ASTRONICS CORP - Annual Report: 2010 (Form 10-K)

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-K

 

 

Commission File Number 0-7087

Astronics Corporation

(Exact Name of Registrant as Specified in its Charter)

 

130 Commerce Way, East Aurora, N.Y. 14052
(Address of principal executive office)

 

Registrant’s telephone number, including area code

(716) 805-1599

 

Securities registered pursuant to Section 12(b) of the Act:

None

 

Securities registered pursuant to Section 12 (g) of the Act:
$.01 par value Common Stock; $.01 par value Class B Stock
(Title of Class)

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes o     No  þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes o     No þ

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes o     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes o     No þ

 

As of February 18, 2011, 10,988,576 shares were outstanding, consisting of 8,858,709 shares of Common Stock $.01 Par Value and 2,129,867 shares of Class B Stock $.01 Par Value. The aggregate market value, as of the last business day of the Company’s most recently completed second fiscal quarter, of the shares of Common Stock and Class B Stock of Astronics Corporation held by non-affiliates was approximately $150 million (assuming conversion of all of the outstanding Class B Stock into Common Stock and assuming the affiliates of the Registrant to be its directors, executive officers and persons known to the Registrant to beneficially own more than 10% of the outstanding capital stock of the Corporation).

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders to be held May 5, 2011 are incorporated by reference into Part III of this Report.

 

 

Table of Contents

 

ASTRONICS CORPORATION

 

Index to Annual Report

on Form 10-K

 

Year Ended December 31, 2010

 

FORWARD LOOKING STATEMENTS

 

This Annual Report contains certain forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that involves uncertainties and risks. These statements are identified by the use of the “may,” “will,” “should,” “believes,” “expects,” “expected,” “intends,” “plans,” “projects,” “estimates,” “predicts,” “potential,” “outlook,” “forecast,” “anticipates,” “presume” and “assume,” and words of similar import. Readers are cautioned not to place undue reliance on these forward looking statements as various uncertainties and risks could cause actual results to differ materially from those anticipated in these statements. These uncertainties and risks include the success of the Company with effectively executing its plans; the timeliness of product deliveries by vendors and other vendor performance issues; changes in demand for our products from the U.S. government and other customers; the acceptance by the market of new products developed; our success in cross-selling products to different customers and markets; changes in government contracts; the state of the commercial and business jet aerospace market; the Company’s success at increasing the content on current and new aircraft platforms; the level of aircraft build rates; as well as other general economic conditions and other factors. Certain of these factors, risks and uncertainties are discussed in the sections of this report entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

 

Astronics is a leading supplier of products to the aerospace and defense industries. Our products include advanced, high-performance lighting systems, electrical power generation systems, aircraft safety systems and electrical power distribution systems for the global aerospace industry as well as test, training and simulation systems primarily for the military.

 

We have six primary locations, five in the United States and one in Canada. We provide our products through our wholly owned subsidiaries Astronics Advanced Electronic Systems Corp., Luminescent Systems, Inc., Luminescent Systems Canada, Inc. and DME Corporation. We have two reportable segments, Aerospace and Test Systems.

 

Products and Customers

 

Our Aerospace segment designs and manufactures products for the global aerospace industry. Product lines include Aircraft Lighting, Cabin Electronics, Airframe Power, and Airfield Lighting. Our Aerospace customers are the airframe manufacturers (OEM’s) that build aircraft for the commercial, military and general aviation markets, suppliers to those OEM’s, aircraft operators such as airlines and branches of the U.S. Department of Defense as well as the Federal Aviation Administration and airport operators. During 2010, this segment’s sales were divided 61% to the commercial transport market, 19% to the military aircraft market, 13% to the business jet market and 7% to the FAA/airport market. Most of this segment’s sales are a result of contracts or purchase orders received from customers, placed on a day-to-day basis or for single year procurements rather than long-term multi-year contract commitments. On occasion the Company does receive contractual commitments or blanket purchase orders from our customers covering multiple year deliveries of hardware to our customers.

 

Our Test Systems segment designs, develops, manufactures and maintains communications and weapons test systems and training and simulation devices for military applications. In the Test Systems Segment, Astronics’ products are sold primarily to the U.S. military, foreign militaries and manufacturers of military communication systems. During 2010, this segment’s sales were all to the military markets. This segment’s revenue is a result of long-term, primarily fixed price contracts and is recognized using the percentage of completion method of accounting, measured by multiplying the estimated total contract value by the ratio of actual contract costs incurred to date to the estimated total contract costs. We make significant estimates involving usage of percentage-of-completion accounting to recognize contract revenues. We periodically review contracts in process for estimates-to-completion, and revise estimated gross profit accordingly. While we believe our estimated gross profit on contracts in process is reasonable, unforeseen events and changes in circumstances can take place in a subsequent accounting period that may cause us to revise our estimated gross profit on one or more of our contracts in process. Accordingly, the ultimate gross profit realized upon completion of such contracts can vary significantly from estimated amounts between accounting periods.

 

Sales by Segment, Geographic Region, Major Customer and Canadian Operations are provided in Note 12 of Item 8, Financial Statements and Supplementary Data in this report.

 

We have a significant concentration of business with two major customers, Panasonic Avionics Corporation and to various Department of Defense branches of the U.S. Government. Sales to Panasonic Avionics accounted for 26.5% of sales in 2010, 19.4% of sales in 2009 and 24.9% of sales in 2008. Accounts receivable from this customer at December 31, 2010 and 2009 were $6.5 million and $3.9 million, respectively. Sales to the U.S. Government accounted for 15.0% of sales in 2010, 19.5% of sales in 2009 and 4.0% of sales in 2008. Accounts receivable from this customer at December 31, 2010 and 2009 were $7.0 million and $2.6 million, respectively.

Strategy

 

Our strategy is to develop and maintain positions of technical leadership in our chosen aerospace and defense markets, to leverage those positions to grow the amount of content and volume of product sold to those markets and to selectively acquire businesses with similar technical capabilities that could benefit from our leadership position and strategic direction.

 

Practices as to Maintaining Working Capital

 

Liquidity is discussed in Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, in the Liquidity section of this report.

 

Competitive Conditions

 

We experience considerable competition in the market sectors we serve, principally with respect to product performance and price, from various competitors, many of which are substantially larger and have greater resources. Success in the markets we serve depends upon product innovation, customer support, responsiveness, and cost management. We continue to invest in developing the technologies and engineering support critical to competing in our markets.

 

Government Contracts

 

All U.S. Government contracts, including subcontracts where the U.S. Government is the ultimate customer, may be subject to termination at the election of the government. Our revenue stream relies on military spending, as a significant portion of the Test Systems’ revenue is derived from military applications.

 

Raw Materials

 

Materials, supplies and components are purchased from numerous sources. We believe that the loss of any one source, although potentially disruptive in the short-term, would not materially affect our operations in the long-term.

 

Seasonality

 

Our business is typically not seasonal.

 

Backlog

 

At December 31, 2010, our backlog was approximately $99.8 million. At December 31, 2009, our backlog was approximately $85.4 million. Backlog in the Aerospace segment was approximately $91.6 million and $75.6 million at December 31, 2010 and 2009, respectively. Approximately $78.2 million for the December 31, 2010 backlog is expected to be realized in 2011. Backlog in the Test Systems segment was approximately $8.2 million at December 31, 2010 of which approximately $6.4 million is expected to be realized in 2011.

 

Patents

 

We have a number of patents. While the aggregate protection of these patents is of value, our only material business that is dependent upon the protection afforded by these patents is our cabin power distribution product. Our patents and patent applications relate to electroluminescence, instrument panels, keyboard technology and a broad patent covering the cabin power distribution technology. We regard our expertise and techniques as proprietary and rely upon trade secret laws and contractual arrangements to protect our rights. We have trademark protection in major markets.

Research, Development and Engineering Activities

 

We are engaged in a variety of engineering and design activities as well as basic research and development activities directed to the substantial improvement or new application of our existing technologies. These costs are expensed when incurred and included in cost of sales. Research and development and engineering costs amounted to approximately $28.3 million in 2010, $27.0 million in 2009 and $22.9 million in 2008.

 

Employees

 

We employed 1,010 employees as of December 31, 2010. We consider our relations with our employees to be good. None of our employees are subject to collective bargaining agreements.

 

Stock Distribution

 

On September 16, 2008, we announced a one-for-four distribution of Class B Stock to holders of both Common and Class B Stock. On or about October 17, 2008, stockholders received one share of Class B Stock for every four shares of Common and Class B Stock held on the record date of October 6, 2008. All share quantities, share prices and per share data reported throughout this report have been adjusted to reflect the impact of this distribution.

 

Available information

 

We file our financial information and other materials as electronically required by the SEC with the SEC. These materials can be accessed electronically via the Internet at www.sec.gov. Such materials and other information about the Company are also available through our website at www.astronics.com.

 

 

The amount of debt we have outstanding, as well as any debt we may incur in the future, could have an adverse effect on our operational and financial flexibility. As of December 31, 2010, we had $38.6 million of debt outstanding, of which $33.3 million is long-term debt. Changes to our level of debt subsequent to December 31, 2010 could have significant consequences to our business, including the following:

 

 

We are subject to debt covenant restrictions. Our credit facility contains several financial and other restrictive covenants. A significant decline in our operating income could cause us to violate our maximum leverage ratio, fixed charge ratio or minimum net worth ratio. A covenant violation would require a waiver by the lenders or an alternative financing arrangement be achieved. This could result in our being unable to borrow under our bank credit facility or being obliged to refinance and renegotiate the terms of our bank

indebtedness. Historically both choices have been available to us however in the current credit market environment it is difficult to predict the availability of these options in the future.

 

Our future operating results could be impacted by estimates used to calculate impairment losses on long term assets. The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires Management to make significant and subjective estimates and assumptions that may affect the reported amounts of long term assets in the financial statements. These estimates are integral in the determination of whether a potential impairment loss exists as well as the calculation of that loss. Actual future results could differ from those estimates.

 

A write-off of all or part of our goodwill or other intangible assets could adversely affect our operating results, net worth and cause us to violate covenants in our bank credit facility. At December 31, 2010, goodwill and purchased intangible assets were approximately 5.0% and approximately 3.3% of our total assets respectively. Our goodwill and other intangible assets may increase in the future since our strategy includes growing through acquisitions. We may have to write off all or part of our goodwill or purchased intangible assets if their value becomes impaired. Although this write-off would be a non-cash charge, it could reduce our earnings and net worth significantly. A write-off of goodwill or other intangible assets could also cause us to violate covenants in our bank credit facility that requires a minimum level of net worth. This could result in our inability to borrow under our bank credit facility or obligate us to refinance or renegotiate the terms of our bank indebtedness.

 

The markets we serve are cyclical and sensitive to domestic and foreign economic conditions and events, which may cause our operating results to fluctuate. In our Aerospace segment, demand by the business jet markets for our products is dependent upon several factors, including capital investment, product innovations, economic growth and wealth creation, and technology upgrades. In addition, the commercial airline industry is highly cyclical and sensitive to fuel price increases, labor disputes, global economic conditions, availability of capital to fund new aircraft purchases and upgrades of existing aircraft and passenger demand. A change in any of these factors could result in a reduction in the amount of air travel and the ability of airlines to invest in new aircraft or to upgrade existing aircraft. These factors would reduce orders for new aircraft and would likely reduce airlines spending for cabin upgrades for which we supply products, thus reducing our sales and profits. A reduction in air travel may also result in our commercial airline customers being unable to pay our invoices on a timely basis or not at all.

 

We are a supplier on various new aircraft programs just entering or expected to begin production in the future such as the Boeing 787, F-35 Joint Strike Fighter and Lear 85. As with any new program there is risk as to whether the aircraft or program will be successful and accepted by the market. As is customary for our business we purchase inventory and invest in specific capital equipment to support our production requirements generally based on delivery schedules provided by our customer. If a program or aircraft is not successful we may have to write off all or a part of the inventory, accounts receivable and capital equipment related to the program. A write off of these assets could result in a significant reduction of earnings and cause covenant violations relating to our debt agreements. This could result in our being unable to borrow additional funds under our bank credit facility or being obliged to refinance or renegotiate the terms of our bank indebtedness.

 

In our Test Systems segment, demand for our products is dependent upon several factors, including government funding levels for our products, our ability to compete successfully for those contracts and our ability to develop products to satisfy the demands of our customers. A change in any of these factors could result in a reduction of our sales and profits.

 

Our products are sold in highly competitive markets. Some of our competitors are larger; more diversified corporations and have greater financial, marketing, production and research and development resources. As a result, they may be better able to withstand the effects of periodic economic downturns. Our operations and financial performance will be negatively impacted if our competitors:

 

 

 

We believe that the principal points of competition in our markets are product quality, price, design and engineering capabilities, product development, conformity to customer specifications, quality of support after the sale, timeliness of delivery and effectiveness of the distribution organization. Maintaining and improving our competitive position will require continued investment in manufacturing, engineering, quality standards, marketing, customer service and support and our distribution networks. If we do not maintain sufficient resources to make these investments, or are not successful in maintaining our competitive position, our operations and financial performance will suffer.

 

The loss of Panasonic Avionics Corporation or the U.S. Government as major customers or a significant reduction in sales to either or both of those two customers would reduce our sales and earnings. In 2010 we had a concentration of sales to Panasonic representing approximately 26.5% of our sales and to the U.S. Government representing approximately 15.0% of our sales. The loss of one or both of these customers or a significant reduction in sales to them would significantly reduce our sales and earnings.

 

Our future success depends to a significant degree upon the continued contributions of our management team and technical personnel. The loss of members of our management team could have a material and adverse effect on our business. In addition, competition for qualified technical personnel in our industry is intense, and we believe that our future growth and success will depend on our ability to attract, train and retain such personnel.

 

Future terror attacks, war, or other civil disturbances could negatively impact our business. Continued terror attacks, war or other disturbances could lead to further economic instability and decreases in demand for our products, which could negatively impact our business, financial condition and results of operations. Terrorist attacks world-wide have caused instability from time to time in global financial markets and the aviation industry. The long-term effects of terrorist attacks on us are unknown. These attacks and the U.S. Government’s continued efforts against terrorist organizations may lead to additional armed hostilities or to further acts of terrorism and civil disturbance in the United States or elsewhere, which may further contribute to economic instability.

 

If we are unable to adapt to technological change, demand for our products may be reduced. The technologies related to our products have undergone, and in the future may undergo, significant changes. To succeed in the future, we will need to continue to design, develop, manufacture, assemble, test, market and support new products and enhancements on a timely and cost effective basis. Our competitors may develop technologies and products that are more effective than those we develop or that render our technology and products obsolete or uncompetitive. Furthermore, our products could become unmarketable if new industry standards emerge. We may have to modify our products significantly in the future to remain competitive, and new products we introduce may not be accepted by our customers.

 

Our new product development efforts may not be successful, which would result in a reduction in our sales and earnings. We may experience difficulties that could delay or prevent the successful development of new products or product enhancements, and new products or product enhancements may not be accepted by our customers. In addition, the development expenses we incur may exceed our cost estimates, and new products we develop may not generate sales sufficient to offset our costs. If any of these events occur, our sales and profits could be adversely affected.

 

We depend on government contracts and subcontracts with defense prime contractors and sub contractors that may not be fully funded, may be terminated, or may be awarded to our competitors. The failure to be awarded these contracts or failure to receive funding or the termination of one or more of these contracts could reduce our sales. Sales to the U.S. Government and its prime contractors and subcontractors represent a significant portion of our business. The funding of these programs is generally subject to annual congressional appropriations, and congressional priorities are subject to change. In addition, government expenditures for defense programs may decline or these defense programs may be terminated. A decline in governmental expenditures or the termination of existing contracts may result in a reduction in the

volume of contracts awarded to us. We have resources applied to specific government contracts and if any of those contracts were terminated, we may incur substantial costs redeploying those resources.

 

We make estimates in accounting for long-term contracts, and changes in these estimates may have significant impacts on our earnings. In the Test Systems segment, the Company has long-term contracts with our customers, accounted for using the percentage of completion method of accounting. Revenue representing approximately 8% of 2010 consolidated sales was accounted for using the percentage of completion method of accounting. Under the percentage of completion method, we recognize revenue as work progresses toward completion as determined by the ratio of cumulative costs incurred to date to estimated total contract costs at completion, multiplied by the total estimated contract revenue, less cumulative revenue recognized in prior periods. Changes in estimates affecting sales, costs and profits are recognized in the period in which the change becomes known using the cumulative catch-up method of accounting, resulting in the cumulative effect of changes reflected in the current period. A significant change in an estimate on one or more contracts could have a material effect on our results of operations. For contracts with anticipated losses at completion, we establish a provision for the entire amount of the estimated loss and charge it against income in the period in which the loss becomes known. When they can be reliably estimated and realization is considered probable, the amounts representing performance incentives, penalties, contract claims, warranty costs or change orders are considered in estimating revenues, costs and profits.

 

If our subcontractors or suppliers fail to perform their contractual obligations, our prime contract performance and our ability to obtain future business could be materially and adversely impacted. Many of our contracts involve subcontracts with other companies upon which we rely to perform a portion of the services we must provide to our customers. There is a risk that we may have disputes with our subcontractors, including disputes regarding the quality and timeliness of work performed by the subcontractor or customer concerns about the subcontractor. Failure by our subcontractors to satisfactorily provide on a timely basis the agreed-upon supplies or perform the agreed-upon services may materially and adversely impact our ability to perform our obligations with our customer. Subcontractor performance deficiencies could result in a customer terminating our contract for default. A default termination could expose us to liability and substantially impair our ability to compete for future contracts and orders. In addition, a delay in our ability to obtain components and equipment parts from our suppliers may affect our ability to meet our customers’ needs and may have an adverse effect upon our profitability.

 

Our results of operations are affected by our fixed-price contracts, which could subject us to losses in the event that we have cost overruns. For the year ended December 31, 2010, fixed-price contracts represented almost 100% of the Company’s sales. On fixed-price contracts, we agree to perform the scope of work specified in the contract for a predetermined price. Depending on the fixed price negotiated, these contacts may provide us with an opportunity to achieve higher profits based on the relationship between our costs and the contract’s fixed price. However, we bear the risk that increased or unexpected costs may reduce our profit.

 

Some of our contracts contain late delivery penalties. Failure to deliver in a timely manner due to supplier problems, development schedule slides, manufacturing difficulties, or similar schedule related events could have a material adverse effect on our business.

 

The failure of our products may damage our reputation, necessitate a product recall or result in claims against us that exceed our insurance coverage, thereby requiring us to pay significant damages. Defects in the design and manufacture of our products may necessitate a product recall. We include complex system design and components in our products that could contain errors or defects, particularly when we incorporate new technology into our products. If any of our products are defective, we could be required to redesign or recall those products or pay substantial damages or warranty claims. Such an event could result in significant expenses, disrupt sales and affect our reputation and that of our products. We are also exposed to product liability claims. We carry aircraft and non-aircraft product liability insurance consistent with industry norms. However, this insurance coverage may not be sufficient to fully cover the payment of any potential claim. A product recall or a product liability claim not covered by insurance could have a material adverse effect on our business, financial condition and results of operations.

Our facilities could be damaged by catastrophes which could reduce our production capacity and result in a loss of customers. We conduct our operations in facilities located throughout the United States and Canada. These facilities could be damaged by fire, floods, high winds, earthquakes, power loss, telecommunication and information systems failure or similar events. Although we carry property insurance, including business interruption insurance, our inability to meet customers’ schedules as a result of catastrophe may result in a loss of customers or significant additional costs such as penalty claims under customer contracts.

 

Changes in discount rates and other estimates could affect our future earnings and equity. Pension obligations and the related costs are determined using actual results and actuarial valuations that involve several assumptions. The most critical assumption is the discount rate. Other assumptions include salary increases and retirement age. The discount rate assumptions are based on current market conditions and are outside of our control. Changes in these assumptions could affect our future earnings and equity.

 

We are subject to financing and interest rate exposure risks that could adversely affect our business, liquidity and operating results. Changes in the availability, terms and cost of capital, increases in interest rates or a reduction in credit rating could cause our cost of doing business to increase and place us at a competitive disadvantage. At December 31, 2010, approximately 64% of our debt was at fixed interest rates with the remaining percentage subject to variable interest rates.

 

We are subject to the risk of loss resulting from our customers defaulting on their obligations to us. The inability of our customers to pay us due to adverse economic conditions or their inability to access available credit could have an adverse effect on our financial condition and liquidity.

 

Our international operations pose currency and other risks that may adversely impact sales and earnings. We have manufacturing and sales operations in foreign countries. In addition, our domestic operations have sales to foreign customers. Our financial results may be adversely affected by fluctuations in foreign currencies and by the translation of the financial statements of our foreign subsidiaries from local currencies into U.S. dollars. The translation of our sales and operating costs designated in foreign currencies, which are primarily the Canadian Dollar to the U.S. dollar had an insignificant impact on both sales for 2010 using average exchange rates for 2010 compared to average exchange rates for 2009 and on sales for 2009 using average exchange rates for 2009 compared to average exchange rates for 2008.

 

Our stock price is volatile. For the year ended December 31, 2010, our stock price ranged from a low of $7.42 to a high of $23.05. The price of our common stock has been and likely will continue to be subject to wide fluctuations in response to a number of events and factors, such as:

 

 

In addition, the stock market in general, and the market prices for companies in the aerospace industry in particular, have experienced significant price and volume fluctuations that often have been unrelated to the operating performance of the companies affected by these fluctuations. These broad market fluctuations may adversely affect the market price of our common stock, regardless of our operating performance.

 

Contracting in the defense industry is subject to significant regulation, including rules related to bidding, billing and accounting kickbacks and false claims, and any non-compliance could subject us to fines and penalties or possible debarment. Like all government contractors, we are subject to risks associated with this contracting. These risks include the potential for substantial civil and criminal fines and penalties. These fines and penalties could be imposed for failing to follow procurement integrity and bidding rules, employing improper billing practices or otherwise failing to follow cost accounting standards, receiving or paying kickbacks or filing false claims. We have been, and expect to continue to be, subjected to audits and investigations by government agencies. The failure to comply with the terms of our government contracts

could harm our business reputation. It could also result in suspension or debarment from future government contracts.

 

Government regulations could limit our ability to sell our products outside the United States and otherwise adversely affect our business. Our failure to obtain the requisite licenses, meet registration standards or comply with other government export regulations would hinder our ability to generate revenues from the sale of our products outside the United States. Compliance with these government regulations may also subject us to additional fees and operating costs. The absence of comparable restrictions on competitors in other countries may adversely affect our competitive position. In order to sell our products in European Union countries, we must satisfy certain technical requirements. If we are unable to comply with those requirements with respect to a significant quantity of our products, our sales in Europe would be restricted. Doing business internationally also subjects us to numerous U.S. and foreign laws and regulations, including, without limitation, regulations relating to import-export control, technology transfer restrictions, foreign corrupt practices and anti-boycott provisions. Failure by us or our sales representatives or consultants to comply with these laws and regulations could result in administrative, civil or criminal liabilities and could, in the extreme case, result in suspension or debarment from government contracts or suspension of our export privileges, which would have a material adverse effect on us.

 

If we fail to meet expectations of securities analysts or investors due to fluctuations in our revenue or operating results, our stock price could decline significantly. Our revenue and earnings may fluctuate from quarter to quarter due to a number of factors, including delays or cancellations of programs. It is likely that in some future quarters our operating results may fall below the expectations of securities analysts or investors. In this event, the trading price of our stock could decline significantly.

 

We may incur losses and liabilities as a result of our acquisition strategy. Growth by acquisition involves risks that could adversely affect our financial condition and operating results, including:

 

 

In addition, any acquisition, once successfully integrated, could negatively impact our financial performance if it does not perform as planned, does not increase earnings, or does not prove otherwise to be beneficial to us.

 

We may become involved in the future in legal proceedings that, if adversely adjudicated or settled, could materially impact our financial condition. As an aerospace company, we may become a party to litigation in the ordinary course of our business, including, among others, matters alleging product liability, warranty claims, breach of commercial or government contract or other legal actions. In general, litigation claims can be expensive and time consuming to bring or defend against and could result in settlements or damages that could significantly impact results of operations and financial condition.

 

None

 

 

On December 31, 2010, we occupied 448,000 square feet of space in the United States and Canada, distributed as follows:

 

 

Our corporate headquarters is located in East Aurora, New York. The lease in Montreal expires in December, 2012. The lease for the Redmond facility expires in March, 2013. The lease for the Orlando facility expires in February, 2015 with one renewal option for seven years. The lease for the Ft. Lauderdale facility expires in April, 2016 with one renewal option of five years. Upon the expiration of our current leases, we believe that we will be able to either secure renewal terms or enter into leases for alternative locations at market terms. We believe that our properties have been adequately maintained and are generally in good condition.

 

 

The Company is subject to various legal proceedings, claims, and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, we do not expect these matters will have a material adverse effect on our business, financial position, results of operations, or cash flows. However, the results of these matters cannot be predicted with certainty. Should the Company fail to prevail in any legal matter or should several legal matters be resolved against the Company in the same reporting period, then the financial results of that particular reporting period could be materially adversely affected.

 

On November 11, 2010, AE Liquidation Inc. filed an action in the Bankruptcy Court seeking to recover $1.4 million of alleged preferential payments received by the Company from Eclipse Aviation Corporation. The Company disputes the Trustee’s allegations and believes any loss, as a result of future proceedings is neither probable nor estimable at December 31, 2010, and we intend to defend this claim vigorously.

 

Other than this proceeding, we are not party to any significant pending legal proceedings that management believes will result in material adverse effect on our financial condition or results of operations.

 

 

 

The table below sets forth the range of prices for the Company’s Common Stock, traded on the NASDAQ National Market System, for each quarterly period during the last two years. The approximate number of shareholders of record as of February 18, 2011, was 811 for Common Stock and 785 for Class B Stock.

 

 

 

The Company has not paid any cash dividends in the three-year period ended December 31, 2010. The Company’s ability to pay dividends is limited by Minimum Net Worth and Minimum Fixed Charge Coverage Ratio covenants contained in the Company’s Credit Agreement. The Company has no plans to pay cash dividends as it plans to retain all cash from operations as a source of capital to finance growth in the business.

 

On September 16, 2008, Astronics Corporation announced a one-for-four distribution of Class B Stock to holders of both Common and Class B Stock. On or about October 17, 2008, stockholders received one share of Class B Stock for every four shares of Common and Class B Stock held on the record date of October 6, 2008.

 

With respect to information regarding our securities authorized for issuance under equity incentive plans, the information contained in the section entitled “Equity Compensation Plan Information” of our definitive Proxy Statement for the 2011 Annual Meeting of Shareholders is incorporated herein by reference.

 

We did not repurchase any shares of our common stock in 2010. On January 30, 2009, 500,000 shares of the Company’s common stock held as treasury shares were issued as part of the acquisition of DME.

The following graph charts the annual percentage change in return on the Company’s common stock compared to the S&P 500 Index — Total Return and the NASDAQ US and Foreign Securities:

 

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN
Assumes Initial Investment of $100
December 2010

 

 

 

Five-Year Performance Highlights

 

 

 

 

 

OVERVIEW

 

Astronics Corporation, through its subsidiaries Astronics Advanced Electronic Systems Corp., Luminescent Systems Inc., Luminescent Systems Canada Inc. and DME Corporation designs and manufactures electrical power generation systems, electrical power control and distribution systems, lighting systems and components, aircraft safety products and test, training and simulation systems. With the 2009 acquisition of DME Corporation (“DME”), the Company now operates in two distinct segments, Aerospace and Test Systems. We have six principal facilities located in New York State, Washington State, New Hampshire, two in Florida and one in Quebec, Canada.

On January 30, 2009 we acquired DME, a designer and manufacturer of military test, training and simulation equipment, airfield lighting and aviation safety products. The DME aerospace business is included our aerospace reporting segment and the test training and simulation business comprises our test systems reporting segment. We purchased 100% of the outstanding stock of DME for approximately $50 million. The acquisition was financed primarily with a $40.0 million, five year term note, 500,000 shares of unregistered Astronics common stock previously held as treasury shares, valued at $3.6 million, and seller financing for $5.0 million.

 

Our Aerospace segment serves four primary markets. They are the military, commercial transport, business jet and FAA/airport markets. We serve one primary market in the Test Systems segment, which is the military. In the Aerospace segment, the breakdown of its 2010 segment sales to the commercial transport market, the military market, business jet market and the FAA/airport market were approximately 61.2%, 19.4%, 12.6% and 6.8%, respectively. In the Test systems market, all of the sales were to the military market.

 

Our strategy is to develop and maintain positions of technical leadership in chosen aerospace and test system markets, to leverage those positions to grow the amount of content and volume of product it sells to the markets in those segments and to selectively acquire businesses with similar technical capabilities that could benefit from our leadership position and strategic direction.

 

Key factors affecting our growth and profitability are the rate at which new aircraft are produced, government funding of military programs, our ability to have our products designed into the plans for new aircraft and the rates at which aircraft owners, including commercial airlines, refurbish or install upgrades to their aircraft. Once designed into a new aircraft, the spare parts business is frequently retained by the Company.

 

Sales to the commercial transport market totaled approximately 56.2% of our total revenue in 2010. Our cabin electronics products which provide in-seat power for passengers and power to in-flight entertainment systems (IFE) found on commercial airlines around the world accounted for the majority of our sales to this market. Since 2005 we have seen our sales to the commercial transport markets increase from approximately $31 million to approximately $110 million in 2010. Most of this growth has been driven by increased installations of our cabin electronics products used to power in-flight entertainment systems and in-seat power systems by airlines around the world. Maintaining and growing our sales to the commercial transport market will depend on airlines capital spending budgets for cabin up-grades as well as the purchase of new aircraft such as the Boeing 787 and Airbus A380. This investment by the airlines is impacted by their profits, cash flow and available financing as well as competitive pressures between the airlines to improve the travel experience for their passengers. We expect the new aircraft, once in production will be equipped with more IFE and in-seat power than previous generation aircraft. Additionally, our ability to maintain and grow sales to this market depends on our ability to maintain our technological advantages over our competitors and maintain our relationships with major in-flight entertainment suppliers and global airlines.

 

Products sold to the military market include our aircraft lighting, airframe power and test, training and simulation products. In 2010, military Aerospace related sales represented approximately 17.8% of consolidated sales while Test Systems military sales accounted for approximately 8.3%. The military market is dependent on governmental funding which can change from year to year. Risks are that overall spending may be reduced in the future, specific programs may be eliminated or that we fail to win new business through the competitive bid process. Astronics does not have significant reliance on any one program such that cancellation of a particular program will cause material financial loss. We believe that we will continue to have opportunities similar to past years regarding this market.

 

Products sold to the business jet market include primarily our aircraft lighting and airframe power products, which accounted for 11.5% of our consolidated sales in 2010. Sales to the business jet market are driven primarily by our content on new aircraft and build rates of new aircraft. Business jet OEM build rates continue to be significantly impacted by global wealth creation and corporate profitability which have been negatively affected during the past several years by the global recession. Our sales to the business jet market will continue to be challenged in the upcoming year as business jet aircraft production rates are not expected to increase significantly during 2011 as the global economy continues to struggle. Additionally, there continues

to be a large supply of used aircraft in the market and financing of aircraft has become challenging for many prospective buyers. Despite the current market conditions, we continue to see a wide range of opportunities to employ our technology in the business jet markets, however there is risk involved in the development of any new aircraft.

 

FAA/airport market sales account for 6.2% of our consolidated sales in 2010 and were comprised of sales of airfield lighting products including navigational lighting aids and airfield lighting products, providing design-build lighting solutions to simplify lighting installation projects and provide seamless airfield upgrades for our customers. Future FAA/airport market sales are dependent on funding availability for airport upgrades and successfully competing for those opportunities.

 

Each of the markets that we serve is presenting opportunities for our product lines that we expect will provide growth for the Company over the long-term. We continue to look for opportunities in all of our markets to capitalize on our core competencies to expand our existing business and to grow through strategic acquisitions.

 

Challenges which continue to face us include improving shareholder value through increasing profitability. Increasing profitability is dependent on many things, primarily revenue growth and the Company’s ability to control operating expenses and to identify means of creating improved productivity. Revenue is driven by increased build rates for existing aircraft, market acceptance and economic success of new aircraft, continued government funding of defense programs, the Company’s ability to obtain production contracts for parts we currently supply or have been selected to design and develop for new aircraft platforms and continually identifying and winning new business for our Test Systems segment. Demand for our products is driven by the discretionary spending of aircraft owners and airlines and new aircraft build rates as well as defense spending. Reduced aircraft build rates driven by a weak economy, tight credit markets, reduced air passenger travel and an increasing supply of used aircraft on the market will likely result in reduced demand for our products which will result in lower profits. Reduction of defense spending may result in fewer opportunities for us to compete, which could result in lower profits in the future. Many of our newer development programs are based on new and unproven technology and at the same time we are challenged to develop the technology on a schedule that is consistent with specific programs. We will continue to address these challenges by working to improve operating efficiencies and focusing on executing on the growth opportunities currently in front of us.

 

ACQUISITION

 

We account for acquisitions under ASC Topic 805 “Business Combinations and Reorganizations” (“ASC Topic 805”). ASC Topic 805 provides revised guidance on how the acquirer recognizes and measures the consideration transferred, identifiable assets acquired, liabilities assumed, non-controlling interests, and goodwill acquired in a business combination. ASC Topic 805 also expands required disclosures surrounding the nature and financial effects of business combinations. Acquisition costs are expensed as incurred. Expensed acquisition costs in 2010 were insignificant. Expensed acquisition costs approximated $0.1 million for 2009 and $0.2 million in 2008.

 

On January 30, 2009, the Company acquired 100% of the common stock of DME Corporation (DME) for approximately $50.0 million. DME is a designer and manufacturer of military test training and simulation equipment and aviation safety products. The following summary combines the consolidated results of operations of the Company with those of the acquired business for the years ended December 31, 2009 and 2008 as if the acquisition took place at the beginning of the periods presented. The pro forma consolidated

results include the impact of certain adjustments, including increased interest expense on acquisition debt, amortization of purchased intangible assets and income taxes.

 

 

The pro forma results are not necessarily indicative of what actually would have occurred if the acquisition had been in effect for the entire years ended December 31, 2009 and 2008. In addition, they are not intended to be a projection of future results.

 

CRITICAL ACCOUNTING POLICIES

 

Our financial statements and accompanying notes are prepared in accordance with U.S. generally accepted accounting principles. The preparation of the Company’s financial statements requires management to make estimates, assumptions and judgments that affect the amounts reported. These estimates, assumptions and judgments are affected by management’s application of accounting policies, which are discussed in the Notes to Consolidated Financial Statements, Note 1 of Item 8, Financial Statements and Supplementary Data of this report. The critical accounting policies have been reviewed with the audit committee of our board of directors.

 

Revenue Recognition

 

In our Aerospace segment, revenue is recognized on the accrual basis at the time of shipment of goods and transfer of title. There are no significant contracts allowing for right of return.

 

In our Test Systems segment, revenue is recognized from its long-term, fixed-price contracts using the percentage-of-completion method of accounting, measured by multiplying the estimated total contract value by the ratio of actual contract costs incurred to date to the estimated total contract costs. Substantially all long-term contracts are with U.S. government agencies and contractors thereto. The Company makes significant estimates involving its usage of percentage-of-completion accounting to recognize contract revenues. At least each quarter we review contracts in process for estimates-to-completion, and revise estimated gross profit accordingly. While we believe the estimated gross profit on contracts in process is reasonable, unforeseen events and changes in circumstances can take place in a subsequent accounting period that may cause us to revise our estimated gross profit on one or more of the contracts in process. Accordingly, the ultimate gross profit realized upon completion of such contracts can vary significantly from estimated amounts between accounting periods.

 

Accounts Receivable and Allowance for Doubtful Accounts

 

We record a valuation allowance to account for potentially uncollectible accounts receivable. The allowance is determined based on Management’s knowledge of the business, specific customers, review of receivable aging and a specific identification of accounts where collection is at risk. At December 31, 2010, the allowance for doubtful accounts for accounts receivable was $0.3 million, or 0.9% of gross accounts receivable. At December 31, 2009, the allowance for doubtful accounts for accounts receivable was $0.4 million, or 1.2% of gross accounts receivable.

 

In the fourth quarter of 2008, we wrote off all receivables totaling approximately $1.0 million from Eclipse Aviation Corporation, a customer that declared bankruptcy during the fourth quarter of 2008. The impact amounted to approximately a $0.6 million reduction in net income or $.06 per diluted share in 2008.

Inventory Valuation

 

We record valuation reserves to provide for excess, slow moving or obsolete inventory or to reduce inventory to the lower of cost or market value. In determining the appropriate reserve, Management considers the age of inventory on hand, the overall inventory levels in relation to forecasted demands as well as reserving for specifically identified inventory that we believe is no longer salable. At December 31, 2010, our reserve for inventory valuation was $11.2 million, or 22.4% of gross inventory. At December 31, 2009, our reserve for inventory valuation was $11.6 million, or 26.7% of gross inventory.

 

In the fourth quarter of 2008, we recorded a reserve for inventory on hand used exclusively for the Eclipse 500 aircraft. Eclipse Aviation Corporation, the manufacturer of the aircraft filed for bankruptcy protection, ceased production, terminated its workforce and petitioned the bankruptcy court to liquidate its assets. The pre-tax charge relating to the Eclipse inventory amounted to approximately $7.4 million, reducing net income by approximately $4.8 million or $0.45 per diluted share in 2008.

 

Deferred Tax Asset Valuation Allowances

 

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. We record a valuation allowance to reduce deferred tax assets to the amount of future tax benefit that we believe is more likely than not to be realized. We consider recent earnings projections, allowable tax carryforward periods, tax planning strategies and historical earnings performance to determine the amount of the valuation allowance. Changes in these factors could cause us to adjust our valuation allowance, which would impact our income tax expense when we determine that these factors have changed.

 

As of December 31, 2010 we had net deferred tax assets of $10.4 million, net of a $0.9 million valuation allowance. As of December 31, 2009, we had net deferred tax assets of $11.8 million, net of a $0.7 million valuation allowance. These assets principally relate to goodwill and intangible assets, employee benefit liabilities, asset reserves, depreciation and state and foreign general business tax credit carry-forwards.

 

Impairment of long-lived assets

 

Goodwill Impairment Testing

 

Our goodwill is the result of the excess of purchase price over net assets acquired from acquisitions. As of December 31, 2010, we had approximately $7.6 million of goodwill. As of December 31, 2009, we had approximately $7.5 million of goodwill. The change in goodwill is due to the impact of changes in foreign currency.

 

We test goodwill for impairment at least annually as of November 1, and more frequently whenever events occur or circumstances change that indicates there may be impairment. These events or circumstances could include a significant long-tem adverse change in the business climate, poor indicators of operating performance or a sale or disposition of a significant portion of a reporting unit. The process of evaluating our goodwill for impairment is subjective and requires significant estimates. These estimates include judgments about future cash flows that are dependent on internal forecasts, long-term growth rates and estimates of the weighted average cost of capital used to discount projected cash flows.

 

We test goodwill at the reporting unit level, which is one level below our operating segments. We identify our reporting units by assessing whether the components of our operating segment constitute businesses for which discrete financial information is available and segment management regularly reviews the operating results of those components. We also aggregate components that have similar economic characteristics into single reporting units (for example, similar products and / or services, similar long-term financial results, product processes, classes of customers, etc.). We currently have four reporting units; three within the Aerospace segment and the fourth being in the Test Systems segment. Three of the four reporting units carry goodwill.

The goodwill impairment test consists of comparing the fair value of a reporting unit, determined using discounted cash flows, with its carrying amount including goodwill. If the carrying amount of the reporting unit exceeds the reporting unit’s fair value, the implied fair value of goodwill is compared to the carrying amount of goodwill. An impairment loss would be recognized for the amount by which the carrying amount of goodwill exceeds the implied fair value of goodwill. Testing goodwill for impairment requires us to estimate fair values of reporting units using significant estimates and judgmental factors. The key estimates and factors used in our discounted cash flow valuation include revenue growth rates and profit margins based on internal forecasts, terminal value, and the weighted-average cost of capital used to discount future cash flows. We also consider any additional risk of each individual reporting unit achieving its forecasts, and adjust the weighted-average cost of capital applied when determining each reporting unit’s estimated fair value for these risks. We also compare the computed fair value to our market capitalization.

 

Future changes in these estimates and assumptions could materially affect the results of our goodwill impairment tests. All other reporting units noted fair values well in excess of the carrying value. If the projected long-term revenue growth rates, profit margins, or terminal rates are considerably lower, and/or the estimated weighted-average cost of capital is considerably higher, future testing may indicate further impairment of one or more of the Company’s reporting units and, as a result, the related goodwill would likely be impaired.

 

During fiscal 2010, based on the evaluation, we determined that none of the reporting units’ fair value was less than its carrying value. For the year ended December 31, 2010, the Company did not record an impairment charge related to goodwill. The compound annual growth rate for revenue during the first six years of our projections ranged between 4.7% and 13.4% for the reporting units. The terminal value was calculated assuming projected growth rates of 3.0% after six years. The estimated weighted-average cost of capital for the reporting units ranged from 11.0% to 14.2% based upon an analysis of companies considered to be market participants and their debt to equity mix, their related volatility and the size of their market capitalization. A decline in the terminal growth rate greater than 200 basis points or an increase in the weighted-average cost of capital greater than 150 basis points would have indicated impairment in 2010 for one reporting unit as of the impairment test date whose goodwill was $2.4 million.

 

In 2009, the test systems unit had a carrying amount exceeding the reporting unit’s fair value due to an unexpected decrease in projected future revenues and cash flows, combined with a higher weighted average cost of capital due to market conditions. Therefore, we initiated step two of the goodwill impairment test which involves calculating the implied fair value of goodwill by allocating the fair value of the reporting unit to its assets and liabilities other than goodwill and comparing it to the carrying amount of goodwill. We estimated that the implied fair value of goodwill for this reporting unit was less than its carrying value by approximately $14.2 million which was recorded as an impairment charge during the fourth quarter of 2009. Prior to the impairment charge, this reporting unit had goodwill of $16.6 million. The compound annual growth rate for revenue during the first five years of our projections ranged between 1.0% and 9.0%. The terminal value was calculated assuming projected growth rates of 3.0% after five years. The estimated weighted-average cost of capital for the reporting units ranged from 14.0% to 20.4% based upon an analysis of companies considered to be market participants and their debt to equity mix, their related volatility and the size of their market capitalization. A decline in the terminal growth rate greater than 290 basis points or an increase in the weighted-average cost of capital greater than 180 basis points would have indicated impairment in 2009 for one reporting unit as of the impairment test date whose goodwill was $2.9 million.

 

Indefinite-lived Intangible Asset Impairment Testing

 

We test our indefinite-lived intangible assets, which totaled $1.1 million as of December 31, 2010 and 2009 for impairment, on an annual basis as of November 1 or more frequently, if an event occurs or circumstances change that indicate that the fair value of an indefinite-lived intangible asset could be below its carrying amount. The impairment test consists of comparing the fair value determined using an in-lieu of royalty valuation approach, with its carrying amount. An impairment loss would be recognized for the carrying amount in excess of its fair value.

For the year ended December 31, 2010, the Company did not record an impairment charge on its indefinite-lived intangible assets. For the year ended December 31, 2009, the Company recorded an impairment charge on its indefinite-lived intangible assets amounting to approximately $0.7 million. The impairment loss was incurred in the Test Systems segment and is included in the Impairment Loss on the Consolidated Statement of Operations. There was no impairment loss for indefinite-lived intangible assets recognized in 2008.

 

Amortized and Depreciable Asset Impairment Testing

 

Property, plant and equipment and amortizable intangible assets are depreciated or amortized over their assigned useful lives. We test these long-lived assets for impairment when events or changes in circumstances indicate that the carrying amount of those assets may not be recoverable. The recoverability test consists of comparing the projected undiscounted cash flows, with its carrying amount. An impairment loss would then be recognized for the carrying amount in excess of its fair value. For the year ended December 31, 2010, the Company did not record an impairment charge on its amortized intangible assets. For the year ended December 31, 2009, the Company recorded an impairment charge on its amortized intangible assets amounting to approximately $4.5 million. The impairment loss was incurred in the Test Systems segment and is included in the Impairment Loss on the Consolidated Statement of Operations. There was no impairment charge taken in 2008.

 

Supplemental Retirement Plan

 

We maintain a supplemental retirement plan for certain executives. Expense recognized for the supplemental retirement plan was $0.5 million for 2010, $0.6 million for 2009 and $0.5 million for 2008. The accounting for this plan is based in part on certain assumptions that may be highly uncertain and may have a material impact on the financial statements if different reasonable assumptions had been used. In 2010, the assumptions for increases in compensation, the discount rate for determining the cost recognized and the discount rate used for the projected benefit obligation were 5.0%, 6.0% and 5.5%, respectively. The assumption for compensation increases takes a long-term view of inflation and performance based salary adjustments based on the Company’s approach to executive compensation. For determining the discount rate the Company considers long-term interest rates for high-grade corporate bonds.

 

Stock-Based Compensation

 

We have stock-based compensation plans, which include non-qualified stock options as well as incentive stock options. Expense recognized for stock-based compensation was $0.9 million for the year ended 2010 and $0.8 million in each of the years ended 2009 and 2008. We determine the fair value of the option awards at the date of grant using a Black-Scholes model. Option pricing models require management to make assumptions and to apply judgment to determine the fair value of the award. These assumptions and judgments include estimating the future volatility of our stock price, expected dividend yield, future employee stock option exercise behaviors and future employee turnover rates. Changes in these assumptions can materially affect the fair value estimate.

CONSOLIDATED RESULTS OF OPERATIONS AND OUTLOOK

 

 

 

 

A discussion by segment can be found at “Segment Results of Operations and Outlook” in this MD&A.

 

CONSOLIDATED OVERVIEW OF OPERATIONS

 

While the business environment remained challenging with headwinds coming from continued low business jet build rates, low military sales activity and delays on Boeings 787, 2010 was a very good year for Astronics. Attention to cost control and increased volume from our Aerospace segment generated consolidated net income of $14.9 million and diluted earnings per share of $1.32 that were each the second highest in Astronics history next to 2007.

 

Driven by a $24.0 million increase from our Aerospace segment our consolidated sales for 2010 increased by $4.6 million to $195.8 million compared with 2009. The Aerospace sales increase was partially offset by a $19.4 million decrease from our Test Systems segment.

 

Our consolidated sales for 2009 increased by $17.5 million to $191.2 million compared with 2008. The increase was a result of sales related to the DME acquisition of $51.2 million offset by a $33.7 million decline of organic sales due to volume. Excluding DME sales, our 2009 sales would have been $140 million. The decreased sales of our organic business was a result of reduced demand for our products in the commercial and business jet markets caused by reduced spending by airlines and lower new aircraft build rates partially offset by a slight increase of sales to the military market.

 

Gross margins improved in 2010 to 24.3% compared with 2009 at 19.5%. The improved margins were a result of increased margins in the Aerospace segment due to leverage on increased sales volume, a more efficient cost structure and favorable sales mix.

 

Gross margins improved in 2009 compared with 2008 as a result of the $9.0 million reserve for inventory and equipment relating to the bankrupt Eclipse Aviation Corporation that was recorded in 2008. Excluding that reserve, 2008 gross margin would have been 22.7% compared with 19.5% in 2009. The decrease of the 2009 gross margin from the 2008 gross margin as adjusted for the Eclipse reserve was a result of decreased sales and the related lost gross profit on those sales not being offset by comparable reductions to our manufacturing overhead and engineering costs. Additionally, gross margins of the acquired DME businesses were 18.3%, slightly lower than our 2008 gross margins adjusted for the Eclipse reserve. Gross margins in 2009 for the organic business, excluding DME would have been 19.9%.

 

Selling, general and administrative expenses (“SG&A”) decreased approximately $0.9 million in 2010 compared with 2009 due primarily to a $2.0 million reduction of amortization expense for purchased intangible assets in our Test Systems segment offset by a small increase in other selling expenses. SG&A expenses were $23.2 million or 11.9% of sales in 2010, compared to $24.1 million, or 12.6% of sales in 2009.

 

SG&A increased in 2009 compared with 2008 due to the addition of the SG&A costs of DME. Excluding DME, SG&A costs decreased by approximately $1.0 million or 5.7% from 2008. The decrease was due

primarily to a $1.0 million bad debt expense in 2008 relating to the Eclipse Aviation Corporation accounts receivable charge off. DME SG&A added $7.7 million in 2009.

 

In 2009 we recorded a pre-tax impairment charge of $19.4 million to write down the carrying value of our Test Systems goodwill by $14.2 million, and purchased intangible assets of our Test Systems segment by $5.2 million.

 

Interest expense in 2010 compared to 2009 was flat due primarily to slightly higher effective interest rates being offset by reduced debt levels when compared with the same period last year. The increase in interest expense in 2009 compared to 2008 was due primarily to higher debt levels and an increase in margins paid to our banks on our debt.

 

The effective tax rate (benefit) was 31.5% in 2010 compared with (50.9)% in 2009. The change in the effective rate was due primarily to the impact of the 2009 pre-tax loss, and lower state and foreign taxes. The effective tax (benefit) rate was (50.9)% in 2009 compared with 32.0% in 2008. The change in the effective rate was due primarily to the impact of the 2009 pre-tax loss, the recognition of approximately $0.8 million in research and development tax credits in 2009 and lower state and foreign taxes.

 

2011 Outlook

 

We expect consolidated sales in 2011 to be between $205 million and $215 million. Our consolidated backlog at December 31, 2010 was $99.8 million of which approximately $84.6 million is expected to ship in 2011. We expect our capital equipment spending in 2011 to be in the range of $5 million to $8 million and our engineering and development costs to be approximately $28 million.

 

SEGMENT RESULTS OF OPERATIONS AND OUTLOOK

 

Operating profit, as presented below, is sales less cost of sales and other operating expenses excluding interest expense, corporate expenses and other non-operating revenue and expenses. Cost of sales and operating expenses are directly attributable to the respective segment. Operating profit is reconciled to earnings before income taxes in Note 12 of Item 8, Financial Statements and Supplementary Data, of this report.

 

AEROSPACE

 

 

 

 

 

 

 

Aerospace sales for 2010 increased by $24.0 million, or 15.4%, to $179.6 million from $155.6 million in 2009. Sales growth was primarily driven by increased sales volume of our Cabin Electronics products used by the Commercial Transport market. This volume increase was due to a general improvement of the financial condition of the commercial airlines and their increased installation of in-seat power systems and in-flight entertainment systems that incorporate our Cabin Electronics products. Military sales were down for the year due primarily to lower Airframe Power sales as scheduled deliveries of the Tactical Tomahawk power control unit ceased in 2009 but are planned to begin again in late 2011. Increased sales to the business jet market was a result of increased sales in the Airframe Power product line to business jet manufacturers. Sales to the FAA/Airport market increased primarily due to the completion of two airfield lighting programs during 2010.

 

Sales for 2009 decreased by $18.1 million or 10.4%, to $155.6 million. Excluding $15.6 million of Aerospace sales of the acquired DME business included in our 2009 results, our Aerospace sales for the year would have decreased by $33.7 million to $140.0 million. By market, the decrease excluding DME revenue was the result of lower sales in the commercial transport market of $22.4 million or 21.3% to $82.9 million and decreased sales to the business jet market of $14.5 million or 42.7% to $19.4 million. These declines were offset somewhat by increased sales to the military market of $3.1 million or 9.1% to $37.8 million and the addition of DME sales to the FAA/Airport, commercial transport markets and business jet markets of approximately $8.0 million and $5.3 million and $2.2 million, respectively. The decrease in sales to the Commercial transport market was primarily a result of lower deliveries of our cabin electronics products caused by reduced spending by the global airlines for cabin upgrades and reduced deliveries of our cabin electronics products for new aircraft. The decrease of sales to the business jet market reflects lower new aircraft build rates by the OEM’s. The military sales increase was related to an increase of volume of our lighting products on various platforms.

 

Operating margins for our Aerospace segment increased in 2010 to 16.8% from 10.5% in 2009. Compared with 2009 our operating margins increased due to the leverage provided on the increased sales volume, the effect of cost reductions and favorable product mix as compared with the same periods of 2009.

 

Operating margins for our Aerospace segment increased in 2009 to 10.5% from 9.4% in 2008. Compared with 2008 our operating margins increased due to a $10 million reserve relating to Eclipse Aviation Corporation for inventory, machinery and equipment and accounts receivable for the Eclipse 500 aircraft we recorded in 2008. In 2008, excluding the Eclipse reserve, our Aerospace segment operating margin would have been 15.1%. Our 2009 operating margin decrease as compared with our 2008 operating margin, excluding the Eclipse charge, was due to the lost margins on the sales decrease over the prior year without a corresponding reduction of fixed costs and lower margins on the acquired DME Aerospace business. The acquired DME Aerospace business had operating margins of 3.5% and sales of $15.6 million.

 

It is our intention to continue investing in capabilities and technologies as needed that allows us to execute our strategy to increase the ship set content and value we provide on aircraft in all markets that we serve. The rate of spending on these activities, however, will continue to be driven by market opportunities.

 

The backlog for our Aerospace segment at December 31, 2010 was $91.6 million compared with $75.6 million at December 31, 2009.

2011 Outlook for Aerospace — We expect 2011 Aerospace segment sales to be in the range of $185 million to $192 million.

 

Test Systems

 

 

 

The Test Systems segment was acquired as part of the DME acquisition on January 30, 2009. Sales in 2010 and 2009 for our Test Systems segment were $16.2 million and $35.6 million respectively, all of which were to the military market. The Test Systems segment continues to face headwinds as military spending has slowed and opportunities for large programs continue to move out. With the lack of large programs we have continued to utilize our engineering capacity to develop our next generation family of synthetic radio testers which we believe will provide a firm base line of repeating business for the future.

 

In 2009, the impairment charge of $19.4 million is included in our operating loss of $18.2 million for the year.

 

The backlog for Test Systems was $8.2 million at December 31, 2010 compared with $9.8 million at December 31, 2009.

 

2011 Outlook for Test Systems — We expect 2011 Test Systems sales to be in the range of $20 million to $23 million.

 

Off Balance Sheet Arrangements

 

We do not have material off-balance sheet arrangements that have or are reasonably likely to have a material future effect on our results of operations or financial condition.

 

Contractual Obligations

 

The following table represents contractual obligations as of December 31, 2010:

 

 

 

 

Notes to Contractual Obligations Table

 

Purchase Obligations — Purchase obligations are comprised of the Company’s commitments for goods and services in the normal course of business.

 

Note Payable and Long-Term Debt — See item 8, Financial Statements and Supplementary Data, Note 2, Long-Term Debt and Note Payable in this report.

 

Operating Leases — Operating lease obligations are primarily related to facility leases for our Astronics AES, Astronics DME and our Canadian operations.

 

Interest on Long-Term Debt — Interest on Long-Term Debt consists of fixed payments related to two interest rate swap agreements described more fully under Item 7A — Quantitative and Qualitative Disclosures About Market Risk.

 

We have excluded the variable rate interest on our note payable and other long-term debt due to its variable nature.

 

LIQUIDITY AND CAPITAL RESOURCES

 

 

Our available borrowing capacity and our cash flow from operations provide us with the financial resources needed to run our operations and reinvest in our business.

 

Operating Activities

 

Cash flow provided by operating activities was approximately $16.5 million in 2010 compared with approximately $31.1 million provided by operating activities in 2009. The decrease of $14.6 million was mainly a result of cash used to invest in working capital components in 2010.

 

Cash flow provided by operating activities was approximately $31.1 million in 2009 compared with approximately $11.5 million provided by operating activities in 2008. The increase of $19.6 million was mainly a result of our net loss offset by non-cash income and expenses and decreases in our investment in net working capital components.

 

Our cash flows from operations are primarily dependent on our net income adjusted for non-cash expenses and the timing of collections of receivables, level of inventory and payments to suppliers. Sales are influenced significantly by the build rates of new aircraft, which are subject to general economic conditions, airline passenger travel and spending for government and military programs. Our sales are also impacted by our ability to obtain new orders for our Test Systems segment. Over time, sales will also be impacted by our success in executing our strategy to increase ship set content and obtain production orders for programs currently in the development stage. A significant change in new aircraft build rates could be expected to impact our profits and cash flow. A significant change in government procurement and funding and the overall health of the worldwide airline industry could be expected to impact our profits and cash flow as well.

 

Investing Activities

 

Cash used for investing activities in 2010 was approximately $3.6 million, used primarily for capital expenditures. Cash used for investing activities in 2009 and 2008 were $42.7 million and $4.6 million respectively. The year ended in 2009 included $40.7 million to acquire DME and made capital expenditures of $2.5 million. The year ended in 2008 was due primarily to capital expenditures.

Cash invested for capital equipment for the last three years ranged between $2.5 million and $4.3 million. Our expectation for 2011 is that we will invest between $5.0 million and $8.0 million. Future capital requirements depend on numerous factors, including expansion of existing product lines and introduction of new products. Management believes that our cash flow from operations and current borrowing arrangements will provide for these necessary capital expenditures.

 

Financing Activities

 

Our ability to maintain sufficient liquidity is highly dependent upon achieving expected operating results. Failure to achieve expected operating results could have a material adverse effect on our liquidity, our ability to obtain financing and our operations in the future. Our obligations under our Credit Agreement are jointly and severally guaranteed by Astronics Advanced Electronic Systems Corp., Luminescent Systems, Inc. and DME Corporation, each a wholly-owned domestic subsidiary of the Company. The obligations are secured by a first priority lien on substantially all of the Company’s and the guarantors’ assets and 100% of the issued and outstanding equity interest of each subsidiary.

 

The Credit Agreement provides for a revolving credit line of $35 million for working capital requirements and is committed through January 2012, with interest at LIBOR plus between 2.75% and 4.50%. In addition, the Company is required to pay a commitment fee of between 0.30% and 0.50% on the unused portion of the total credit commitment for the preceding quarter, based on the Company’s leverage ratio under the Credit Agreement. The credit facility allocates up to $20 million of the $35 million revolving credit line for the issuance of letters of credit, including certain existing letters of credit. The credit facility contains various covenants. The covenant for minimum fixed charge coverage, defined as the ratio of the sum of net income, interest expense, provision for taxes based on income, total depreciation expense, total amortization expense, other non-cash items reducing net income minus other non-cash items increasing net income minus capital expenditures, minus cash taxes paid and dividends paid to interest expense plus scheduled principal payments on long-term debt calculated on a rolling four-quarter basis ranges from 1.05 to 1.25 from December 31, 2010 through March 31, 2012, when it becomes fixed at 1.25. The covenant for maximum leverage, defined as the ratio of the sum of net income, interest expense, provision for taxes based on income, total depreciation expense, total amortization expense, other non-cash items reducing net income minus other non-cash items increasing net income to funded debt calculated on a rolling four-quarter basis now ranges from 3.25 to 2.75 from December 31, 2010 through September 30, 2011 when it becomes fixed at 2.75. The covenant for minimum net worth, defined as total stockholder equity shall not be less than $57.0 million increased annually by adding 50% of net income. As of December 31, 2010 the minimum net worth is $64.6 million. The covenant for maximum capital expenditures is $10 million annually. The agreement also restricts the payment of dividends.

 

There was no balance outstanding on our revolving credit facility at December 31, 2010. The credit facility allocates up to $20 million of the revolving credit line for the issuance of letters of credit, including certain existing letters of credit totaling approximately $12.5 million at December 31, 2010. For working capital requirements, the Company had available on its credit facility, $22.5 million at December 31, 2010. At December 31, 2010, we were in compliance with all of the covenants pursuant to the credit facility.

 

The Company’s cash needs for working capital, debt service and capital equipment during 2011 are expected to be met by cash flows from operations and cash balances and if necessary, utilization of the revolving credit facility.

 

DIVIDENDS

 

Management believes that it should retain the capital generated from operating activities for investment in advancing technologies, acquisitions and debt retirement. Accordingly, there are no plans to institute a cash dividend program. Additionally, the Company’s ability to pay dividends is limited by in the Company’s Credit Agreement.

BACKLOG

 

At December 31, 2010, the Company’s backlog was approximately $99.8 million compared with approximately $85.4 million at December 31, 2009.

 

RELATED-PARTY TRANSACTIONS

 

None.

 

RECENT ACCOUNTING PRONOUNCEMENTS

 

See Note 1 of the Consolidated Financial Statements at Item 8 of this report.

 

 

The Company has limited exposure to fluctuation in Canadian currency exchange rates to the U.S. dollar. Nearly all of the Company’s consolidated sales are transacted in U.S. dollars. Net assets held in or measured in Canadian dollars amounted to $5.2 million at December 31, 2010. Annual disbursements transacted in Canadian dollars were approximately $6.5 million in 2010. A 10% change in the value of the U.S. dollar versus the Canadian dollar would impact net income by approximately $0.5 million.

 

Risk due to fluctuation in interest rates is a function of the Company’s floating rate debt obligations, which total approximately $33.5 million at December 31, 2010. To offset this exposure, the Company entered into two interest rate swaps to fix the interest rate on a portion of the underlying debt for a set period of time.

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Board of Directors and Shareholders of Astronics Corporation

 

We have audited the accompanying consolidated balance sheets of Astronics Corporation as of December 31, 2010 and 2009, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2010. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Astronics Corporation at December 31, 2010 and 2009, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2010, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Astronics Corporation’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 3, 2011 expressed an unqualified opinion thereon.

 

 

Buffalo, New York

March 3, 2011

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act. Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2010 based upon the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on that evaluation, our management concluded that our internal control over financial reporting is effective as of December 31, 2010.

 

Ernst & Young LLP, independent registered public accounting firm, has audited our consolidated financial statements included in this Annual Report on Form 10-K and, as part of their audit, has issued their report, included herein, on the effectiveness of our internal control over financial reporting.

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Board of Directors and Shareholders of Astronics Corporation

 

We have audited Astronics Corporation’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Astronics Corporation’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, Astronics Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on the COSO criteria.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Astronics Corporation as of December 31, 2010 and 2009 and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2010 of Astronics Corporation and our report dated March 3, 2011 expressed an unqualified opinion thereon.

 

 

Buffalo, New York

March 3, 2011

ASTRONICS CORPORATION

 

CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

See notes to consolidated financial statements.

ASTRONICS CORPORATION

 

CONSOLIDATED BALANCE SHEETS

 

 

See notes to consolidated financial statements.

ASTRONICS CORPORATION

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

See notes to consolidated financial statements.

ASTRONICS CORPORATION

 

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY