a lesser extent, across private aviation OEMs also. Our typical content for major aircraft programs is spelled out on our investor presentation, which is available on our website. And quite simply, when OEMs make more planes, we ship more product. Second, we are heavily involved, as you all surely know, in passenger connectivity and entertainment in aircraft, and it is a well-established secular trend in our world today that people want to be connected and entertained at all times, including when they are riding in airplanes. This reality, combined with the fact that the consumer electronics industry is characterized by high levels of innovation and short life cycles, means that adoption rates on new aircraft are increasing and retrofit and upgrade opportunities across the existing fleet are regularly present. We work with more than 200 airlines around the world, along with the broad set of in-flight entertainment and connectivity providers to help ensure that the expectations of airline passengers around the world are met. These expectations are high and getting higher, which provides an excellent field of opportunity for us. Third, we are specialists in developing technically advanced flight critical electrical power distribution systems for smaller aircraft in particular. And our electrical power franchise is gaining acceptance on a wide range of new and innovative aircraft types that are in development today. We started with business jets and turboprops, but today, we are also involved with a wide range of emerging types, including eVTOLs, electric vertical takeoff and landing aircraft, unmanned drones and smaller military aircraft, both rotary and fixed wing. A high-profile example, which is getting lots of attention these days is Bell's V-280 aircraft, now known as the MV-75, which is the U.S. Army's replacement for the Sikorsky Black Hawk. This program is in development currently, and Bell has chosen Astronics to supply the electrical power distribution system. There's a lot I could say about this program, but suffice it now to say it has the potential one day soon to be a very significant aircraft production program for our company and to run for a very long time. Finally, there are some other important new programs, which we expect to come online in short order, particularly for our Test business. One of the most significant is the radio test program that we've talked about before on this call for the U.S. Army called 4549/T. We have been in development on this one for some time and expect production turn on at year-end or shortly thereafter. It's a $215 million IDIQ contract to start that will run for the next 4 to 5 years. Our Test business with all the cost reductions that we've implemented is running at breakeven currently. But when the 4549/T program gets layered on top, the financial profile in that segment will be much improved. We believe these industry trends and opportunities have legs. We've been benefiting from some of them for a while, but others will only begin to positively impact our business in coming quarters. Collectively, we feel they provide an excellent opportunity set as we move into 2026 and beyond. So again, the growth from these drivers should have a positive impact on our earnings as we ramp. And as such, we expect to turn in a strong finish to 2025 and believe 2026 will be a very good year for Astronics. That ends our prepared remarks, so we can open up the lines now for questions.

[Operator Instructions] First question comes from Greg Palm with Craig-Hallum.

Congrats on the results, the execution and probably most impressively, the profitability or operating leverage in the quarter. I wanted to maybe first maybe bridge Q3 to Q4 in terms of the expectation, what is built in for Test relative to the revenue that you achieved in Q3?

We expect Test to take a little step up. I don't have that in front of me. I guess it's in the $20 million, $21 million range. They were at $18 million in the third quarter. So that will be a little bit of a step-up, but it will be their strongest revenue quarter for 2025. So it hopefully lays a good foundation as we round the corner to 2026 also.

Okay. So that implies that aerospace should see a bigger step-up even excluding the impact of acquisitions. So I guess it begs the question, what are you seeing there, whether it's increased build rates, whether it's higher retrofit activity, anything in military with the FLRAA program? Just a little bit more color on maybe the step-up there expected in Q4.

Yes. I'd say a couple of things. First of all, we are expecting a general ramp between where we were in Q3 and where we will be in the first quarter. I'm getting a little bit ahead of myself because we're still in the budgeting process, but the early look at 2026 is that we'll run a sustained rate that's above what we're forecasting for the fourth quarter. So the fourth quarter we will see, to a large extent, a general ramp across the business, but there are a few kind of significant programs that are in play, hence, the wide range of the revenue forecast for the fourth quarter. We're not sure if a lot of them are going to fall in the fourth quarter and therefore, be 2025 revenue or you always run the risk at the end of the year that things can slip into the new year. So it's a little bit of a wider range than we prefer to have at this point. But basically, it's just scheduling of major point in time -- that's not true. The revenue overtime programs for the most part.

It's a mix.

It's a mix.

Yes. Understood. Okay. Well, and then I was going to maybe dovetails into my question on fiscal '26, just in terms of the confidence level at this time to provide not guidance, but expectations of that low double-digit growth. And specifically, what is baked in, in terms of the Army test program at this point? And just given the shutdown, I mean, I wouldn't have expected your visibility levels to be all that good. But what -- it still sounds like you expect that ramp-up to begin sort of end of this year, maybe early next.

Yes. It's a very good question, and we are guessing a little bit, and that's a little bit why we're hedging. But long story short, we were -- when the government shut down, hoping for production turn on towards the end of the year, it might be this year, it might slip into the next year, but basically either late fourth quarter or early first quarter. At this point, we don't have reason to think that, that's going to slide a whole lot. It's probably reasonable to think it's going to slide day per day with the shutdown. And obviously, the longer the shutdown goes on, the more at-risk year-end turn on becomes. But we've had some unofficial contact with program managers and executives who have reiterated that the funding is secure. The user community really wants to have the product get going. And so it's just not obvious at this point if there's going to be a big delay there or not. So we will have to make a decision there as to what we include or what we don't include. But in general, we're still on a track where we think it's going to be a pretty significant contributor over the course of 2026.

And just to be clear, in terms of that full year '26 expectation, there's some, I guess, presumably significant level of contribution that's baked in or not necessarily?

No, there will be, absolutely. It's a -- we expect that program to be an important contributor, both top line and bottom.

Next question, John Tanwanteng with CJS Securities.

This is actually Jeremy on for John. Kind of working off of what we were just talking about, how should we think about the FLRAA program revenue and margin over the medium to longer term as it transitions out of development and into production?

Well, into production is a little bit early to say because we don't know the ramp, and we don't have pricing ready to go on that one. We don't have pricing agreement with the customer, I should say. And also, I don't know if you're aware, but there is an active debate going on in the industry about when production is actually going to start. The Army is interested in trying to accelerate that program, which would mean production -- the production ramp would start a couple of years earlier than it otherwise would. But closer to home and from what we can tell right now, we had revenue of about $28 million in 2025 we're planning. And we're thinking that 2026 will be closer to 38% to 40%, something in that range. From a margin standpoint, it's worth pointing out that we basically have been doing development work at 0 margin thus far because we're still negotiating a development program. Once that program is developed, we will catch up on margin that we would otherwise have recognized earlier. And so it should be a pretty significant contributor as we turn the corner and go through 2026. Would you say anything?

Okay. That's right.

Very helpful. And then switching gears a little. Could you just talk more about the Bühler and the capability it brings to the table and the accretion you're expecting over the next year?

Well, it's a smaller company. We expect revenue of $20 million to $25 million. At that level, we do expect it to be profitable. So I think it's a reasonable assumption that its margin profile will be consistent with the rest of our company. It's going to report through our PGA operations. So you're basically going to take 2 competitors and have them act as one. And there are certain efficiencies that you might expect there. There's market knowledge and reach that can be beneficial. Their products basically do what a lot of our products do. We're talking about seat motion here, high-end aircraft seats, first-class seats, business class seats where you have a lot of moving surfaces, think lie flat and things like that, reclining seats. So the product lines are complementary, but they are not really interchangeable. So their products are sold to seat companies that are designed around their type of system, and our products are designed into seats and seat customers that use our system. But we'll be able to get some efficiencies. We might have some -- the market concentration might yield some pricing efficiencies. Those are things that will play out over the next few years. It's a smaller market. We don't talk a whole lot about it. But combined, we should be somewhere in the $80 million a year range.

[Operator Instructions]Next question comes from Alexandra Mandery with Truist.

This is Alexandra Mandery on for Michael Ciarmoli, Truist Securities. Great results, guys. Can you talk about the integration of these 2 recent acquisitions and any additional capabilities you may look for in the future?

Sure. Well, the integration of BMA or Bühler will be reporting through our PGA operation in France. So that will -- that's already underway, and we intend to maintain both operations. We think moving and consolidating, it's often easier, in my opinion, to calculate savings than it is to actually achieve them. So that is not our objective. Our objective is to work efficiently from a 2 operation setup, both in Germany and in France. We're early on in that. This thing just closed 2 weeks ago, 3 weeks ago. So we've got a long ways to go, but it's a smaller operation, and so we should be able to get our hands around it pretty quickly. We don't think it represents any systemic risk necessarily whatsoever. Envoy, I think of Envoy as a consulting company. It's basically a bunch of engineers who are well versed in FAA rules and regulations. And we have it reporting through our CSC operation, which is where we do most of our connectivity and in-flight entertainment electronics out of Waukegan, Illinois. So Envoy is essentially part of CSC. The exercise that we're going to go through from an integration standpoint is figure out how we can take the Envoy expertise and apply it more broadly across our company to our other operations. And again, the real advantage of Envoy is it gives us the ability basically if we can maintain the ODA, which is our full intent to certify our own development programs, which is where we get into a competitive advantage with other companies because we can more realistically guarantee program and schedule success to our customers when they know that we can self-certify with the blessing of the FAA. That's the whole idea. And we'll report back on that as time goes by, but we do a fair amount of retrofit work. And to the extent that a company does retrofit work, having an ODA just makes it -- it's like reaching the wheels. It just makes everything go a little bit easier.

Okay. Great. And then I just had one follow-up. I might have missed it, but can you add more color on 4Q guide for interest expense, CapEx and depreciation and amortization?

So in terms of interest expense, like Pete said, the interest rate on the ABL is -- and the RCF are very similar. We are going to have a pretty heavy CapEx quarter in the fourth quarter. So a tick up in the debt is not unexpected under the revolver. We're still carrying $33 million of debt on the convertible -- on the 5.5% convertible bond. So that will contribute as well. But then the remainder of the debt, that $225 million is at 0%. And then in terms of depreciation and amortization, that's -- I don't have those numbers, unfortunately, in front of me. I would expect a slight tick up there as well as the -- we're working through the valuation of the 2 acquisitions, but it's fair to assume that some portion of that is going to be allocated to intangibles, and there will be a life assigned to those as well, and those will start to amortize during the quarter as well. I mean I don't anticipate a material change from what our quarterly run rate has been.