Tough Questions For Astronics Management

First – as a matter of record, I have zero financial interest in Astronics. I am simply an interested industry observer, a past employee (left 5 years ago) of a company that was subsequently acquired by Astronics, and independent businessman. Since the company I own is also in Redmond, WA, I have a perspective to be able to integrate together many different public data sources and maybe analyze some of Astronics’ operations a little better than a typical analyst.

The recent rise of questionable accounting techniques seems to have found a home in the IFE industry; the result for this company is almost 20% of its market capitalization or $30 million wiped out. News from Astronics Corp with its announced delay in filing required SEC documents, subsequent restatement of financial results covering 2 fiscal years and it’s profit decline on a 43% sales surge offers us an unusual window into the finances of an industry supplier. Most suppliers within the IFE industry are either very small privately held firms or operating units of much larger companies which don’t segment their financial reporting to a fine enough level. In the case of Astronics, a little analysis of their reports can yield some pretty interesting data.

Apparently, their problems began during 2005 when some executives got a little too aggressive with taking sales credit for hardware deliveries that never left the factory. Astronics announced the same type of accounting transactions were reported throughout 2006 and only raised the eyebrows of its auditors in the last month. Interestingly enough, these anomalies occurred within the portion of the company that produces and sells EmPower In-Seat Power Systems and was attributed to an arrangement with a single airline.

Astronics announced today that sales totaling $2.3 million and net income of $0.9 million have moved amongst various quarters in their restated financial reports. Presuming that their other expenses remained unchanged, this implies these sales had a gross margin of 39%. On its face, a gross margin of 39% might not seem too interesting, but look at their overall reported gross margin over the same time periods of ~19%; EmPower appears to be paying all the bills (note to airlines: Did you leave too much money on the negotiating table?).

So why is Astronics able to sell EmPower at a 20% premium? Is it the result of their 1995 patent? Maybe it is time for the industry to start thinking about life after this patent protection expires in another 8 years. With the replacements for the 737 and A320 now in the thinking stages, it might be time for other industry suppliers to propose lighter, better, more cost effective solutions.

I think there are some tough questions that need to be asked of Astronics’ management; here are a few:

With a 49% sales increase, gross margin was only up 1 point? What happened to economies of scale, operating leverage, etc.?

A ~30% increase in SG&A costs seems excessive. Is this a case of management giving itself rewards for performance during 2005/2006 that has now subsequently been restated?

Given that the Advanced Electronics Systems’ management was responsible for putting the series of events into motion that wiped out $30 million of market capitalization in 3 weeks – how have they been held responsible?

Sure, their sales growth looks great, but look a little deeper, their book:bill ratio has dropped over the past year. Over the past 12 months, they have barely maintained their backlog. Given the data they have made public regarding their planned 2007 sales, they will need to increase new orders by 40% just to stand still.
a. Now, take a look at their product pipeline: http://www.astronics.com/news/pipeline.php and notice many of the past announced programs are either disappearing or sliding to the right. Three major examples A380 – sliding to the right and losing sales, Eclipse – sliding to the right, V-22, JSF. Aviation programs are notoriously risky.

Astronics announced they are virtually doubling their facilities and a quick check of Internet job posting sites uncovered many ads to fill those new offices with expensive engineering and management bodies.

a: Given typical productivity increases of 3-5% annually, a few percentage points of synergy from the acquisition, and 5% price inflation they should be able to easily accommodate 10-12% sales growth annually without any net increases in facilities/personnel. Instead, the facilities are doubling, personnel being added and capital expended which will soak up the equivalent of all their 2006 operating income.

b: Successful businesses find ways to stretch in times of growth through overtime and outsourcing to avoid over-capacity; this is especially true of highly cyclical industries such as aerospace.

c: Does the Redmond facility still take Friday afternoons off?

Where is the strategy to harness the power of the Internet with on-line spares ordering, document delivery, and service bulletins? Companies like Rockwell Collins and Boeing have been making these investments for years and are reaping productivity gains and increases in customer satisfaction.

Where is the China out-sourcing strategy? Airbus will be assembling A320s in China, Boeing has outsourced 747 freighter conversions to both China and Taiwan. Maybe there is a strategy to outsource production to China and skinny down the facility growth in the US.

These are just some of the questions begging to be answered.